A recent Virginia sales and use tax ruling illustrates how ignoring basic sales and use principles can be costly for businesses. The concept is simple – a sales tax is a consumption tax imposed on the end user of a product. Thus, if your company purchases tangible personal property with the intent of reselling the property (i.e., not consuming it), it generally should not pay sales tax on that purchase. This concept holds true for leases as well. However, a purchaser must notify a seller of this intent by providing a certificate to the seller indicating that the purchased product will be resold. Otherwise, the seller is obligated to collect sales tax.
The failure to apply this foundational sales and use tax concept had a costly result for a Virginia lessee in a recent ruling issued by the Virginia Department of Taxation (Virginia Public Document Ruling No. 13-41, 03/21/2013). The lessee was a hotel operator that leased the furniture, fixtures, and equipment associated with the hotels. The lessor acquired the assets and paid sales tax on the purchase of those assets. Thus, the lessor did not present a resale certificate to the vendor from which the assets were purchased, despite intending to resell (or lease) those assets to a third party. The lessor did not charge the lessee sales tax on the lease payments. The Department assessed the lessee for the unpaid sales tax on the lease payments. The taxpayer contested the assessment by arguing that it did not owe sales tax because the lessor had already paid the sales tax at the time of purchasing the assets.
The Department concluded that the lessor should have purchased the property for resale pursuant to a resale exemption certificate, and should have charged sales tax to the lessee. Unfortunately for the lessee, the Department also found that the lessee’s sales and use tax liability cannot be avoided because of the lessor’s noncompliance with the sales tax collection rules, as the legal incidence of Virginia’s sales tax is on the end purchaser. Finally, the fact that the lessor paid sales tax on the initial purchase had no bearing on the lessee’s lease payments also being subject to tax under the law.
The legal conclusion in this ruling was unfortunately correct, but the lack of an equitable result meant that the Commonwealth earned double the revenue. Moreover, assuming that the lessor built in to the lease payments its cost of paying sales tax on the purchase, the lessee essentially paid sales tax twice. Granted, the lessor can file a refund and, if the lessee is lucky, receive a refund from the lessor. However, this after-the-fact option will entail making uneasy requests to the lessor that can hamper a future business relationship. Taking the additional time to get it right up front will avoid the pain felt by the taxpayer in this ruling and, more importantly, prevent the state from getting double the taxes.