Tax Type
Retail Sales and Use Tax
Description
Manufacturer of cigarettes and smokeless tobacco products
Topic
Assessment
Manufacturing Exemption
Date Issued
10-07-2004
October 7, 2004
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear **********:
This will reply to your letter in which you seek correction of a retail sales and use tax assessment issued to your client, ***** (the "Taxpayer"), for the period January 1999 through March 2002. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a manufacturer of cigarettes and smokeless tobacco products. An audit of the Taxpayer's business by the Department resulted in an assessment of use tax on various purchases. The Taxpayer disputes the assessment of use tax on tobacco curing barns, contending they are used directly in industrial processing. The Taxpayer also appeals the assessment of use tax on items used at one of the Taxpayer's plants located in Virginia. The Taxpayer suggests that these items qualify for the industrial manufacturing and processing exemption. The items include laboratory testing supplies, and equipment used in the handling, storage and distribution of tobacco.
DETERMINATION
Tobacco Curing Barns: Industrial Processing
The Taxpayer has developed a patented curing process that substantially reduces the levels of certain carcinogens found in tobacco products. The Taxpayer contracts with tobacco farmers to provide, at no cost to the farmers, specially designed tobacco curing barns that are used in the patented process. The Taxpayer retains title to the curing barns and the farmers provide a concrete pad and electrical and gas hook-ups for the barns. The Taxpayer also provides equipment handlers that are used with the barns and transports the barns for placement at the farm sites at no cost to the farmers. The Taxpayer gives farmers detailed procedures on the use of the curing barns to insure the curing process results in the lowest levels of carcinogens in the tobacco.
The farmers agree under the terms of the contract to supply the specially cured tobacco to the Taxpayer. The contract guarantees participating farmers a premium price for the tobacco if the tobacco meets the required levels of carcinogens based on testing performed by the Taxpayer. The Taxpayer is not required to purchase from the farmers tobacco that does not meet the required levels of carcinogens.
The Taxpayer maintains that the curing barns qualify for exemption from sales and use tax because they are used directly in industrial processing. The Department's auditor denied the industrial processing exemption because the barns were not located at a single plant site and the Taxpayer did not own the tobacco that was cured in the barns. Both the Taxpayer and the Department agree that the curing barns are tangible personal property and the Taxpayer's patented curing process makes the tobacco more marketable or useful.
Title 23 of the Virginia Administrative Code (VAC) 10-210-920(B)(1) defines industrial processors to be:
- establishments engaged in the treatment of materials, substances, or other products in such a manner as to render such products more useful or marketable. Products need not undergo a change in state or form in order
for an establishment to be classified as an industrial processor.
In this case, the Taxpayer is a manufacturer of tobacco products, but the Taxpayer does not itself process or cure tobacco with the curing barns. The Taxpayer merely contracts to provide farmers with the curing barns and places the barns on the farmers' sites. The farmers, using procedures provided by the Taxpayer, are the processors curing their tobacco in the barns. The farmer is responsible for the correct use of the drying equipment to cure the tobacco and assumes the economic risk of producing tobacco that must meet the carcinogen standards required by the Taxpayer.
Title 23 VAC 10-210-920(A) states, "for a business to obtain the [industrial manufacturing] exemption, it first must be manufacturing or processing products for sale or resale and secondly, such production must be industrial in nature." Virginia Code § 58.1-602 contains a definition of "manufacturing, processing, refining, or conversion." The Department uses this definition as a guideline to determine if businesses are engaged in industrial manufacturing or processing. The definition states that the term "industrial in nature" shall include businesses classified in codes 10 through 14 and 20 through 39 of the Standard Industrial Classification ("SIC") Manual.
The farmers under contract with the Taxpayer perform the curing or processing of the tobacco. Tobacco farmers are classified in SIC Industry Number 0132, an agricultural code. The North America Industry Classification System ("NAICS"), which replaced the SIC Manual in 1997, classifies tobacco farmers in industry group 111910. Both the SIC and NAICS classifications put tobacco farmers in agricultural codes that fall outside the statutory industrial manufacturing and processing classifications in codes 10 through 14 and 20 through 39. The processing of tobacco by the farmers is clearly incidental to the farmers' primary business of farming tobacco.
