Tax Type
Retail Sales and Use Tax
Description
Drilling, extraction, refining, or processing of natural gas or oil; "used directly"
Topic
Appropriateness of Audit Methodology
Exemptions
Date Issued
07-27-2004
July 27, 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 audit assessment issued to your client, ********** (the "Taxpayer"), for the period August 1998 through March 2002. I apologize for the delay in the Department's response.
FACTS
The Taxpayer is an independent contractor engaged exclusively in the construction of gas pipelines from gas well heads to processing plants, all located in Virginia. The Taxpayer's services include clearing pipeline right-of-ways, digging ditches for piping, welding, bending and fusing pipeline, hauling pipe, installing pipeline underground, and covering, testing and hydro-seeding the pipeline right-of-ways. The pipelines constructed by the Taxpayer gather coal bed methane gas from various locations in Virginia and transport the gas to a processing plant located in Virginia where the gas is collected, processed and piped outside Virginia for further processing. The Taxpayer is contesting the entire audit and claims that all purchases are exempt under Va. Code § 58.1-609.3(12).
DETERMINATION
Virginia Code § 58.1-609.3(12) provides a retail sales and use tax exemption for the following:
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- From July 1, 1994, and ending July 1, 2006, raw materials, fuel power, energy, supplies, machinery or tools, or repair parts therefor or replacement thereof, used directly in the drilling, extraction, refining, or processing of natural gas or oil and the reclamation of the well area . . . . For the purposes of this section, "drilling," "extraction," "refining," and "processing" shall include production, inspection, testing, dewatering, dehydration, or distillation of raw natural gas into a usable condition consistent with commercial practices, and the gathering and transportation of raw natural gas to a facility wherein the gas is converted into such a usable condition. Machinery, tools and equipment, or repair parts therefor or replacement thereof, shall be exempt if the preponderance of their use is directly in the drilling, extraction, refining, or processing of natural gas or oil for sale or resale, or in well area reclamation activities required by state or federal law. [Emphasis added.]
As can be seen from a reading of the exemption set forth above, the exemption is limited to tangible personal property "used directly" in drilling, extraction, refining, or processing of natural gas or oil. Virginia Code § 58.1-602 defines "used directly" as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing or mining process, but not including ancillary activities such as general maintenance or administration."
Keeping this in mind, I will address those categories and specific items as set forth in your appeal.
Administrative Supplies: It is a long-standing policy that office supplies and equipment serve an indirect ancillary administrative function and are taxable. See Title 23 of the Virginia Administrative Code (VAC) 10-210-960(B)(9).
Printer/Copier and supplies: The copier/printer is used to copy forms required by federal law to track employee training. In addition, the Taxpayer purchased pens, ink cartridges, and paper used to complete and sign the employee training forms. Diskettes are used to maintain the records of employee training and required safety meetings.
Markers: You indicate that the markers are used to mark steel pipe in order to determine the amount of bend needed to conform to the contour of the land.
Office chairs and other miscellaneous supplies: These items are listed in your appeal; however, you provide no explanation of their use.
As provided above, in order to meet the mining and mineral processing exemption, tangible personal property must be used directly in mining and processing. The fact that a particular item is required either by law or practical necessity does not, of itself, mean that the item is used directly in mining or mineral processing operations. Based on the regulation above, the copier/printer and supplies used in connection with recording employee training is an ancillary administration function and is taxable. Markers used to mark exempt steel pipe is indirectly used in mining and processing and are subject to the tax. Other office supplies and chairs listed in your appeal are property used in administration and are taxable. Accordingly, the tax assessed on the purchase of the printer/copier, office supplies and equipment is correct.
Repair/Replacement Parts: Tangible personal property used in the repair and replacement of worn or damaged exempt machinery and equipment, as well as operating supplies, which are actively and continually consumed in the operation of exempt machinery and equipment, are deemed used directly in mining and/or mineral processing and are not subject to the tax. Repair or replacement parts, fuel, and supplies used in repair or maintenance equipment are subject to the tax. See Title 23 VAC 10-210-960(A)(3)(e).
When a single item of tangible personal property is used in two different activities, one of which is direct use in mining or mineral processing (exempt) and the other of which is a taxable activity, the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in taxable activities. Likewise, tangible personal property will be totally exempt from the tax if the preponderance of its use is in exempt activities. See Title 23 VAC 10-210-960(C).
Steel Doors: The steel doors are installed at the shop where maintenance of heavy equipment is performed. The steel doors are not used directly in the maintenance of exempt equipment and are taxable.
Batteries: The batteries are used in hand-held radios for communication when employees are outside areas where vehicles or equipment are being used. While the batteries are essential for communication among employees on the job, they are not used directly in mining or mineral processing and are taxable.
SOS Kits: Based on the documentation provided, the sales tax was paid on the purchase of the SOS kits. Therefore, this item will be removed from the audit.
Tires and repair/replacement parts for vehicles: The Taxpayer states that the tires are used on trucks to transport equipment from the warehouse to the job site and also used to pull joints on exempt pipe. In this case, the tires are used on both taxable vehicles (for transporting equipment) and exempt vehicles (for pulling pipe). The Taxpayer has provided no documentation to determine the preponderance of the vehicles' use.
I will allow the Taxpayer the opportunity to furnish records substantiating the actual use of the vehicles in each activity. Upon verification of the vehicles' use, the auditor will determine the pro-ration of the tires and parts for purposes of the sales tax, as appropriate. Public Document 01-129 (9/14/01) further addresses the application of the tax to fungible items for dual-use equipment.
Apparel: Title 23 VAC 10-210-960(B)(3) exempts protective apparel (including goggles, lamps, self rescuers, and methanometers) furnished to production personnel. Apparel used in nonoperational aspects of the mining or mineral processing operation (employee comfort and convenience) is subject to the tax. See Title 23 VAC 10-210960(A)(i).
Various jackets/caps and work clothes: The Taxpayer provided no information as to the specific use of the contested apparel. Therefore, there is no basis to adjust the audit at this time. If the Taxpayer can provide evidence that the contested items are protective apparel provided to production personnel, I will remove the items from the audit.
Land Restoration: Title 23 VAC 10-210-960(A)(h) addresses the restoration or conversion of mined land. Restoration activities (recontouring, reseeding, and reforesting the land) required by state or federal law is a part of the mining process when performed by a mining company on land that it has previously mined.
Grass seed: The restoration of land on right-of-ways disturbed by the installation of a pipeline is not land that has been previously mined. Accordingly, the grass seed used to reseed right-of-ways is subject to the tax.
Sales Tax Charged on Invoice: The Taxpayer claims that the auditor held taxable items on which the sales tax was charged. It is the Department's understanding that the auditor verified with the vendor that the tax charged on the contested invoices was not paid by the Taxpayer. Without documentation to verify that the tax was paid on the contested items, there is no basis to adjust the audit.
CONCLUSION
The audit will be revised in accordance with the above determination, and the Taxpayer will receive a revised audit report and bill. If the Taxpayer can provide additional documentation with respect to the "vehicle use" and "apparel" issues, the department will review this information and, if appropriate, revise the assessment. The information should be made available to the Department within 60 days of the date of this letter. The information should be sent to the attention of *****, Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 1880, Richmond, Virginia 23218-1880. If no new information is furnished to the Department within the time allotted, it will be presumed that it is not forthcoming and no further adjustments to the assessment will be made.
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 regarding the documentation needed to determine vehicle use, you may contact ***** Audit Supervisor, at *****. Questions regarding this determination should be directed to ***** at *****.
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- Sincerely,
Kenneth W. Thorson
Tax Commissioner
- Sincerely,
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AR/43949T
Rulings of the Tax Commissioner