Tax Type
Retail Sales and Use Tax
Description
Co-generation plant, manufacturing electric generating machinery and generating electricity for resale to power companies
Topic
Exemptions
Property Subject to Tax
Date Issued
04-26-2000
April 26, 2000
Re: § 58.1-1821 Application: Retail Sales and Use Tax
This will reply to your letter in which you seek correction of the retail sales and use tax audit assessment issued to **** (the "Taxpayer") for the period of July 1995 through December 1997. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is in the business of manufacturing electric generating machinery and generating electricity for resale to power companies. The Taxpayer also processes by-products, i.e., heat and water, from its co-generation facilities for resale. The Taxpayer was audited as a manufacturer and assessed tax on items the auditor determined were not used directly in the Taxpayer's manufacturing operation. The Taxpayer is taking exception to a number of items held taxable in the audit. I will address each area of contention separately below.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof fuel, power, energy, or supplies, used directly in... manufacturing... products for sale or resale." The term "used directly" is defined in Code of Virginia § 58.1-602 as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing...process, but not including ancillary activities such as general maintenance or administration." (Emphasis added).
Interpreting the above statutes, ' B(2) of Title 23 of the Virginia Administrative Code (VAC) 10-210-920 (copy enclosed) provides;
Items of tangible personal property which are used directly in manufacturing... are machinery, tools and repair parts therefor, fuel, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing... (Emphasis added).
Keeping the above in mind, l will address each disputed area of the audit separately below.
Manufacturing Supplies
This area consists of general purpose tie wraps and cable ties. Based on the information provided in your letter, and the auditor's comments, it appears that these items constitute two separate classes of property. The Taxpayer states that the tie wraps at issue are those used to wrap wire located inside exempt manufacturing machinery that the Taxpayer produces for sale or resale. The auditor maintains that the tie wraps held taxable in the audit are used as supports for production machinery wiring throughout the plant site.
Based on the information provided by the Taxpayer, l will agree to remove from the audit any tie wraps or cable ties that become a component part of production machinery manufactured for sale or resale. On the other hand, tie wraps or cable ties used for wrapping general plant wiring will remain taxable.
Manufacturing Tools
The Taxpayer contests the tax assessed on electrical volt meters used at various stages throughout the production process. According to the Taxpayer, these volt meters are used to determine the wire status, perform measurements, and perform intermediate subsystem tests of production equipment being manufactured.
Title 23 VAC 10-210-920.C(2) provides that equipment used for production line testing and quality control is exempt from taxation. This section goes on to provide that testing to improve administrative efficiency or any other testing not related to quality control is a taxable activity. Based on the information provided in your letter, the volt meters are used to test and check the wiring on manufactured equipment during the production process. If this is the case, and in accordance with P.D. 96-119 (6/4/96), copy enclosed, l will agree to remove the volt meters from the audit.
Engine Cooling System
Co-generation plants are generally highly integrated operations which utilize the by-products of electricity generation as fuel or energy sources which can be resold. A major by-product of a co-generation plant is heat, which may be used as fuel or resold. Heat may be removed from a co-generation plant by two methods, water system or air system, each being interchangeable. The Taxpayer employs both types of heat removal systems. The department has deemed the water-based heat removal system to be an exempt function. The auditor held the air-based heat removal system to be taxable as a ventilation system maintained for the comfort of the employees and for extending the life of the production machinery.
Based on the information provided in your letter and the auditor's comments, it appears that the engine cooling system serves a dual function of heat recovery and plant ventilation. Title 23 VAC 10-210-920.D provides that when machinery and equipment are used in both exempt and taxable activities, the preponderance of use rule applies in determining the tax application. If the equipment is used in a tax-exempt activity fifty percent or more of the time, the equipment is totally exempt. Similarly, if it is used fifty percent or more in a taxable activity, the machinery and equipment are totally taxable.
Based on the above, if the Taxpayer can provide documentation that the preponderance of use of the engine cooling system is for heat recovery and not for plant ventilation, l will agree to remove the system from the audit. However, absent additional documentation, l must hold the system taxable.
Exhaust System Components
The item at issue is a heat recovery muffler. The heat recovery muffler is located at the end of the heat recovery system and used to dispose of waste products, namely exhaust gases which are a by-product of the heat recovery system. As provided above, heat is a by-product of the Taxpayer's electric generating equipment, and the processing of the heat for use as a fuel or for resale is tax exempt function. The Taxpayer takes the position that the heat recovery muffler is directly used in a tax-exempt activity.
