Tax Type
Retail Sales and Use Tax
Description
Manufacture of CD's and DVD's; Data prep equipment and storage envelopes
Topic
Exemptions
Property Subject to Tax
Date Issued
04-24-2001
April 24, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
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 April 1996 through March 1999. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a manufacturer of compact disks (CD's) and digital video disks (DVD's). The Taxpayer receives customer-supplied media, e.g., tapes, CD's, 8mm tapes. The customer's media is sent to the Taxpayer's Data Prep Department, where it is reviewed, edited, and checked for quality. From this department, the media is transferred to a department that produces a glass master used to produce a stamper. The stamper contains all the information included on the glass master and is used to produce the actual CD's and DVD's.
The Taxpayer was assessed tax on equipment (computers, monitors, etc.) used in the Data Prep Department. The Taxpayer believes that the Data Prep Department is the first step in the production process, and all equipment used in this area qualifies for the manufacturing exemption contained in Code of Virginia § 58.1-609.3(2). The auditor determined that the Data Prep Department performs a pre-production function, and the equipment used in this function does not qualify for the manufacturing exemption. The Taxpayer is also taking exception to the tax assessed on cushioned mailing envelopes used to store stampers after production of the CD's or DVD's. The Taxpayer believes the envelopes, used to store and protect stampers used directly in the production process, should be exempt. The Taxpayer is also requesting waiver of the audit penalty.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for machinery, tools, and 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."
In accordance with the above statutes, Title 23 of the Virginia Administrative Code (VAC) 10-210-920.B(2) addresses direct use and provides the exemption applies to "machinery, tools and repair parts therefor . . . which are indispensable to the actual production of products for sale and which are used as an immediate part of the production process. (Emphasis added).
Title VAC 10-210-920.A states "for a business to obtain the (industrial manufacturing) exemption, it first must be manufacturing or processing for sale or resale and secondly, such production must be industrial in nature. [Insert added for clarity]. In order to determine whether a manufacturing or processing activity is industrial in nature, the department looks to the Standard Industrial Classification ("SIC") Manual as a general guideline. As provided in VAC 10-210-920.13, establishments classified within major group codes 20 through 39 are considered industrial in nature. The Taxpayer's business is classified under SIC Industry Number 3652, the manufacturer of audio tapes and disks. Further guidance is found in the North America Industry Classification System ("NAICS") which replaced the SIC Manual in 1997. The Taxpayer's CD and DVD production operations are classified under NAICS industry code 33461, a manufacturing code.
Equipment Used in Data Prep Department
The Taxpayer believes that equipment used in the Data Prep Department qualifies for the industrial manufacturing exemption. In order for equipment to qualify for the exemption, such equipment must be "used directly" in the process. The Taxpayer enjoys the exemption for items used directly in the manufacture of CD's and DVD's. However, prior to the actual production of CD's or DVD's, the Taxpayer must prepare the customer-provided media in the Data Prep Department. In this case, the equipment in the Data Prep Department is used in a pre-production activity, before the actual production process of the CD or DVD begins. While I realize the function of the Data Prep Department is essential, I cannot agree that it is part of the actual production process. This position is supported in Public Document (P.D.) 97-430 (10/27/97)
and P.D. 99-21 (3/4/99) , copies enclosed. Accordingly, equipment and other items used in this pre-production function do not qualify for the manufacturing exemption.
Storage Envelopes
The cushioned storage envelopes are used to store and protect the stampers, which are used directly in the production process. It has been the longstanding policy of the department that the industrial manufacturing exemption does not extend to items used in the storage of exempt processing equipment. This policy is set forth in P.D. 98-127 (8/11/98), copy enclosed.
Penalty
Generally, audit penalty is mandatory and cannot be waived unless the Taxpayer has achieved an acceptable level of compliance. On third and subsequent audits, a taxpayer's use tax compliance ratio must be 85% or higher in order to avoid a penalty. According to the audit report, the Taxpayer's use tax compliance ratio on this third audit of the Taxpayer is 36%. Based on this level of compliance, I find that waiver of the audit penalty is not warranted.