The Department agrees that the Taxpayer's tobacco curing method results in tobacco that is more marketable than tobacco cured by traditional flue-cured methods. However, the tobacco farmers are the establishments that perform the tobacco curing. The Taxpayer does not perform industrial processing with respect to the use of the curing barns. Using the Department's criteria, the industrial processing exemption does not apply to the Taxpayer's purchase of the curing barns. The assessment of use tax on the curing barns is correct.
Agricultural Exemption
The Department denied the agricultural exemption on the Taxpayer's purchase of the barns because the barns were not used to cure tobacco owned by the Taxpayer. Title 23 VAC 10-210-50(A) states that the agricultural exemption applies to "farm machinery and agricultural supplies sold to farmers for use in agricultural production for market." (Emphasis added). While the Taxpayer owns the curing barns, the farmers use the barns to cure tobacco grown on their farms. The Taxpayer provides the curing barns to farmers at no charge. The Taxpayer is not a farmer, and because the curing barns were not sold or leased to farmers for the purpose of producing crops for market, the agricultural exemption is not available on the Taxpayer's purchase of the curing barns.
This position is supported by Public Document 94-68 (3/17/94), in which a business that loaned farm equipment to farmers was held liable for use tax on purchases of the equipment. The agricultural exemption did not apply to the equipment purchased because the equipment was not sold or leased to farmers as required by the regulation. The equipment was provided at no charge to the farmers. The Department ruled that the loaning of the equipment to farmers was considered a taxable use of the equipment by the business.
Property Used at the Virginia Plant
Baling Equipment
The Taxpayer maintains that certain equipment at its Virginia plant qualifies for the industrial manufacturing and processing exemption but was held taxable in the audit. The items include a baling press, bale lifter and power balers used in the handling and storage of incoming raw tobacco and the packaging of tobacco for transportation to purchasers. The equipment is used to press the tobacco into bales for shipment. The Taxpayer notes that the equipment is essential for this purpose.
The Taxpayer has not provided evidence that the baling equipment is used directly in industrial manufacturing or processing. The baling is performed at the plant to facilitate the shipment of the tobacco to customers. The handling and subsequent baling of incoming tobacco for shipment to customers is a distribution function. The distribution of goods by manufacturers and processors is a taxable activity and does not qualify for exemption. Title 23 VAC 10-210-920(C)(3) discusses the distribution function and states that tangible personal property used in this manner is taxable. Use tax was properly assessed on the baling equipment.
Truck Unloading System
The Taxpayer uses a truck unloading system for the handling and storage of incoming raw tobacco. The unloading system tracks the tobacco delivered by farmers to the Taxpayer's receiving station. The system assists graders in determining the price of the tobacco.
The Taxpayer has not provided evidence that the truck unloading system at the ***** plant is used directly in industrial manufacturing or processing. The Taxpayer uses the system to track and price incoming tobacco. The use of the truck unloading system in this manner is an administrative function. Administrative activities are taxable as discussed in Title 23 VAC 10-210-920(C)(1). Use tax was properly assessed on the truck unloading system.
Lab Supplies
The Taxpayer states that lab supplies are used at the Virginia facility for production line quality control. The lab supplies are used to test incoming tobacco and confirm that the tobacco meets the Taxpayer's low carcinogen standards.
The Taxpayer has not provided evidence that the lab supplies at issue are used directly in industrial manufacturing or processing. The Taxpayer states that the testing occurs on the production line but has not provided detailed information to substantiate that the production line is part of an exempt industrial manufacturing or processing activity. Quality control testing performed by the Taxpayer solely to verify carcinogen levels in the tobacco as part of the distribution function at the Taxpayer's plant is a taxable activity.
The Department's determination on the property used at the Taxpayer's Virginia plant is based on information gathered by the Department's auditor during a tour of the plant. While the Taxpayer does manufacture products at this facility, the equipment and supplies at issue are not used directly in the production of these products. The items under appeal are used to handle incoming tobacco, test the tobacco and ship the tobacco to customers.
Conclusion
Based on the determination above, the Taxpayer's audit assessment is correct. The Taxpayer should remit its payment for the outstanding balance of ***** within 30 days from the date of this letter to avoid the accrual of additional interest. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Attention: *****, Richmond, Virginia 23230. If you have any questions concerning payment of the assessment, you may contact ***** at *****.
The Code of Virginia sections, public documents and regulations cited are available on-line in the Tax Policy Library section of the Department's web site, located at www.tax.state.va.us. If you have any questions concerning this determination, please 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
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AR/42348S
Rulings of the Tax Commissioner