Title 23 VAC 10-210-920.C(2) addresses processing activities and provides that production begins with the handling and storage of raw materials at the plant site and continues through the last step of production where finished product is stored at the plant site. Based on the information provided, the heat recovery muffler is utilized to capture and dispose of waste products (i.e., exhaust gases) subsequent to the processing of the heat by way of the heat recovery system. For this reason, l find that the recovery muffler is used indirectly in the actual processing of the heat and is taxable.
Heat Delivery System
Once heat has been recovered through the Heat Recovery System, the product needs to be transferred to the customer. The Taxpayer utilizes piping from the co-generation plant to transfer heat to their customers. This piping is called a "heat loop". In addition, at the end of the heat loop, the Taxpayer has a monitoring and metering station used by the customer to monitor and control the temperature of the heat purchased. It is also used by the Taxpayer for billing purposes. The Taxpayer believes these items are used directly in the heat production process and should be exempt.
Title 23 VAC 10-210-920.C(3) addresses distribution and provides that distribution is the transfer or conveyance of product after the completion of production and is not part of manufacturing or processing. It has been the longstanding policy of the department that the distribution of a finished product is a taxable function. Therefore, l find the piping utilized in the heat loop to be taxable. In addition, the metering equipment utilized by the Taxpayer in its administrative billing function is clearly taxable in accordance with Title 23 VAC 10-210-920.
Crankcase Vent System Parts
The parts held taxable in this area include electronic control cards used in the Programmable Logic Controllers ("PLC's") and piping and tubing used in monitoring gauges on production machinery. The PLC's are industrial computers that directly control the engines that produce electricity. The electronic control cards are used to monitor the internal condition of the production equipment and can direct automatic devices within the equipment to shut down automatically. Unlike the electronic control cards, the piping and tubing used in monitoring gauges on production equipment only notify plant personnel of adjustments that need to be made, and do not automatically adjust production equipment.
Title 23 VAC 10-210-920.C(2) provides that "computer hardware and software used to direct or control production line and/or quality control operations" are exempt. Conversely, "computer hardware and software used merely to monitor production operation, e.g., ... make production information available to plant personnel... are deemed taxable." Based on the reading of this regulation, l find the electronic control cards to be exempt from the tax, as they actually direct the manufacturing equipment. However, the piping and tubing which are attachments to gauges that assist plant personnel are taxable. This position is upheld in P.D. 88-154 (6/23/88), copy enclosed.
Process Water System Items
This contested area consists of storage tanks and structural steel used to modify the tanks. According to the auditor, the tanks are the property of ****** ("FWP"), which is in the business processing waste water that contains fuel. The water and fuel mixture is allowed to separate and is then pumped out and resold as a fuel and as water used as a raw material for manufacturing. The Taxpayer believes the tanks are used for storing raw materials and are exempt from the tax.
According to the auditor, FWP is an affiliate of the Taxpayer and a separate legal entity. The auditor also advised that FWP does not enjoy the industrial manufacturing or processing exemption. Therefore, tanks owned and operated by FWP are subject to the tax.
Lightning Arresters
The Taxpayer believes these items to be a component part of the switchgears and, therefore, used directly in manufacturing. According to the auditor, the function of the lightning arrester is to protect the Taxpayer's power supply from lightning strikes. While the lightning arrester may be necessary to protect the Taxpayer's power supply, it is not an immediate part of the production process and is taxable.
Summary
Based on all of the above, the audit will be returned to the **** District Office for revisions in accordance with this letter. Once the audit revisions have been made, a revised audit report and bill will be mailed to the Taxpayer. If you should have any questions, please contact *****, Office of Tax Policy, at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
TO WHOM IT MAY CONCERN
Under the authority of § 58.1-1 of the Code of Virginia, l hereby delegate to Janie E. Bowen, Assistant Tax Commissioner, the authority to sign for me any and all documents, including, but not limited to, affidavits, warrants, rulings, appeals, offers in compromise and sales tax revocations.
This authority shall not extend to matters or documents related to my service on any statutorily created board or commission, including, but not limited to, the Compensation Board and the Treasury Board.
