Tax Type
Retail Sales and Use Tax
Description
Pharmaceutical drug manufacturing; Product testing; Bar code system
Topic
Exemptions
Property Subject to Tax
Date Issued
04-30-2001
April 30, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****:
This is in reply to your letter in which you seek correction of a retail sales and use tax audit assessment issued to **** (the "Taxpayer"), for the period November 1994 though December 1997. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a producer of healthcare products. Among its many products, the Taxpayer manufactures biological and allergy products at production facilities outside Virginia. These products are sold by the Taxpayer to licensed physicians in Virginia for use in their professional practices to treat patients. As a result of the department's audit, the Taxpayer was assessed tax on sales of the biological and allergy products. The Taxpayer disagrees with the assessment and believes the products are considered controlled drugs qualifying for the exemption in Code of Virginia § 58.1-609.7(1).
In addition, the Taxpayer maintains a production facility in Virginia that manufactures liquid reagents used in blood testing kits. The auditor determined that supplies used to test the liquid reagents were used in finished product testing and assessed the tax. The auditor also assessed the tax on the purchase of a bar code system used to track and identify the liquid reagents. The Taxpayer disputes the tax in both instances and contends the testing supplies and the bar code system qualify for the manufacturing exemption provided in Code of Virginia § 58.1-609.3(2). The Taxpayer cites a number of prior department rulings to support its position.
Lastly, the Taxpayer disputes the penalty and interest applied to the audit assessment.
DETERMINATION
Biological and Allergy Products
Code of Virginia § 58.1-609.7(1) provides a sales tax exemption for "[m]edicines, drugs ...dispensed by or sold on prescription or work orders of licensed physicians ...and controlled drugs purchased for use by a licensed physician in his professional practice..." The exemption applies to controlled drugs contained in Schedules 1 through VI of the Virginia Drug Control Act (Chapter 34 of the Code of Virginia § 54.1).
The biological products are derived from human blood plasma and used in the treatment of hemophilia conditions. The allergy products are derived from allergens in the environment and used to test and treat hypersensitivity to such allergens. Both types of products are under the federal regulatory authority of the Food and Drug Administration (FDA) and carry the federal legend that prohibits dispensing without a prescription.
It is the department's understanding, based on information received from the Virginia Board of Pharmacy, that the products at issue are considered Schedule VI controlled drugs for use by licensed physicians and prescriber practitioners. As such, the products qualify for exemption under the cited statute and will be removed from the audit assessment.
Product Testing
The liquid reagents are a component used in blood testing kits and must be tested as required by the FDA to ensure that they meet certain federally mandated standards. The Taxpayer is unable to release the product for sale unless the testing is performed. Because of the federal requirements, the Taxpayer believes the product testing is an integral part of the manufacturing process and the supplies used in the testing qualify for the manufacturing exemption.
Code of Virginia § 58.1-609.3(2) provides a sales tax exemption for "machinery or tools,...fuel, power, energy, or supplies, used directly in processing, manufacturing,... products for sale or resale." Code of Virginia § 58.1-602 defines "manufacturing" and "processing" to include "equipment and supplies used for production line testing and quality control." (Emphasis added).
While the testing is federally mandated by the FDA, such federal requirements by themselves do not render the supplies used in the required testing exempt of the sales and use tax. Product testing and quality control functions do qualify for the manufacturing exemption, provided these functions are done on the production line. Based on the Taxpayer's letter and the auditor's comments, the testing is performed away from the production line. The liquid reagent product is complete and packaged in a finished goods inventory when the testing is performed. Only a random sampling of each production batch is withdrawn for testing. As such, the Taxpayer's testing of the liquid reagents is not considered an integral part of the manufacturing process, and the supplies used in such testing do not qualify for the manufacturing exemption.
Bar Code System
The Taxpayer is required by federal law to provide a system to track and identify the liquid reagents for recovery purposes in the event of a medical recall or similar situation. To satisfy the federal requirement, the Taxpayer purchased a bar code system for its production plant. The bar code system consists of two stations. At one station, the product containers are bar coded with the lot and product number data for batch identification purposes. At the other station, additional bar code information is imprinted on the product containers to enable the Taxpayer to monitor the inventory. Because the Taxpayer is required to code the liquid reagents before release for sale, it believes the bar code system qualifies as an integral part of the manufacturing process and is exempt of the tax.
Code of Virginia § 58.1-602 defines "used directly" to include "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 and administration."
The Taxpayer purchased the bar code system to satisfy the federal requirements and for purposes of inventory tracking. The bar coding does not take place on the production line, and the system is not used directly in the manufacture of the liquid reagents. The bar code system is used in post-manufacturing activities and serves an administrative function. Therefore, the equipment and supplies associated with the bar code system do not qualify for the manufacturing exemption.
To support its position, the Taxpayer cites a number of department rulings. In Public Document (P.D.) 97-72 (2/18/97), a manufacturer of automobile parts was required by its customer to manufacture parts with a bar code for inventory tracking purposes. Some of the manufactured parts were packaged in boxes and labels were fixed to the boxes for shipment to the customer. Other parts were placed in returnable shipping containers and affixed with labels that were returned to the taxpayer to be reused. While the taxpayer in that case used the bar code labels to track the inventory upon shipment, it was determined that the labels that were not returned to the taxpayer became a component part of the manufactured product and therefore qualified for the exemption. However, the labels that were returned for reuse by the taxpayer remained taxable.
In P.D. 95-52 (3/23/95), a designer and manufacturer of ship accouterments and metal products inquired whether bar coding equipment was exempt from the tax. In that case, at the end of each production run, the taxpayer imprinted a code on each batch of products that identified the design and contract destination of the product. It was determined that the bar coding was an exempt activity provided it was performed prior to conveying the products to the finished goods inventory.
Lastly, P.D. 94-265 (8/26/94) addresses a code printing system at a food processing plant used to print an hourly code on the product package that would enable the taxpayer to notify customers about a particular batch of food product. The code printer was used on the production line at the plant site and it was determined that the product was not ready for sale or resale until the hourly coding and batch information was printed on the product. The code system was determined to be used in an exempt activity.
In P.D. 97-72 and P.D. 95-52, the bar coding was used to fulfill customer requirements in order to complete the products for sale. In the case of P.D. 94-265, the code printer was used on the production line. Each case is distinguishable from the Taxpayer's situation in that the Taxpayer's product is complete prior to the bar coding and the bar coding is not performed in production line activity. While it is undisputed that the federal requirements may be necessary to distribute the product, as stated earlier such federal requirements by themselves do not render equipment and supplies exempt of the sales and use tax.
Penalty and Interest Waiver
Title 23 of the Virginia Administrative Code (VAC) 10-210-2032 addresses penalties and interest applied to audit assessments. Section (A)(6) of the regulation provides the exceptions for audit penalty and states that penalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audits. The issues addressed in this appeal have not been the subject of prior audits of the Taxpayer. Therefore, the penalty will be removed from the audit assessment. Penalty will be assessed in future audits if the Taxpayer fails to apply the tax in accordance with the determinations in this appeal.
As established in Code of Virginia § 58.1-15, the application of interest to an audit assessment is mandatory and is waived only when the associated tax is waived. As such, interest will apply to the remaining balance of the assessment.
Conclusion
The auditor will adjust the audit consistent with this determination. The Taxpayer will receive a revised assessment, which should be paid within 30 days to avoid the accrual of additional interest charges.
If you have questions regarding the policy set forth in this letter, please contact **** in the Office of Tax Policy at *****. Questions concerning the audit adjustments should be directed to **** of the **** at ****.
.
Sincerely,
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ****:
This is in reply to your letter in which you seek correction of a retail sales and use tax audit assessment issued to **** (the "Taxpayer"), for the period November 1994 though December 1997. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a producer of healthcare products. Among its many products, the Taxpayer manufactures biological and allergy products at production facilities outside Virginia. These products are sold by the Taxpayer to licensed physicians in Virginia for use in their professional practices to treat patients. As a result of the department's audit, the Taxpayer was assessed tax on sales of the biological and allergy products. The Taxpayer disagrees with the assessment and believes the products are considered controlled drugs qualifying for the exemption in Code of Virginia § 58.1-609.7(1).
In addition, the Taxpayer maintains a production facility in Virginia that manufactures liquid reagents used in blood testing kits. The auditor determined that supplies used to test the liquid reagents were used in finished product testing and assessed the tax. The auditor also assessed the tax on the purchase of a bar code system used to track and identify the liquid reagents. The Taxpayer disputes the tax in both instances and contends the testing supplies and the bar code system qualify for the manufacturing exemption provided in Code of Virginia § 58.1-609.3(2). The Taxpayer cites a number of prior department rulings to support its position.
Lastly, the Taxpayer disputes the penalty and interest applied to the audit assessment.
DETERMINATION
Biological and Allergy Products
Code of Virginia § 58.1-609.7(1) provides a sales tax exemption for "[m]edicines, drugs ...dispensed by or sold on prescription or work orders of licensed physicians ...and controlled drugs purchased for use by a licensed physician in his professional practice..." The exemption applies to controlled drugs contained in Schedules 1 through VI of the Virginia Drug Control Act (Chapter 34 of the Code of Virginia § 54.1).
The biological products are derived from human blood plasma and used in the treatment of hemophilia conditions. The allergy products are derived from allergens in the environment and used to test and treat hypersensitivity to such allergens. Both types of products are under the federal regulatory authority of the Food and Drug Administration (FDA) and carry the federal legend that prohibits dispensing without a prescription.
It is the department's understanding, based on information received from the Virginia Board of Pharmacy, that the products at issue are considered Schedule VI controlled drugs for use by licensed physicians and prescriber practitioners. As such, the products qualify for exemption under the cited statute and will be removed from the audit assessment.
Product Testing
The liquid reagents are a component used in blood testing kits and must be tested as required by the FDA to ensure that they meet certain federally mandated standards. The Taxpayer is unable to release the product for sale unless the testing is performed. Because of the federal requirements, the Taxpayer believes the product testing is an integral part of the manufacturing process and the supplies used in the testing qualify for the manufacturing exemption.
Code of Virginia § 58.1-609.3(2) provides a sales tax exemption for "machinery or tools,...fuel, power, energy, or supplies, used directly in processing, manufacturing,... products for sale or resale." Code of Virginia § 58.1-602 defines "manufacturing" and "processing" to include "equipment and supplies used for production line testing and quality control." (Emphasis added).
While the testing is federally mandated by the FDA, such federal requirements by themselves do not render the supplies used in the required testing exempt of the sales and use tax. Product testing and quality control functions do qualify for the manufacturing exemption, provided these functions are done on the production line. Based on the Taxpayer's letter and the auditor's comments, the testing is performed away from the production line. The liquid reagent product is complete and packaged in a finished goods inventory when the testing is performed. Only a random sampling of each production batch is withdrawn for testing. As such, the Taxpayer's testing of the liquid reagents is not considered an integral part of the manufacturing process, and the supplies used in such testing do not qualify for the manufacturing exemption.
Bar Code System
The Taxpayer is required by federal law to provide a system to track and identify the liquid reagents for recovery purposes in the event of a medical recall or similar situation. To satisfy the federal requirement, the Taxpayer purchased a bar code system for its production plant. The bar code system consists of two stations. At one station, the product containers are bar coded with the lot and product number data for batch identification purposes. At the other station, additional bar code information is imprinted on the product containers to enable the Taxpayer to monitor the inventory. Because the Taxpayer is required to code the liquid reagents before release for sale, it believes the bar code system qualifies as an integral part of the manufacturing process and is exempt of the tax.
Code of Virginia § 58.1-602 defines "used directly" to include "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 and administration."
The Taxpayer purchased the bar code system to satisfy the federal requirements and for purposes of inventory tracking. The bar coding does not take place on the production line, and the system is not used directly in the manufacture of the liquid reagents. The bar code system is used in post-manufacturing activities and serves an administrative function. Therefore, the equipment and supplies associated with the bar code system do not qualify for the manufacturing exemption.
To support its position, the Taxpayer cites a number of department rulings. In Public Document (P.D.) 97-72 (2/18/97), a manufacturer of automobile parts was required by its customer to manufacture parts with a bar code for inventory tracking purposes. Some of the manufactured parts were packaged in boxes and labels were fixed to the boxes for shipment to the customer. Other parts were placed in returnable shipping containers and affixed with labels that were returned to the taxpayer to be reused. While the taxpayer in that case used the bar code labels to track the inventory upon shipment, it was determined that the labels that were not returned to the taxpayer became a component part of the manufactured product and therefore qualified for the exemption. However, the labels that were returned for reuse by the taxpayer remained taxable.
In P.D. 95-52 (3/23/95), a designer and manufacturer of ship accouterments and metal products inquired whether bar coding equipment was exempt from the tax. In that case, at the end of each production run, the taxpayer imprinted a code on each batch of products that identified the design and contract destination of the product. It was determined that the bar coding was an exempt activity provided it was performed prior to conveying the products to the finished goods inventory.
Lastly, P.D. 94-265 (8/26/94) addresses a code printing system at a food processing plant used to print an hourly code on the product package that would enable the taxpayer to notify customers about a particular batch of food product. The code printer was used on the production line at the plant site and it was determined that the product was not ready for sale or resale until the hourly coding and batch information was printed on the product. The code system was determined to be used in an exempt activity.
In P.D. 97-72 and P.D. 95-52, the bar coding was used to fulfill customer requirements in order to complete the products for sale. In the case of P.D. 94-265, the code printer was used on the production line. Each case is distinguishable from the Taxpayer's situation in that the Taxpayer's product is complete prior to the bar coding and the bar coding is not performed in production line activity. While it is undisputed that the federal requirements may be necessary to distribute the product, as stated earlier such federal requirements by themselves do not render equipment and supplies exempt of the sales and use tax.
Penalty and Interest Waiver
Title 23 of the Virginia Administrative Code (VAC) 10-210-2032 addresses penalties and interest applied to audit assessments. Section (A)(6) of the regulation provides the exceptions for audit penalty and states that penalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audits. The issues addressed in this appeal have not been the subject of prior audits of the Taxpayer. Therefore, the penalty will be removed from the audit assessment. Penalty will be assessed in future audits if the Taxpayer fails to apply the tax in accordance with the determinations in this appeal.
As established in Code of Virginia § 58.1-15, the application of interest to an audit assessment is mandatory and is waived only when the associated tax is waived. As such, interest will apply to the remaining balance of the assessment.
Conclusion
The auditor will adjust the audit consistent with this determination. The Taxpayer will receive a revised assessment, which should be paid within 30 days to avoid the accrual of additional interest charges.
If you have questions regarding the policy set forth in this letter, please contact **** in the Office of Tax Policy at *****. Questions concerning the audit adjustments should be directed to **** of the **** at ****.
.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner