Tax Type
Retail Sales and Use Tax
Description
Exempt certified pollution control equipment
Topic
Appropriateness of Audit Methodology
Exemptions
Manufacturing
Date Issued
09-14-2004
September 14, 2004
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear ********:
This is in response to your letters requesting correction of the retail sales and use tax audit assessments issued to ***** (the "Taxpayer") covering two business locations of the taxpayer for the periods April 2000 through March 2003 and October 1999 through March 2003, respectively. This letter also acknowledges receipt of the Taxpayer's payment in the amount of ***** for the noncontested portion of the audit assessment. I apologize for the delay in the Department's response to your appeal.
FACTS
The Taxpayer is a manufacturer of utility trailers. An audit of the Taxpayer's two locations in Virginia resulted in assessments of tax on purchases of tangible personal property. The Taxpayer contests the tax assessed on certain purchases of supplies and equipment, contending the purchases qualify for the industrial manufacturing exemption set out under Va. Code § 58.1-609.3(2). In addition, the Taxpayer requests a refund for tax and interest paid on a noncontested asset that was certified as pollution control equipment subsequent to the audit. Lastly, the Taxpayer contests the penalties assessed in both audits.
DETERMINATION
General
Virginia Code § 58.1-609.3(2) provides an exemption from the sales and use tax for machinery, toots, fuel, power, energy or supplies "used directly" in manufacturing products for sale or resale. The term "used directly" is defined in Va. Code § 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 provides that the exemption applies to "machinery, tools, and repair parts therefor, power, 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." (Emphasis added.) Section (B)(2) of this regulation states, "[c]onvenient or facilitative items,... or items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing." Subsection (C)(2) of this regulation goes on to define those items used in manufacturing and processing activities that are deemed to be taxable and specifically holds taxable "[m]aterials and apparatus used to support exempt production machinery, including flooring, concrete and metal platforms, etc., except supports or legs which are a component part of exempt production machinery and do not become affixed to realty." (Emphasis added.) Included in the list of taxable items are "[c]atwalks, walkways, etc., regardless of whether used to provide access to production machinery for the operation, maintenance or repair of such machinery." In view of this background, I will address the application of the manufacturing exemption to the contested items described in your letter.
Building Mezzanine
The information provided indicates that the mezzanine is a constructed, two-level section of the trailer production line in which trailer roofs and side bottom rails are produced. The upper portion of the mezzanine supports hydraulic and pneumatic trailer roofing tools and safety structures required by government regulation. The lower level of the mezzanine is equipped with a hydraulic system and other powered operated tools that are attached to the mezzanine and used in the production of trailer side bottom rails. The mezzanine enables production-line assemblers to be at the proper level for roof attachment and also allows the assemblers to move along the entire length of the trailer during the roof and bottom rail installation process. The mezzanine is also used to store roof parts such as corner gussets and clamping strips.
The Taxpayer maintains that the mezzanine is similar to gantry equipment or a staging device addressed in Public Document (P.D.) 87-45 (2/26/87). In that case, the Tax Commissioner determined that the gantry equipment was used directly in building and repairing ships and, therefore, qualified for the industrial manufacturing exemption.
Based on the information provided, I find that the Taxpayer's mezzanine is more analogous to taxable gantry units addressed in P.D. 95-43 (3/17/95) than to the exempt staging devices in P.D. 87-45. In P.D. 95-43, gantry units were used to support loom heads that fed threads to weaving looms used to manufacture towels. The gantry units were also used as walkways for plant workers to access the loom heads. The Department determined that the gantry units helped expedite production and quality control but did not play an immediate role in the production or quality process. Further, because the gantry units served other functions in addition to their use as supports, they were not considered a component part of the loom heads and thus subject to the tax.
Although the contested mezzanine in this case is essential to the Taxpayer's operation, it is not an immediate part of the actual production. Further, supporting structures must be used solely to support exempt machinery to be considered a "component part" of such machinery. Because the mezzanine is used to serve other functions, e.g., for use by production assemblers, storage of materials and as a safety structure, it is not considered a component part of exempt machinery. Accordingly, the mezzanine was appropriately held taxable in the assessment.
Capitalized purchases
There are several items the Taxpayer claims are capitalized items that were included in the audit sample as expense purchases. Such items include steel pipe and platform grating, rolling ladders, plant communication equipment, adhesive mixing tube, Hit HY 150 and steel rods and a scanner and software. You state that the Taxpayer was advised to pay the tax associated with these transactions and to file a protective claim for refund. Provided the Taxpayer can furnish documentation to show that these items were capitalized, they will be removed from the sample and itemized under fixed assets.
Pollution Control
After the audit was assessed, the Taxpayer received notification from the Virginia Department of Environmental Quality ("DEQ") that the ThermalPhase Oil Water Separator was certified as pollution control equipment.
Virginia Code § 58.1-609.3(9) exempts from the retail sales and use tax certain certified pollution control equipment and facilities. Accordingly, tangible personal property comprising the ThermalPhase Oil Water Separator will be removed from the assessment. Any tax and interest paid on the ThermalPhase Oil Water Separator will be applied to the remaining audit liability.
CRC Contact Cleaner
The Taxpayer claims that the contested cleaner is an operating supply, actively and continually consumed in the operation of exempt machinery and equipment. The Taxpayer maintains that the spray cleaner is used to remove carbon deposits and other contaminating substances off printed circuits of the welding machine boards, punch cutters, press brakes and all other electrical conductors used in the manufacturing process. Thus, the Taxpayer maintains that the CRC contact cleaner serves an exempt manufacturing function and, therefore, is exempt from the tax.
As noted above, the manufacturing exemption does not apply to incidental activities such as general maintenance. Further, Title 23 VAC 10-210-920 provides that the tax applies to items "used in the repair, servicing, and maintenance of production machinery ...." Based on the product information, the CRC contact cleaner is a cleaning solvent used to eliminate carbon deposits or contaminants that cause corrosion on production equipment. The CRC contact cleaner is clearly used in a maintenance function and is taxable. See P.D. 96-36 (4/3/96).
Penalties
Penalty was assessed to the Taxpayer's two locations on the untaxed purchases of tangible personal property. The Taxpayer claims that the alternative method used to determine the level of use tax compliance is unfairly biased against manufacturers by allowing dealers to include in the formula's numerator the measure of tax paid to vendors. The Taxpayer also requests waiver of the penalty on its new location because this is a first audit of this business.
In computing use tax compliance under the alternative method, the "measure paid to vendor" is included in both the numerator and denominator of the use tax compliance ratio formula. Thus, the alternative method provides only a larger population and does not change the formula for computing the use tax measure. I would point out that the formula does not exclude the "measure paid to vendors" in the denominator, as indicated by the Taxpayer. Therefore, the Taxpayer's argument that dealers have an advantage over manufacturers in computing the measure of compliance on purchases is not valid.
Title 23 VAC 10-210-2032 addresses audit penalty regarding new locations and states, "The audit of a business that has experienced a change in responsible partners or officers or the addition of new locations, and where the business is conducted in the same manner and for the same purposes as during the prior audit, will not be considered a first audit for purposes of this subsection." Based on the above, I cannot consider the current audit of the new location as a first audit for audit penalty purposes.
This same regulation provides that penalty will generally be applied on third and subsequent audit unless the compliance ratio exceeds 85% for use tax. In this case, the use tax compliance ratios for the Taxpayer's two locations are 59% and 51%. The Taxpayer has not demonstrated a sufficient level of tax compliance to warrant a waiver of the assessed penalties.
Subsequent to the audit revision regarding the certified pollution control equipment issue, the use tax compliance ratio will be recomputed. Once a new compliance ratio has been established, the penalty will be applied in accordance with the tolerances established in the regulation.
Conclusion
The audit will be revised to remove the exempt certified pollution control equipment. In addition, I will allow the Taxpayer 30 days from the date of this letter to furnish to the auditor documentation regarding the purchases it claims were capitalized. Following the auditor's review of the documentation or the expiration of 30 days if no documentation is furnished, the Taxpayer will receive a revised audit report reflecting the appropriate revisions. A revised bill will be sent to the Taxpayer shortly thereafter.
Please note that Va. Code § 58.1-1840.1 mandates the imposition of an additional 20% penalty (in addition to all other penalties) on unpaid tax assessments that were eligible for Virginia's Tax Amnesty Program. In this case, the additional 20% penalty, plus additional accrued interest, will be imposed on the unpaid tax unless the Taxpayer pays the outstanding balance within 30 days from the date of the revised bill. The Taxpayer should remit its payment to: Virginia Department of Taxation, Post Office Box 27203, Richmond, Virginia 23261-7203, Attn: *****.
The Code of Virginia sections, regulations and public documents cited are available on-line 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 about this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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Kenneth W. Thorson
Tax Commissioner
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AR/48809, 48810T
Rulings of the Tax Commissioner