Tax Type
Retail Sales and Use Tax
Description
Embroidery and screen printing; Non-industrial activity
Topic
Exemptions
Property Subject to Tax
Date Issued
04-10-2001
April 10, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in response to a request for correction of the retail sales and use tax
assessment issued to ***** (the "Taxpayer"). I apologize for the delay in responding to this matter. Copies of the cited sources (except court cases) are enclosed.
FACTS
The Taxpayer provides custom screen printing and embroidery of garments, apparel and other materials for sale mainly to end users or for resale to some retail trade customers, such as restaurants. The Taxpayer's predominant activity is in custom screen printing of apparel. Customers may order in small or large quantities. A minimum order of 24 articles is required for most orders. The Taxpayer also offers a line of standard embroidered textile merchandise for sale.
Although located in a mall, the Taxpayer does not carry any merchandise readily available for sale or resale. All merchandise offered for sale must be ordered. The Taxpayer maintains no showroom or inventory of finished or unfinished products. However, it has a display rack and case to display samples of its products for walk-in customers. It also has a website to advertise its products and take orders.
An audit for the period February 1997 through January 1999 resulted in the assessment of sales tax on certain untaxed retail sales. In addition, use tax was assessed on untaxed tangible personal property purchased for the Taxpayer's operations. This is the first audit of the Taxpayer.
The Taxpayer takes exception to the use tax assessed on untaxed embroidery equipment, screen printing equipment, and computer software. The Taxpayer maintains that it is an industrial processor and that these items should qualify for the industrial processing exemption set out by Code of Virginia § 58.1-609.3(2).
DETERMINATION
As you are aware, it has been the department's longstanding policy to treat businesses which are primarily engaged in the custom embroidery and screen printing of apparel products as non-industrial activities, not entitled to the industrial manufacturing and processing exemption. After an extensive review by my tax policy staff of the issues presented in this case, we find insufficient basis for reversing the department's longstanding policy on this matter based on the reasons set forth below.
Court Cases
Although you cite Caffee v. City of Portsmouth (202 Va. 928, 1962) in support of your case, I must note a critical distinction between Caffee and Golden Skillet Corp. v. Commonwealth (214 Va. 276, 1973). The decision in Golden Skillet emphasizes manufacturing "in the industrial sense." This is not the case in Caffee.
As the court stated in Golden Skillet, the Caffee decision does not address whether Caffee's bakery operation was manufacturing in the industrial sense. Rather, the Caffee decision only confirms that Caffee's bakery is a manufacturer for local license tax purposes. Moreover, the court in Golden Skillet concluded that the Caffee decision "is not persuasive" in the Golden Skillet case.
For sales and use tax purposes, the manufacturing exemption is more narrow. There must be manufacturing and that manufacturing must be industrial in nature. The Golden Skillet case emphasizes this distinction between "manufacturing" for local license tax purposes and "industrial manufacturing" for sales and use tax purposes.
Standard Industrial Classifications
To qualify for the industrial processing exemption set out by Code of Virginia
§ 58.1-609.3(2), a business must manufacture or process products for sale or resale, and such production must be "industrial in nature." Pursuant to Code of Virginia § 58.1-602, "industrial in nature" is defined by the terms "manufacturing" and "processing" to include those businesses classified in codes 10 through 14 and 20 through 39 of the Standard Industrial Classification ("SIC") Manual. Since 1983, these classifications have served as the primary determinant for classifying a business as "industrial." The determination of whether a business which does not fall into these SIC codes is industrial in nature is made on a case by case basis, with primary emphasis on its relative similarity to businesses classified in the above codes.
A review of the SIC Manual for 1987 reveals that establishments primarily engaged as commercial screen printers of non-textile products are included in code 2759 of that volume. Although not defined by the SIC Manual, the term "commercial" is commonly defined as "involved in work designed or planned for the mass market" and "designating products, often unrefined, made and distributed in large quantities for industrial use." Webster's II New College Dictionary, 1995. In contrast, establishments primarily engaged in the custom printing of tee shirts are classified under SIC code 5699, a retail trade classification. Webster's defines "retail" as "the sale of goods in small quantities to consumers."
In regard to embroidery businesses, establishments which primarily embroider products for the trade are classified under SIC code 2395. The department has traditionally interpreted the phrase "for the trade" as referring to businesses related to the same industry. In contrast, establishments which primarily engage in performing similar services for individuals are classified in service industries. For example, establishments which primarily embroider advertising on t-shirts are classified under SIC code 7389, a service classification. Therefore, custom embroidery and screen printing of the type performed by the Taxpayer are activities which are not classified as industrial in nature by the SIC Manual.
