Bucking a nationwide trend, the Massachusetts Supreme Court has denied a taxpayer's refund claim for sales and use tax paid on overhead items indirectly used in the performance of federal government contracts.¹ The taxpayer, Raytheon Company, had claimed that its purchase of the overhead items fell within Massachusetts' resale exemption.

Raytheon was reimbursed by the federal government for both the direct costs incurred under its federal government contracts and the indirect costs incurred under those contracts. The indirect costs included amounts paid for items such as cellular telephones, toilet paper, trash bags and office furnishings. Under the Federal Acquisition Regulations (FARs), title for these indirect cost items transferred to the federal government. Citing cases in states such as Arizona, Missouri, California, and Texas, Raytheon argued that because the passage of title constituted a "sale," and the sale occurred in the ordinary course of its business of performing its contracts with the federal government, the items were purchased for resale and not subject to tax.

Massachusetts rejected Raytheon's argument, reasoning that while the items were technically resold to the federal government, Raytheon had not purchased the items with the "purpose" of reselling them, and therefore the purchase was still taxable. The court determined Raytheon's "purpose" in purchasing the overhead items by looking to the nature of Raytheon's business, which the court determined to be producing and selling defense systems and not purchasing indirect cost items for purpose of resale to the federal government. Since the indirect costs were merely incidental to its business, Raytheon did not purchase them for the purpose of resale, and the purchases were therefore taxable. In reaching its conclusion, the court refused to follow a recent Texas Court of Appeals decision involving Raytheon, in which the Texas court found that Raytheon's business was performing government contracts, and the overhead items purchased by Raytheon were resold in furtherance of that business.²

The Massachusetts ruling will likely come as a disappointment to federal contractors, but Massachusetts finds itself in the minority on this issue. The court admitted as much when it noted that its ruling was based specifically on Massachusetts case law regarding the resale exemption—case law that differs significantly from case law in other states that had addressed this issue.

Therefore, federal contractors should continue to review their contracts to determine whether under the contract terms, title passes to the federal government for overhead and other goods "indirectly used" in performing any of their contracts. Items "indirectly used" in a business is an extremely expansive concept and could extend to items such as computers, software and office supplies. If so, significant sales and use tax refund opportunities may continue to exist in states other than Massachusetts, including states like Pennsylvania, which have yet to rule on whether overhead items indirectly used in federal government contracts qualify for a resale exemption.

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If you have a question about the Raytheon case, or sales and use tax refund opportunities for federal government contractors in general, please contact one of the authors, or the Reed Smith lawyer with whom you usually work. For additional information on Reed Smith's State Tax Practice, visit www.reedsmith.com/statetax.

1. Raytheon Company v. Commissioner of Revenue, Mass. Supreme Judicial Court, Docket No. SJC-10346 (Nov. 10, 2009).
2. Strayhorn v. Raytheon E-Systems, Inc., 101 S.W.3d 558 (Tex. Ct. App. 2003).