Title of Regulation: 23VAC10-210. Retail Sales and Use Tax (amending 23VAC10-210-910).

Statutory Authority: § 58.1-203 of the Code of Virginia.

Public Hearing Information:

March 25, 2009 - 10 a.m. - 2200 West Broad Street, Multipurpose Room, Rear Entrance, Richmond, VA

Public Comments: Public comments may be submitted until 5 p.m. on April 17, 2009.

Agency Contact: Bland Sutton, Analyst, Department of Taxation, 600 East Main Street, Richmond, VA 23219, telephone (804) 371-2332, FAX (804) 371-2355, or email bland.sutton@tax.virginia.gov.

Basis: Section 58.1-203 of the Code of Virginia provides that the "Tax Commissioner shall have the power to issue regulations relating to the interpretation and enforcement of the laws of this Commonwealth governing taxes administered by the Department." The authority for the current regulatory action is discretionary.

Purpose: As a result of legislation passed by the 1994 General Assembly, the department’s policy with respect to the application of the sales tax to maintenance contracts that contain both parts and labor was overturned. This regulation section must be amended to reflect this legislative change and provide examples of the new policy. TAX receives frequent inquiries as to the proper sales tax application to maintenance contract and warranty plans.

This regulatory action is necessary to ensure a predictable and adequate revenue stream for the government to provide for the health, safety and welfare of its citizens.

Substance: The application of the retail sales and use tax to maintenance contracts that provide both parts and labor was amended by the 1994 General Assembly effective January 1, 1996. This regulation section is being amended to reflect this statutory change and provide examples illustrating the tax application of this change. TAX receives frequent inquiries as to the proper sales tax application to maintenance contract and warranty plans.

The 1994 General Assembly changed the application of the retail sales and use tax with respect to maintenance contracts that include both parts and labor. These contracts are now taxed at one-half of the total charge for the contract, as opposed to the previous policy of taxing the entire amount of the contract if parts were included. As this is the subject of frequent inquiries and audit issues, the regulation section is being amended to reflect this legislative change.

Issues: The primary advantages of this proposed regulatory action are to provide guidance to the public and the Commonwealth as to the sales and use tax application to all types of maintenance contracts and to reflect a 1994 legislative change to maintenance contracts and warranty plans that include both parts and labor. This guidance will ensure compliance with TAX’s policies with regard to maintenance contracts and warranty plans and ensure that these policies are universally applied by TAX’s audit staff.

The regulatory action poses no disadvantages to the public or the Commonwealth.

The Department of Planning and Budget's Economic Impact Analysis:

Summary of the Proposed Amendments to Regulation. The proposed regulations will clarify in the regulations the application of retail and use tax to maintenance contracts.

Result of Analysis. The benefits likely exceed the costs for all proposed changes.

Estimated Economic Impact. The application of retail sales and use tax to maintenance contracts was amended by legislation in 1994¹ to be effective January of 1996. However, the regulations have never been updated to reflect the 1994 legislative change. The proposed regulations will merely amend the regulatory language to clarify that only one-half of the total charge for maintenance contracts that provide labor and materials is subject to sales and use tax. Prior to the 1994 legislative change, the full amount of the charge for maintenance contracts that provide labor and materials was subject to sales and use tax.

Because the proposed changes have been already in effect since 1994 under the statutory language, no significant economic effect is expected. However, updating the current language in the regulations that is in direct conflict with the statute and the current policy enforced in practice is expected to create net benefits in terms of potential costs that could have surfaced from inaccurate regulatory language.

Businesses and Entities Affected. The proposed regulations apply to maintenance contracts that provide labor and materials.

Localities Particularly Affected. The proposed regulations apply throughout the Commonwealth.

Projected Impact on Employment. No significant impact on employment is expected.

Effects on the Use and Value of Private Property. No significant impact on the use and value of private property is expected.

Small Businesses: Costs and Other Effects. No significant costs and other effects on small businesses are expected.

Small Businesses: Alternative Method that Minimizes Adverse Impact. No adverse impact on small businesses is expected.

Real Estate Development Costs. No adverse impact on real estate development costs is expected.

Legal Mandate. The Department of Planning and Budget (DPB) has analyzed the economic impact of this proposed regulation in accordance with § 2.2-4007.04 of the Administrative Process Act and Executive Order Number 36 (06). Section 2.2-4007.04 requires that such economic impact analyses include, but need not be limited to, the projected number of businesses or other entities to whom the regulation would apply, the identity of any localities and types of businesses or other entities particularly affected, the projected number of persons and employment positions to be affected, the projected costs to affected businesses or entities to implement or comply with the regulation, and the impact on the use and value of private property. Further, if the proposed regulation has adverse effect on small businesses, § 2.2-4007.04 requires that such economic impact analyses include (i) an identification and estimate of the number of small businesses subject to the regulation; (ii) the projected reporting, recordkeeping, and other administrative costs required for small businesses to comply with the regulation, including the type of professional skills necessary for preparing required reports and other documents; (iii) a statement of the probable effect of the regulation on affected small businesses; and (iv) a description of any less intrusive or less costly alternative methods of achieving the purpose of the regulation. The analysis presented above represents DPB’s best estimate of these economic impacts.