This authority will continue until revoked. The delegation of authority dated June 3, 1994, is hereby revoked and replaced.
Done at Richmond, Virginia this tenth day of September, 1999.
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
This will reply to your letter in which you seek correction of the retail sales and use tax audit assessment issued to **** (the "Taxpayer") for the period of July 1995 through December 1997. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is in the business of manufacturing electric generating machinery and generating electricity for resale to power companies. The Taxpayer also processes by-products, i.e., heat and water, from its co-generation facilities for resale. The Taxpayer was audited as a manufacturer and assessed tax on items the auditor determined were not used directly in the Taxpayer's manufacturing operation. The Taxpayer is taking exception to a number of items held taxable in the audit. I will address each area of contention separately below.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof fuel, power, energy, or supplies, used directly in... manufacturing... products for sale or resale." The term "used directly" is defined in Code of Virginia § 58.1-602 as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing...process, but not including ancillary activities such as general maintenance or administration." (Emphasis added).
Interpreting the above statutes, ' B(2) of Title 23 of the Virginia Administrative Code (VAC) 10-210-920 (copy enclosed) provides;
Items of tangible personal property which are used directly in manufacturing... are machinery, tools and repair parts therefor, fuel, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing... (Emphasis added).
Keeping the above in mind, l will address each disputed area of the audit separately below.
Manufacturing Supplies
This area consists of general purpose tie wraps and cable ties. Based on the information provided in your letter, and the auditor's comments, it appears that these items constitute two separate classes of property. The Taxpayer states that the tie wraps at issue are those used to wrap wire located inside exempt manufacturing machinery that the Taxpayer produces for sale or resale. The auditor maintains that the tie wraps held taxable in the audit are used as supports for production machinery wiring throughout the plant site.
Based on the information provided by the Taxpayer, l will agree to remove from the audit any tie wraps or cable ties that become a component part of production machinery manufactured for sale or resale. On the other hand, tie wraps or cable ties used for wrapping general plant wiring will remain taxable.
Manufacturing Tools
The Taxpayer contests the tax assessed on electrical volt meters used at various stages throughout the production process. According to the Taxpayer, these volt meters are used to determine the wire status, perform measurements, and perform intermediate subsystem tests of production equipment being manufactured.
Title 23 VAC 10-210-920.C(2) provides that equipment used for production line testing and quality control is exempt from taxation. This section goes on to provide that testing to improve administrative efficiency or any other testing not related to quality control is a taxable activity. Based on the information provided in your letter, the volt meters are used to test and check the wiring on manufactured equipment during the production process. If this is the case, and in accordance with P.D. 96-119 (6/4/96), copy enclosed, l will agree to remove the volt meters from the audit.
Engine Cooling System
Co-generation plants are generally highly integrated operations which utilize the by-products of electricity generation as fuel or energy sources which can be resold. A major by-product of a co-generation plant is heat, which may be used as fuel or resold. Heat may be removed from a co-generation plant by two methods, water system or air system, each being interchangeable. The Taxpayer employs both types of heat removal systems. The department has deemed the water-based heat removal system to be an exempt function. The auditor held the air-based heat removal system to be taxable as a ventilation system maintained for the comfort of the employees and for extending the life of the production machinery.
Based on the information provided in your letter and the auditor's comments, it appears that the engine cooling system serves a dual function of heat recovery and plant ventilation. Title 23 VAC 10-210-920.D provides that when machinery and equipment are used in both exempt and taxable activities, the preponderance of use rule applies in determining the tax application. If the equipment is used in a tax-exempt activity fifty percent or more of the time, the equipment is totally exempt. Similarly, if it is used fifty percent or more in a taxable activity, the machinery and equipment are totally taxable.
Based on the above, if the Taxpayer can provide documentation that the preponderance of use of the engine cooling system is for heat recovery and not for plant ventilation, l will agree to remove the system from the audit. However, absent additional documentation, l must hold the system taxable.
Exhaust System Components
The item at issue is a heat recovery muffler. The heat recovery muffler is located at the end of the heat recovery system and used to dispose of waste products, namely exhaust gases which are a by-product of the heat recovery system. As provided above, heat is a by-product of the Taxpayer's electric generating equipment, and the processing of the heat for use as a fuel or for resale is tax exempt function. The Taxpayer takes the position that the heat recovery muffler is directly used in a tax-exempt activity.
