Rulings of the Tax CommissionerJanuary 18, 2003Re: § 58.1-1821 Application: Retail Sales and Use TaxDear *****:This is in response to your letter submitted on behalf of ***** (the "Taxpayer") torequest correction of the retail sales and use tax assessment issued to the Taxpayeras a result of an audit. I apologize for the delay in responding to your letter.FACTSDuring the audit period, the Taxpayer developed and published multi-player onlinegames and distributed game content platforms to Internet service providers and onlineservices. An audit for the period July 1994 through April 2000 resulted in theassessment of tax on computer hardware and software, supporting equipment andaccessories, and maintenance contracts.The Taxpayer contests the entire audit assessment on the grounds that the assessedtangible personal property qualifies for the research and development exemptionpursuant to Va. Code § 58.1-609.3(5). In this regard, you maintain that if any taxableuse was made of the research property, such taxable use was de minimis. In addition,the Taxpayer maintains that most of the contested items are exempt of the taxpursuant to the audiovisual exemption set out in Va. Code § 58.1-609.6(6).DETERMINATIONResearch and developmentVa. Code § 58.1-609.3(5) provides an exemption from the retail sales and use tax for:Tangible personal property purchased for use or consumption directly andexclusively in basic research or research and development in theexperimental or laboratory sense. (Emphasis added.)The mandate for exclusive use notwithstanding, Title 23 of the Virginia AdministrativeCode (VAC) 10-210-3071(C) indicates that if research property is used in some taxablemanner, that research property "will continue to be exempt from the taxif the taxableDocument Number:03-2Tax Type:Retail Sales and Use TaxBrief Description:Research and Development, Online gamesTopics:Appropriateness of Audit Methodology; ExemptionsDate Issued:01/18/2003Page1of5Rulings of the Tax Commissioner--03-29/14/2007mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\VATaxCommissioner03-2.mhtuse is de minimis in nature." The regulation also indicates that taxable use of researchproperty is considered to be de minimis if the taxable use:1. Does not involve a continuous or ongoing operation,2. Does not follow a consistent pattern, i.e., weekly, monthly, quarterly, etc.,3. Is occasional in nature occurring no more than three times, and4. In total, accounts for no more than three days.The de minimis usage applies only if the property meets all four criteria cited above.Furthermore, pursuant to Va. Code § 58.1-205, the burden of proof is upon theTaxpayer to establish that the above de minimis criteria are not exceeded in order forthe research and development exemption to apply to the contested items.You claim that any taxable use of the contested computers was de minimis in nature.In this regard, you maintain the Taxpayer's computer hardware (that to some extentmay have been equipped with e-mail and Internet access capability) was so equippednot to facilitate administrative functions, but to enable developers to carry out their day-to-day research and development activities. You further maintain that it is likely someof the computers in question were never equipped for internal e-mail or Internetaccess.I understand, however, that the Taxpayer books its operating expenditures into anumber of basic areas, including (1) the holding company, (2) the retail subscriptionportal (whereby customers can subscribe to and play the Taxpayer's online games),and (3) the aggregating, publishing and distribution domain (which includes publicationof its own and other developers' games). These activities include administrativefunctions, retail subscription services, and assisting third-party publishers. It appearsvery unlikely that assets used in these three activities would satisfy the direct usemandate of the exemption.The fourth basic area involves software development, and the audit staff agrees thatthis activity would likely include exempt research and development. This is consistentwith 23 VAC 10-210-765(A). This regulation indicates that the research anddevelopment exemption applies to "computer hardware and software used inprogramming and other developmental activities with respect to new computersoftware products ...."To determine direct and exclusive use of tangible personal property with respect to thissoftware development activity, the audit staff requested a tour of the Taxpayer's facility.Such a tour would have allowed the audit staff to determine the use of the contestedequipment, including e-mail applications, (such as inbox, deleted items, specializedfolders, etc.), and Internet access software (reviewing bookmarks, cookies, downloads,and other traceable uses showing content, frequency, and duration of taxable usage).However, the Taxpayer denied the audit staff's request to tour its facility to verify theTaxpayer's claims of direct and exclusive use.You indicate that a physical examination of the contested property would be impossiblePage2of5Rulings of the Tax Commissioner--03-29/14/2007mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\VATaxCommissioner03-2.mhtbecause the Taxpayer replaces its computers every year or two. Consequently, manyof the assessed items, especially from the early part of the audit period, were no longerin use. I certainly do not disagree with your observation. Still, an on site tour wouldhave at least provided a greater understanding of how contested items were used.Now, and as a result of the Taxpayer's reorganization, there appears to be no practicalway to verify any of the Taxpayer's claims that the research and developmentexemption applies to the contested items. I understand that the Taxpayer's softwaredevelopment department was eliminated after the conclusion of the audit and severalmonths prior to the submission of your appeal in this matter. The means to verify theTaxpayer's claim of direct and exclusive use is no longer available.Based on the foregoing, the Taxpayer has not met its burden of proof as requiredunder the law that the contested items qualify for the research and developmentexemption.Audiovisual worksEffective July 1, 1995, Va. Code § 58.1-609.6(6) provides an exemption from the retailsales and use tax for:a. (i) The lease, rental, license, sale, other transfer, or use of any audio orvideo tape, film or other audiovisual work where the transferee or
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