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¹ Senate Bill 28, Chapter 595, 1994 Acts of Assembly.

Agency's Response to the Department of Planning and Budget's Economic Impact Analysis: The agency agrees with the Department of Planning and Budget's economic impact analysis.

Summary:

The application of the retail sales and use tax to maintenance contracts that provide both parts and labor was amended by the 1994 General Assembly effective January 1, 1996. The proposed amendments reflect this statutory change and provide examples illustrating the tax application of this change.

23VAC10-210-910. Maintenance contracts and warranty plans.

A. Definitions. The following words and terms when used in this section shall have the following meanings unless the context clearly indicates otherwise:

"Maintenance contract" defined. As used in this regulation the term "maintenance contract" means any an agreement whereby a person agrees to maintain or repair an item of tangible personal property over a specified period of time for a fee which that is determined at the time when the agreement is entered into made. A maintenance contract may provide for provision of labor only, parts only, or labor and parts.

B. Maintenance contracts, generally.

1. Labor only contracts. Maintenance contracts which that provide only solely for the furnishing of repair labor are contracts for the provision of a service only services and charges for such contracts are not subject to the tax taxable. This includes software maintenance contracts that provide services, i.e., updates, revisions, replacements and programming, by electronic means such as online downloads or online remote access. Persons providing repair services under such contracts are liable for the tax on all items purchased for use in making repairs used and consumed in the provision of their services.

C. 2. Parts only contracts. Maintenance contracts which that provide only solely for the furnishing or replacement of parts, rather than labor, represent a sale of tangible personal property. The total charge to the customer for such parts only contracts is subject to the tax taxable. Persons providing replacement parts may purchase such parts under a resale certificate of exemption.

Example: Buyer A purchases a maintenance contract from Seller B that provides for repair and replacement parts only. It is stipulated in the contract that all repair labor will be billed separately to the buyer based on an hourly rate. This contract constitutes a parts only contract and is 100% taxable.

D. 3. Parts and labor contracts. Maintenance contracts, the terms of which provide that provide for the furnishing of both repair or replacement parts and repair labor, represent a sale of tangible personal property are a combination of taxable sales and nontaxable services. As it is impossible to determine in advance the percentages of labor and parts that will be provided under the contract, the contract will be deemed to be a contract for one-half labor and one-half parts, regardless of the percentages of labor and parts actually provided under the contract. The Thus, one-half of the total charge for such contracts a contract is subject to the tax since at the time the contract is entered into it is impossible to ascertain what portion of future repair transactions will represent parts and what portion will represent labor. Persons providing maintenance pursuant to such contracts may purchase repair or replacement parts under a resale certificate of exemption, but are liable for the tax on all items purchased for their own personal use and consumption in performing repairs or maintenance.

Example 1: A maintenance contract provides that if Purchaser C's refrigerator breaks down, Seller D will come out and fix it (repair labor) and replace any parts that are defective (replacement parts) for one year. The contract is a parts and labor contract and subject to tax on one-half of the total contract price.

Example 2: Buyer E purchases a maintenance contract for computer hardware and software from Seller F. Under the terms of the contract, Seller F provides 24-hour telephone hotline support, parts replacement for hardware, new releases, updates, revisions, and replacements of licensed software in tangible form, and services to correct programming errors. This maintenance contract constitutes a parts and labor contract and would be subject to the tax based on one-half the total contract price.

Thus the tax will apply to the total charge for such contracts, regardless of the fact that the contract may specify separate charges for parts and labor. Persons providing maintenance pursuant to such contracts may purchase repair or replacement parts under a resale certificate of exemption, but are liable for the tax on all items purchased for use in performing the repairs or maintenance.

E. 4. After hours maintenance charges. Additional Any additional charges for extended or after hours maintenance which that are based upon a percentage of or addition to the standard maintenance contract are taxable in the same manner as the contract upon which the additional charges are based.

Example: A maintenance contract that is part labor and part replacement parts will continue to be taxed at one-half of the total charge whether or not the buyer decides to add additional after hours protection to the contract.

F. 5. Extended warranty plans. The With the exception of extended warranty plans issued by licensed insurance companies, the tax applies to charges for extended warranty plans which that provide for the provision of repair parts and labor. The application of the tax to extended warranty plans is calculated in the same manner as maintenance contracts in this subsection. Extended warranty plans issued by an insurance company regulated by the Bureau of Insurance of the State Corporation Commission are insurance transactions and are not subject to the tax. For repairs generally, see 23VAC10-210-3050.