Title 23 VAC 10-210-920.C(2) addresses processing activities and provides that production begins with the handling and storage of raw materials at the plant site and continues through the last step of production where finished product is stored at the plant site. Based on the information provided, the heat recovery muffler is utilized to capture and dispose of waste products (i.e., exhaust gases) subsequent to the processing of the heat by way of the heat recovery system. For this reason, l find that the recovery muffler is used indirectly in the actual processing of the heat and is taxable.
Heat Delivery System
Once heat has been recovered through the Heat Recovery System, the product needs to be transferred to the customer. The Taxpayer utilizes piping from the co-generation plant to transfer heat to their customers. This piping is called a "heat loop". In addition, at the end of the heat loop, the Taxpayer has a monitoring and metering station used by the customer to monitor and control the temperature of the heat purchased. It is also used by the Taxpayer for billing purposes. The Taxpayer believes these items are used directly in the heat production process and should be exempt.
Title 23 VAC 10-210-920.C(3) addresses distribution and provides that distribution is the transfer or conveyance of product after the completion of production and is not part of manufacturing or processing. It has been the longstanding policy of the department that the distribution of a finished product is a taxable function. Therefore, l find the piping utilized in the heat loop to be taxable. In addition, the metering equipment utilized by the Taxpayer in its administrative billing function is clearly taxable in accordance with Title 23 VAC 10-210-920.
Crankcase Vent System Parts
The parts held taxable in this area include electronic control cards used in the Programmable Logic Controllers ("PLC's") and piping and tubing used in monitoring gauges on production machinery. The PLC's are industrial computers that directly control the engines that produce electricity. The electronic control cards are used to monitor the internal condition of the production equipment and can direct automatic devices within the equipment to shut down automatically. Unlike the electronic control cards, the piping and tubing used in monitoring gauges on production equipment only notify plant personnel of adjustments that need to be made, and do not automatically adjust production equipment.
Title 23 VAC 10-210-920.C(2) provides that "computer hardware and software used to direct or control production line and/or quality control operations" are exempt. Conversely, "computer hardware and software used merely to monitor production operation, e.g., ... make production information available to plant personnel... are deemed taxable." Based on the reading of this regulation, l find the electronic control cards to be exempt from the tax, as they actually direct the manufacturing equipment. However, the piping and tubing which are attachments to gauges that assist plant personnel are taxable. This position is upheld in P.D. 88-154 (6/23/88), copy enclosed.
Process Water System Items
This contested area consists of storage tanks and structural steel used to modify the tanks. According to the auditor, the tanks are the property of ****** ("FWP"), which is in the business processing waste water that contains fuel. The water and fuel mixture is allowed to separate and is then pumped out and resold as a fuel and as water used as a raw material for manufacturing. The Taxpayer believes the tanks are used for storing raw materials and are exempt from the tax.
According to the auditor, FWP is an affiliate of the Taxpayer and a separate legal entity. The auditor also advised that FWP does not enjoy the industrial manufacturing or processing exemption. Therefore, tanks owned and operated by FWP are subject to the tax.
Lightning Arresters
The Taxpayer believes these items to be a component part of the switchgears and, therefore, used directly in manufacturing. According to the auditor, the function of the lightning arrester is to protect the Taxpayer's power supply from lightning strikes. While the lightning arrester may be necessary to protect the Taxpayer's power supply, it is not an immediate part of the production process and is taxable.
Summary
Based on all of the above, the audit will be returned to the **** District Office for revisions in accordance with this letter. Once the audit revisions have been made, a revised audit report and bill will be mailed to the Taxpayer. If you should have any questions, please contact *****, Office of Tax Policy, at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
TO WHOM IT MAY CONCERN
Under the authority of § 58.1-1 of the Code of Virginia, l hereby delegate to Janie E. Bowen, Assistant Tax Commissioner, the authority to sign for me any and all documents, including, but not limited to, affidavits, warrants, rulings, appeals, offers in compromise and sales tax revocations.
This authority shall not extend to matters or documents related to my service on any statutorily created board or commission, including, but not limited to, the Compensation Board and the Treasury Board.
This authority will continue until revoked. The delegation of authority dated June 3, 1994, is hereby revoked and replaced.
Done at Richmond, Virginia this tenth day of September, 1999.
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner