04-21 | Virginia Tax

Tax Type

BTPP Tax

Machinery Tools Tax

Description

Taxpayer classification as a manufacturer or a processor

Topic

Local Power to Tax

Date Issued

06-02-2004

June 2, 2004

Re: Appeal of Assessment: Final Local Determination
Taxpayer: *****
Locality Assessing Tax: *****
Business Tangible Personal Property (BTPP) Tax
Machinery and Tools (M&T)
Business, Professional and Occupational License (BPOL) tax

Dear *********:

This final state determination is issued upon the application for correction filed by you on behalf of ********** (the "Taxpayer") with the Department of Taxation. You appeal the ******** (the "City") finding that the Taxpayer is a processor, and not a manufacturer, in determining the rate of the City's BTPP tax as it applies to the Taxpayer's machinery and tools. The City also directed the Taxpayer to file a BPOL tax return for license year 2003, as a processor.

The BTPP, M&T and BPOL taxes are imposed and administered by local officials. Virginia Code § 58.1-3983.1(D) authorizes the Department to issue determinations on taxpayer appeals of BTPP and M&T tax assessments. Virginia Code § 58.1-3703.1(D) authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a local tax assessment is deemed prima facie correct. In other words, the local assessment will stand unless the taxpayer proves that it is incorrect.

The following determination is based on the facts presented to the Department as summarized below. This determination addresses the question of whether the Taxpayer should be classified as a manufacturer or a processor for purposes of the City's tangible personal property and license tax assessments.

Copies of 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.

FACTS

The Taxpayer states that "it is in the business of converting lye soap stock, a byproduct of another manufacturing process, consisting of 60 percent water and 40 percent soap, into an edible feed stock oil and glycerin." The Taxpayer states that it sells both the feed stock oil and glycerin at wholesale. The original product (lye soap stock) is combined with sulfuric acid and heat. The resulting endothermic chemical reaction produces an edible fatty acid and glycerin. These products are "then dried, filtered and sold predominately to the animal feed marketplace under the name of feed fat." The Taxpayer contends that such activities constitute manufacturing for purposes of local business taxation.

The City maintains there is no substantial change or transformation of the raw materials into articles or products of a substantially different character. Accordingly, the City has determined that the Taxpayer does not qualify as a manufacturer and has classified the Taxpayer as a processor. The City assessed the Taxpayer at the BTPP rate of $4.35 per $100, rather that the lower M&T rate of $3.00 per $100 that the City applies to manufacturers. The Taxpayer disputes this, stating that the original product is indeed soap stock, not oil, and that the processing of the soap stock produces two products that are substantially different in chemical structure, character, and use.

ANALYSIS

Manufacturers

For local tax purposes, the term "manufacturer" is not defined in the Code of Virginia. The Supreme Court of Virginia has developed a test involving three essential elements in determining whether a manufacturing activity is being undertaken. These elements are: (1) original material, referred to as raw material; (2) a process whereby the original material is changed; and (3) a resulting product, which by reason of being subject to such processing is different from the original material. Prentice v. City of Richmond, 197 Va. 724, 729 (1956). Thus, for local tax purposes, a manufacturer is defined as one who is engaged in a processing activity whereby the original materials are transformed into a product that is substantially different in character from the original materials. In other words, "while all manufacturing is a type of processing, not all processing constitutes manufacturing." Commonwealth v. Orange-Madison Coop., 220 Va. 655, 658 (1980).

The information provided indicates that the Taxpayer's process starts with one previously manufactured material (lye soap stock). The material undergoes a chemical process, resulting in two different products. You indicate that the Taxpayer then sells these products at wholesale to different users, primarily in the animal feed industry.

The City, in its rejection of the Taxpayer's appeal, cites Solite Corp v. King George County, 220 Va. 661 (1980), in which the Court ruled that taking a mixture of rock sand and clay and producing sand and gravel was processing but not manufacturing. In its conclusion in Solite, the Court found that, "after Solite's processing of the raw materials, the sand is still sand and the rock is still rock. The sand and gravel marketed by Solite have not been transformed into articles of substantially different character." In the present case, the question presented is: Does the Taxpayer's process of taking lye soap stock and converting it through a chemical process into an edible oil used in the making of animal feed and a byproduct of glycerin constitute manufacturing?

Other rulings of the Supreme Court of Virginia, opinions of the Attorney General and rulings by the Tax Commissioner would suggest that this activity does indeed constitute manufacturing. In Commonwealth v. Meyer, 180 Va. 466, 473 (1942), the Court found that: "A hog on the hoof put through the plaintiffs' packing plant is no longer a hog. It comes out as hams, shoulders, middlings, sausage, souse, chitterlings and other articles of commerce fit for consumption." An opinion of the Attorney General found that the pasteurization of milk did not constitute manufacturing, stating "none of the milk processes you describe would, in my opinion, constitute manufacturing, because the processing does not transform the milk into a product of substantially different character." In the same opinion, however, the Attorney General found that the addition of flavored powders and powdered tea and sugar to water did constitute manufacturing. 1995 Op Va. Att'y Gen., 257, 258, 259. The Tax Commissioner has also ruled on this issue in Public Documents (P.D.) 01-41 (04/13/01) and 02-01(01/04/02). In the first document, the Tax Commissioner determined that the blending together of certain ingredients to make salad dressing is manufacturing. In the second, he found that the processing of live chickens into various ready-to-eat meals and condiments is manufacturing, as long as this activity constituted a substantial part of the taxpayer's business.

Based upon the information provided, and a review of case law, opinions of the Attorney General and rulings by the Tax Commissioner, it would appear that the Taxpayer's business is indeed that of a manufacturer and should be classified as such for purposes of all local business taxes. Contrary to the situation in Solite, the Taxpayer subjects a raw material (lye stock soap) to a process that transforms the original material into products (edible feed stock oil and glycerin) that are substantially different in character from the original material. The chemical process that transforms the raw material is necessary so the resulting products can be used for animal feed. Clearly, without this transformation, the lye stock soap could not be used for a similar purpose.

Taxation of Machinery and Tools

Article X, Section 1 of the Constitution of Virginia provides that all property within the Commonwealth shall be taxed, with the few exceptions and limitations that are provided for by the Constitution. The taxation of business tangible personal property is provided for in Va. Code § 58.1-3500 et seq. Several special categories are created in this chapter, including that of machinery and tools. Virginia Code § 58.1-3507(A) states that certain machinery and tools are to be segregated for local taxation only, and they may be taxed at a lower rate than business tangible personal property. Imposing the M&T tax at a lower rate than the BTPP tax is a local option.

Localities have some discretion in the methodology used in determining the valuation of such property. The only restriction placed on localities is on the rate of the tax. The rate of the tax cannot exceed the rate imposed on the general class of tangible personal property. The City's tax on machinery and tools is less than that imposed on the general class of tangible personal property. The City has chosen to isolate the categories of "Manufacturer, Miner and Radio or Television Broadcaster" for the machinery and tools classification. Because the Taxpayer is properly classified as a manufacturer, the appropriate M&T rate must be applied.

BPOL Tax

Pursuant to Va. Code § 58.1-3703(C)(4), Virginia localities are prohibited from imposing a license fee or tax "[o]n a manufacturer for the privilege of manufacturing and selling goods, wares and merchandise at wholesale at the place of manufacture."

While I have determined that the Taxpayer is a manufacturer, in order to qualify for the exemption under Va. Code § 58.1-3703(C)(4), the Taxpayer must be selling its product at wholesale from the place of manufacture. The Taxpayer states that it is selling his products at wholesale from the place of manufacture; however, the local commissioner of the revenue must determine this. If the local commissioner of the revenue finds that the Taxpayer is selling his products at wholesale from the place of manufacture, the Taxpayer qualifies for exemption from the BPOL tax.

DETERMINATION

After reviewing the facts as presented, it is my determination that the Taxpayer is a manufacturer and should be taxed accordingly. Therefore, in accordance with the provisions of Va. Code § 58.1-3981, the Taxpayer is entitled to a refund of past BTPP taxes paid with interest and the City must reassess the Taxpayer at the M&T rate.

If you have any questions regarding this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/45999H

Rulings of the Tax Commissioner