Established Policies - Prior Rulings
The department has consistently deemed businesses primarily or otherwise engaged in custom embroidery for sale to end users to be engaged in non-industrial activities not entitled to the industrial manufacturing exemption. See Public Document ("P.D.") 94-71 (3/18/94) and 96-386 (12/23/96) which deny the industrial manufacturing exemption to businesses predominately engaged in custom embroidery and screen printing for sale to end users. In both instances, orders were generally of a customized nature and relatively small in number. These orders are characteristic of businesses that are retailers or service providers.
The department has also addressed other types of custom production. In P.D. 93-29 (2/17/93), the department said that "the ancillary nature of the manufacturing is evidenced by the fact that . . . (products) . . . are custom produced (rather than mass marketed) to meet the needs of each customer, in much the same way that an artist or photographer carries on his trade." (Insert added.) The same principle applies to the Taxpayer in the instant case.
Proposed Legislation - Denied
During the 1997 and 1999 Sessions of the General Assembly, legislation proposed to exempt equipment used by embroidery and engraving businesses failed to pass. In 1997, House Bill 1700 was proposed to exempt machinery and equipment, including computers and related software, used directly in the engraving and embroidering of commercial awards or textile products sold exclusively at retail. This measure did not pass. In 1998, an almost identical bill (House Bill 204) was introduced and subsequently carried over to the 1999 Session of the General Assembly. However, that proposal also failed.
As shown by the 1997 and 1999 impact statements prepared by the department, the legislature was informed that these operations were not industrial in nature and therefore not entitled to the industrial processing exemption. With this in mind, the legislature still chose not to alter the tax liability of such operations.
Conclusion
Based on all of the foregoing and the rule of strict construction of the exemptions from the sales and use tax required by the courts, I must conclude that the Taxpayer's embroidery and screen printing activities do not enjoy the industrial manufacturing exemption. Accordingly, the tax assessed on the Taxpayer's embroidery and screen printing machinery, equipment and software is proper.
Under separate cover, the Taxpayer will receive a bill for the outstanding liabilities with interest to date. Please remit payment to the attention of **** at the department's Office of Tax Policy, P. O. Box 1880, Richmond, Virginia 23218-1880, within 60 days of this letter.
If you have any questions about this response, please contact *** at ***.
Sincerely,
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
This is in response to a request for correction of the retail sales and use tax
assessment issued to ***** (the "Taxpayer"). I apologize for the delay in responding to this matter. Copies of the cited sources (except court cases) are enclosed.
FACTS
The Taxpayer provides custom screen printing and embroidery of garments, apparel and other materials for sale mainly to end users or for resale to some retail trade customers, such as restaurants. The Taxpayer's predominant activity is in custom screen printing of apparel. Customers may order in small or large quantities. A minimum order of 24 articles is required for most orders. The Taxpayer also offers a line of standard embroidered textile merchandise for sale.
Although located in a mall, the Taxpayer does not carry any merchandise readily available for sale or resale. All merchandise offered for sale must be ordered. The Taxpayer maintains no showroom or inventory of finished or unfinished products. However, it has a display rack and case to display samples of its products for walk-in customers. It also has a website to advertise its products and take orders.
An audit for the period February 1997 through January 1999 resulted in the assessment of sales tax on certain untaxed retail sales. In addition, use tax was assessed on untaxed tangible personal property purchased for the Taxpayer's operations. This is the first audit of the Taxpayer.
The Taxpayer takes exception to the use tax assessed on untaxed embroidery equipment, screen printing equipment, and computer software. The Taxpayer maintains that it is an industrial processor and that these items should qualify for the industrial processing exemption set out by Code of Virginia § 58.1-609.3(2).
DETERMINATION
As you are aware, it has been the department's longstanding policy to treat businesses which are primarily engaged in the custom embroidery and screen printing of apparel products as non-industrial activities, not entitled to the industrial manufacturing and processing exemption. After an extensive review by my tax policy staff of the issues presented in this case, we find insufficient basis for reversing the department's longstanding policy on this matter based on the reasons set forth below.
Court Cases
Although you cite Caffee v. City of Portsmouth (202 Va. 928, 1962) in support of your case, I must note a critical distinction between Caffee and Golden Skillet Corp. v. Commonwealth (214 Va. 276, 1973). The decision in Golden Skillet emphasizes manufacturing "in the industrial sense." This is not the case in Caffee.
As the court stated in Golden Skillet, the Caffee decision does not address whether Caffee's bakery operation was manufacturing in the industrial sense. Rather, the Caffee decision only confirms that Caffee's bakery is a manufacturer for local license tax purposes. Moreover, the court in Golden Skillet concluded that the Caffee decision "is not persuasive" in the Golden Skillet case.
For sales and use tax purposes, the manufacturing exemption is more narrow. There must be manufacturing and that manufacturing must be industrial in nature. The Golden Skillet case emphasizes this distinction between "manufacturing" for local license tax purposes and "industrial manufacturing" for sales and use tax purposes.
Standard Industrial Classifications
To qualify for the industrial processing exemption set out by Code of Virginia
§ 58.1-609.3(2), a business must manufacture or process products for sale or resale, and such production must be "industrial in nature." Pursuant to Code of Virginia § 58.1-602, "industrial in nature" is defined by the terms "manufacturing" and "processing" to include those businesses classified in codes 10 through 14 and 20 through 39 of the Standard Industrial Classification ("SIC") Manual. Since 1983, these classifications have served as the primary determinant for classifying a business as "industrial." The determination of whether a business which does not fall into these SIC codes is industrial in nature is made on a case by case basis, with primary emphasis on its relative similarity to businesses classified in the above codes.
A review of the SIC Manual for 1987 reveals that establishments primarily engaged as commercial screen printers of non-textile products are included in code 2759 of that volume. Although not defined by the SIC Manual, the term "commercial" is commonly defined as "involved in work designed or planned for the mass market" and "designating products, often unrefined, made and distributed in large quantities for industrial use." Webster's II New College Dictionary, 1995. In contrast, establishments primarily engaged in the custom printing of tee shirts are classified under SIC code 5699, a retail trade classification. Webster's defines "retail" as "the sale of goods in small quantities to consumers."
In regard to embroidery businesses, establishments which primarily embroider products for the trade are classified under SIC code 2395. The department has traditionally interpreted the phrase "for the trade" as referring to businesses related to the same industry. In contrast, establishments which primarily engage in performing similar services for individuals are classified in service industries. For example, establishments which primarily embroider advertising on t-shirts are classified under SIC code 7389, a service classification. Therefore, custom embroidery and screen printing of the type performed by the Taxpayer are activities which are not classified as industrial in nature by the SIC Manual.
Established Policies - Prior Rulings
The department has consistently deemed businesses primarily or otherwise engaged in custom embroidery for sale to end users to be engaged in non-industrial activities not entitled to the industrial manufacturing exemption. See Public Document ("P.D.") 94-71 (3/18/94) and 96-386 (12/23/96) which deny the industrial manufacturing exemption to businesses predominately engaged in custom embroidery and screen printing for sale to end users. In both instances, orders were generally of a customized nature and relatively small in number. These orders are characteristic of businesses that are retailers or service providers.
The department has also addressed other types of custom production. In P.D. 93-29 (2/17/93), the department said that "the ancillary nature of the manufacturing is evidenced by the fact that . . . (products) . . . are custom produced (rather than mass marketed) to meet the needs of each customer, in much the same way that an artist or photographer carries on his trade." (Insert added.) The same principle applies to the Taxpayer in the instant case.
Proposed Legislation - Denied
During the 1997 and 1999 Sessions of the General Assembly, legislation proposed to exempt equipment used by embroidery and engraving businesses failed to pass. In 1997, House Bill 1700 was proposed to exempt machinery and equipment, including computers and related software, used directly in the engraving and embroidering of commercial awards or textile products sold exclusively at retail. This measure did not pass. In 1998, an almost identical bill (House Bill 204) was introduced and subsequently carried over to the 1999 Session of the General Assembly. However, that proposal also failed.
As shown by the 1997 and 1999 impact statements prepared by the department, the legislature was informed that these operations were not industrial in nature and therefore not entitled to the industrial processing exemption. With this in mind, the legislature still chose not to alter the tax liability of such operations.
Conclusion
Based on all of the foregoing and the rule of strict construction of the exemptions from the sales and use tax required by the courts, I must conclude that the Taxpayer's embroidery and screen printing activities do not enjoy the industrial manufacturing exemption. Accordingly, the tax assessed on the Taxpayer's embroidery and screen printing machinery, equipment and software is proper.
Under separate cover, the Taxpayer will receive a bill for the outstanding liabilities with interest to date. Please remit payment to the attention of **** at the department's Office of Tax Policy, P. O. Box 1880, Richmond, Virginia 23218-1880, within 60 days of this letter.
If you have any questions about this response, please contact *** at ***.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner