Tax Type
Retail Sales and Use Tax
Description
Manufacturing exemption, and items not used directly in manufacturing
Topic
Accounting Periods and Methods
Allocation and Apportionment
Appropriateness of Audit Methodology
Date Issued
10-11-2002
October 11, 2002
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to the letter submitted by ***** seeking correction of the retail sales and use tax audit assessment issued to ***** (the "Taxpayer"), for the period November 1994 through January 1997. I apologize for the delay in the department's response.
FACTS
The Taxpayer is an industrial gravure printing operation that enjoys the manufacturing exemption afforded under Code of Virginia § 58.1-609.3(2). The Taxpayer operates an integrated process that includes the subprocessing activities of copper plating the printing cylinders, engraving the cylinders, and chroming the cylinders to protect the soft copper plating during production runs. These functions constitute exempt subprocessing activities, and tangible personal property used directly in these activities is exempt pursuant to the industrial manufacturing exemption.
In addition to the printing cylinder processing activity, the Taxpayer has installed a K-Walter System. The K-Walter System is a system the Taxpayer utilizes to review the engraving scheme prior to the actual etching of the cylinders. The system allows the Taxpayer to direct personnel on how to set the engraving machines to ensure the proper holes and depths during the engraving process. Prior to the installation of the K-Walter System, the Taxpayer would engrave the printing cylinder and run proof copies on the actual production line. The auditor assessed use tax on the purchase of the K-Walter System. The Taxpayer believes this system is used directly in its printing process and should be exempt.
The Taxpayer also contests the use tax assessed on the purchase of boiler chemicals used in its pollution control facility. The Taxpayer uses boilers to provide steam used in its solvent recovery process, to liquefy ink used in the presses, and to provide heat for the building.
The boiler supplies steam to the pollution control facility for the solvent recovery process and that facility has been certified by the Department of Environmental Quality.
DETERMINATION
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 replacement 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." Keeping this in mind, I will address the two areas of contention separately below.
Preproduction Activities
Based on the information provided in your letter, the auditor assessed tax on hardware, software, printers, engraving machinery, and ink used in the proofing phase of the prepress activities. Part of the prepress activities involves the chroming, etching and copper plating of the printing cylinders. The prepress activities also involve the use of the K-Walter System that has replaced the proofing phase of prepress activities.
The facts presented indicate that the K-Walter System provides the engraving operator the necessary information to adjust the engraving settings in order to engrave the printing cylinders properly, thus eliminating the running of proofs prior to production. Because the processing of printing cylinders is considered an exempt subprocessing activity, and not a prepress activity, I find that the K-Walter System is used directly in an exempt subprocessing activity.
The Taxpayer also contests the assessment of use tax on the Shira/Gypsy system. The Shira/Gypsy system consists of tangible personal property used by the Taxpayer to electronically receive printing materials from customers. This allows the Taxpayer to review and edit the material prior to printing. This system performs a function that is clearly preproduction and does not constitute a subprocessing activity (such as printing cylinder processing). For this reason, I find that the Shira/Gypsy system is not directly used in the actual printing process and does not qualify for the exemption under Code of Virginia § 58.1-609.3(2).
Boiler Chemicals
The Taxpayer believes that the boiler chemicals held taxable in the audit should be exempt because the boilers are used to produce steam used directly in the production process and are also used in the certified pollution control facility to ensure that the waste water meets state and local water standards. It is noted in the auditor's comments that in some instances the steam produced by the boilers is also used to provide heat to the building.
In interpreting the exemption provided under Code of Virginia § 58.1-609.3(2), Title 23 of the Virginia Administrative Code (VAC) 10-210-920(B) provides that the exemption applies to "machinery, tools, and repair parts therefor, fuel, power, energy, or supplies which are used as an immediate part of such product production process." However, this section continues, "items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt production machinery."
In addition, in the case of Webster Brick Company, Inc., v. Department of Taxation, 219 Va. 812 (1978), the Virginia Supreme Court upheld the application of the sales and use tax to certain chemicals used in connection with the maintenance and smooth operation of a boiler, stating that while such chemicals were essential to the taxpayer's brick manufacturing process they were not an immediate part of actual production.
While I agree that the use of boiler chemicals in the present case is essential for the proper functioning of the boilers in both the manufacturing process and the pollution control facility, based on the regulation and Virginia Supreme Court decision in Webster Brick, I find that such chemicals are not an immediate part of either process and are, therefore, taxable.
Based on the foregoing, a refund associated with the exempt use of the K-Walter System will be issued to the Taxpayer. In all other respects, the assessment is correct. The Code of Virginia sections and regulations cited above are available online in the Tax Policy Library section of the Department of Taxation's web site located at www.tax.state.va.us. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Policy Development, at *****.
Sincerely,
Kenneth W. Thorson
Tax Commissioner
PD/34842K
Rulings of the Tax Commissioner