Tax Type
Retail Sales and Use Tax
Description
Chemicals used to clean equipment at dairy processing operation
Topic
Appropriateness of Audit Methodology
Property Subject to Tax
Date Issued
04-22-2002
April 22, 2002
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek correction of retail sales and use tax assessments issued to ***** (collectively, the "Taxpayer") for the audit periods ending December 2000. I apologize for the delay in the department's response.
FACTS
The Taxpayer operates a dairy processing operation. The only contested issue is the tax assessed on chemicals used to clean equipment at the Taxpayer's dairy processing operation.
The Taxpayer indicates that the complete sanitation of dairy equipment is a three-step process and consists of: (1) a fresh water rinse to remove loose soil, (2) a chemical wash to remove organic film and microorganisms, and (3) sanitizing to eliminate any remaining microorganisms. The audit staff did not assess the tax on the sanitizing solution used in the third step of this procedure because it was found that this item was used directly to protect the integrity of the Taxpayer's dairy products. However, the chemicals used in the second step were assessed because it was initially determined that this activity was analogous to taxable routine maintenance.
Industry documents provided by the Taxpayer indicate that microorganisms are imbedded in organic film (sometimes called milkstone) that accumulates on milk processing equipment. This organic film insulates and protects the contaminating microorganisms, and it must be removed (in the second step) in order for the sanitizing solution to work. In effect, the Taxpayer maintains that without the contested cleaning chemicals, the processing equipment cannot be properly sanitized. Further, the three-part cleaning and sanitizing process must be performed daily or upon the completion of each product run in order to prevent the contamination of the dairy products being processed and to meet regulatory standards.
Based on the above description of the cleaning and sanitizing process, the Taxpayer maintains that the contested chemicals used in the second step are an integral part of the daily sanitation program of the processing operation and qualify for the industrial manufacturing exemption under Code of Virginia § 58.1-609.3(2).
DETERMINATION
Code of Virginia § 58.1-609.3(2) provides an exemption from the sales and use tax for machinery, equipment, supplies, etc. 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."
Title 23 of the Virginia Administrative Code (VAC) 10-210-920(B)(2) further defines the term "used directly" noting that "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." This section further provides that "integrated manufacturing includes the production line of a plant . . . starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished . . . and conveyed to a warehouse at the plant site . . . ." Subsection C.2 of this regulation provides that equipment used for production line testing and quality control is exempt from taxation. The department has interpreted this regulation to only include that equipment which is "used directly" in the quality control function on the production line of the plant site during the manufacturing process.
In Public Document 92-65 (5/11/92), the Tax Commissioner determined that certain cleaning and sanitizing chemicals used in a food production facility were an indispensable part of the quality control function of the manufacturing process. In that prior case, the entire production process was shut down daily in order to sanitize it. Also, this daily cleaning was so specialized and closely related to the processing function that production could not take place unless the cleaning and sanitizing of the production equipment were performed.
Based on the facts presented in this case, the Taxpayer's three-part cleaning and sanitizing operation ensures the integrity of the product by preventing the contamination of the dairy products being processed. Further, the cleaning chemicals used in the three-part cleaning and sanitizing process are an indispensable part of the quality control process. Accordingly, the assessment will be revised to remove the contested chemicals used in the cleaning of the production equipment. I would note that any cleaning chemicals not being used directly in the actual manufacturing process within the limitations set forth in the above statutes and regulation are taxable.
The audit will be returned to the ***** office for revision. The Taxpayer will receive a revised audit report and a revised bill. Payment should be made within 30 days from receipt of the revised bill to avoid the accrual of additional interest.
The Code of Virginia, regulations and public document cited are included for reference purposes. These and other reference documents are also 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 matter, please contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
AR/33652T
Rulings of the Tax Commissioner