Conclusion
Based on all of the above, I find no basis for revising the audit assessment. Please forward a check in the amount of $*** for the contested tax, penalty and interest, within 30 days of the date of this letter. Please mail your check to ****, Office of Tax Policy, P.O. Box 1880, Richmond, Virginia 23218-1880. If you should have any questions concerning this determination, please contact **** at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****
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 April 1996 through March 1999. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a manufacturer of compact disks (CD's) and digital video disks (DVD's). The Taxpayer receives customer-supplied media, e.g., tapes, CD's, 8mm tapes. The customer's media is sent to the Taxpayer's Data Prep Department, where it is reviewed, edited, and checked for quality. From this department, the media is transferred to a department that produces a glass master used to produce a stamper. The stamper contains all the information included on the glass master and is used to produce the actual CD's and DVD's.
The Taxpayer was assessed tax on equipment (computers, monitors, etc.) used in the Data Prep Department. The Taxpayer believes that the Data Prep Department is the first step in the production process, and all equipment used in this area qualifies for the manufacturing exemption contained in Code of Virginia § 58.1-609.3(2). The auditor determined that the Data Prep Department performs a pre-production function, and the equipment used in this function does not qualify for the manufacturing exemption. The Taxpayer is also taking exception to the tax assessed on cushioned mailing envelopes used to store stampers after production of the CD's or DVD's. The Taxpayer believes the envelopes, used to store and protect stampers used directly in the production process, should be exempt. The Taxpayer is also requesting waiver of the audit penalty.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for machinery, tools, and 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."
In accordance with the above statutes, Title 23 of the Virginia Administrative Code (VAC) 10-210-920.B(2) addresses direct use and provides the exemption applies to "machinery, tools and repair parts therefor . . . which are indispensable to the actual production of products for sale and which are used as an immediate part of the production process. (Emphasis added).
Title VAC 10-210-920.A states "for a business to obtain the (industrial manufacturing) exemption, it first must be manufacturing or processing for sale or resale and secondly, such production must be industrial in nature. [Insert added for clarity]. In order to determine whether a manufacturing or processing activity is industrial in nature, the department looks to the Standard Industrial Classification ("SIC") Manual as a general guideline. As provided in VAC 10-210-920.13, establishments classified within major group codes 20 through 39 are considered industrial in nature. The Taxpayer's business is classified under SIC Industry Number 3652, the manufacturer of audio tapes and disks. Further guidance is found in the North America Industry Classification System ("NAICS") which replaced the SIC Manual in 1997. The Taxpayer's CD and DVD production operations are classified under NAICS industry code 33461, a manufacturing code.
Equipment Used in Data Prep Department
The Taxpayer believes that equipment used in the Data Prep Department qualifies for the industrial manufacturing exemption. In order for equipment to qualify for the exemption, such equipment must be "used directly" in the process. The Taxpayer enjoys the exemption for items used directly in the manufacture of CD's and DVD's. However, prior to the actual production of CD's or DVD's, the Taxpayer must prepare the customer-provided media in the Data Prep Department. In this case, the equipment in the Data Prep Department is used in a pre-production activity, before the actual production process of the CD or DVD begins. While I realize the function of the Data Prep Department is essential, I cannot agree that it is part of the actual production process. This position is supported in Public Document (P.D.) 97-430 (10/27/97)
and P.D. 99-21 (3/4/99) , copies enclosed. Accordingly, equipment and other items used in this pre-production function do not qualify for the manufacturing exemption. Storage Envelopes
The cushioned storage envelopes are used to store and protect the stampers, which are used directly in the production process. It has been the longstanding policy of the department that the industrial manufacturing exemption does not extend to items used in the storage of exempt processing equipment. This policy is set forth in P.D. 98-127 (8/11/98)
, copy enclosed. Penalty
Generally, audit penalty is mandatory and cannot be waived unless the Taxpayer has achieved an acceptable level of compliance. On third and subsequent audits, a taxpayer's use tax compliance ratio must be 85% or higher in order to avoid a penalty. According to the audit report, the Taxpayer's use tax compliance ratio on this third audit of the Taxpayer is 36%. Based on this level of compliance, I find that waiver of the audit penalty is not warranted.
Conclusion
Based on all of the above, I find no basis for revising the audit assessment. Please forward a check in the amount of $*** for the contested tax, penalty and interest, within 30 days of the date of this letter. Please mail your check to ****, Office of Tax Policy, P.O. Box 1880, Richmond, Virginia 23218-1880. If you should have any questions concerning this determination, please contact **** at ****.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner