04-45 | Virginia Tax

Tax Type

BPOL Tax

BTPP Tax

Description

Taxpayer classified service business vs manufacturer

Topic

Documents Subject to Tax

Local Power to Tax

Date Issued

08-13-2004

August 13, 2004

Re: Appeal of Final Local Determination
Taxpayer: *****
Locality: *****
Business Tangible Personal Property (BTPP) Tax
Business, Professional and Occupational License (BPOL) Tax

Dear ************:

This final state determination is issued upon the application for correction filed by your firm on behalf of ***** (the "Taxpayer") with the Department of Taxation. You appeal ***** (the "County") final local determination that the Taxpayer should be classified as a business service rather than as a manufacturer and, therefore, is not entitled to the manufacturer's exemption from certain BTPP taxation. You also ask for a correction of a BPOL tax assessment issued by the ***** (the "Town"). I apologize for the delay in the Department's response.

The local license tax and fee are imposed and administered by local officials. Virginia Code § 58.1-3703.1(A)(5) authorizes the Department to issue determinations on taxpayer appeals of certain BPOL tax assessments. Virginia Code § 58.1-3983.1 authorizes the Department to issue determinations on taxpayer appeals of certain BTPP tax assessments. On appeal, a BPOL tax or a BTPP assessment is deemed prima facie correct, that is, 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 whether the Taxpayer should be classified as a manufacturer. Its classification would determine whether it is subject to the BTPP and BPOL taxes imposed by the County and the Town, respectively.

The Town has refrained from issuing a final local determination until such time as the Tax Commissioner has reviewed the County's final local determination on the Taxpayer's classification for purposes of the BTPP tax. After receipt of the Tax Commissioner's final determination, the Town will issue its final local determination on the Taxpayer's request for correction of the Town's BPOL tax assessment.

The Code of Virginia sections 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 represents itself as "pioneers in the design of high-volume systems for turning paper mail into web-retrievable documents." According to the Taxpayer, its core business is helping companies access documents electronically using standard technologies. The Taxpayer takes a wide variety of document types. (standard correspondence, blueprints, forms, financial sheets, etc.), scans them and indexes the data using both human review and computer programs. Once the review of the indexed data is complete, it is returned to the client in whatever format the client has requested. Formats include streaming tape formats, CD-ROM, DVD-ROM, magnetic media systems or material hosted on in-house systems for client access through secure network connections. The Taxpayer states that more than 45 percent of its work product is delivered on a tangible medium.

The Taxpayer states its "business infrastructure products and services enable everyday users to file, manage and retrieve documents on their public and private network web sites faster, better and less expensively than they can file and retrieve the paper itself." The Taxpayer also engages in image based hosting, co-location and remote indexing. The Taxpayer's hosting services range from managing image arrays to full site and retrieval system management by the Taxpayer. Additionally, the Taxpayer's services make it possible for clients to develop index image data remotely.

The County has classified the Taxpayer as a business service for purposes of BTPP taxation, citing Hartranft v. Weigmann, 121 U.S. 609 (1887). In this case, the United States Supreme Court found that in order to be classified as a manufacturer, there must be a transformation; a new and different article must emerge, having a distinctive name, character or use. The County found that "[t]he printed or computer output data is meant to be read and the words and images are the same from the beginning of this process to the end." Although the media through which the Taxpayer's end product was viewed changed during the process, and the end product has a valueadded nature, there was no transformation of new material.¹

The Taxpayer contends that it is a manufacturer, meeting the three-part test of taking raw material (the customer's paper, microfilm or electronic inputs), scanning them (transformation into electronic code), and producing a different tangible medium. The Taxpayer states that as a manufacturer, certain tangible personal property it uses in its business should be classified as intangible, pursuant to Va. Code §§ 58.1-1100 and 58.1-1101.

ANALYSIS

Pursuant to Article X, § 4 of the Constitution of Virginia, tangible personal property is segregated for local taxation. Intangible property is segregated for state taxation, and the General Assembly has provided that among the subjects defined as "intangible personal property" is "Capital which is personal property, tangible in fact, used in manufacturing . . . businesses." See Va. Code § 58.1-1101. The Taxpayer contends that it is a manufacturer and, therefore, capital used in its manufacturing business should be classified as intangible personal property exempt from the local BTPP tax.

Is the Taxpayer a Manufacturer?

The local tax statutes in the Code of Virginia do not define the term "manufacturing" for purposes of the BTPP tax. 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. County of Chesterfield v. BBC Brown Boveri, 238 Va. 64 (1989). In summary, for BTPP tax purposes, a manufacturer means one 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 the present case, the original material has merely been reformatted and indexed in such a fashion as to enhance its usefulness. The essential substance and character of the original material has not been changed. It has merely been subjected to a process that makes data retrieval more manageable. The Taxpayer's clients could in all probability perform the same functions in-house should they so desire. I must agree with the County in its finding that the Taxpayer is not a manufacturer. Rather, it is providing a business service.

In a similar case, the Maryland Tax Court held that while it appeared that a new product emerged from the taxpayer's services, it emerged from "ideas, concepts, thoughts, problems and solutions. A program is being written that allows the computer to access and store information more efficiently. In its base elements, the product is a solution and directives created by human intellect that is placed in a form that a computer can process." Qstar Technologies, Inc. v. State Department of Assessments and Taxation, Maryland Tax Court, TP-C No. 765, August 18, 1994.

The Taxpayer has also used the "substantiality test" of BBC Brown Boveri to substantiate its contention that it is a manufacturer. That test was thoroughly discussed in Public Document (P.D.) 02-120 (9/25/02). While the burning of the CD-ROMS and the DVD-ROMs can be considered to be a manufacturing activity, such activity is ancillary to the Taxpayer's major function of providing clients with custom-designed, state-of-the-art data management services. Therefore, the question of substantiality is not appropriate in this case. The Taxpayer holds itself out as a provider of data management services in a variety of forms: electronic storage, electronic transmittal of reconfigured records and CD-ROMs. The production of the CD-ROMs is ancillary to its primary function of providing data management services.

Business Service

The Taxpayer's primary function is that of "data processing," which is defined as the "storing or processing of data by a computer.”²

Data processing, computer and systems development services are all classified as "Repair, Personal, Business and Other Services" in the 2000 BPOL Guidelines. The Taxpayer's representation of its service leads to no other conclusion other than it is a business service for BPOL purposes. This method of classification generally, but not always, lends itself to classification for purposes of the BTPP tax as well. I believe it does so in this case.

BTPP Subject to Local Taxation

Business tangible personal property is subject to local taxation. Virginia Code § 58.1-3506 establishes separate classifications for certain items. Among these are:

- Computer hardware used by businesses primarily engaged in providing data processing services to other nonrelated or nonaffiliated businesses; and

- Programmable computer equipment and peripherals employed in a trade or business.

Because the Taxpayer has been determined to be a business service, rather than a manufacturer, all such capital is subject to the BTPP tax. In accordance with Va. Code § 58.1-3506, the rates of tax and rates of assessment for the items enumerated above may not exceed that applicable to the general class of tangible personal property.

Intangible Property

As discussed earlier, certain properties are defined as "intangible" and subject to state taxation only. This classification includes computer application software that is not inventory. Such software is defined as "computer instructions, in any form, which are designed to be read by a computer and to enable it to perform specific operations with data or information stored by the computer." Therefore, such application software used by the Taxpayer is intangible property and is not subject to the BTPP.

Sales Tax Law

The Taxpayer refers to sections of the sales tax law in presenting its argument that it is a "manufacturer." Specifically, the Taxpayer refers to P.D. 87-8 (1/15/87) in its appeal, stating its situation is analogous to the facts presented in that ruling.

Public Document 87-8 is a sales tax ruling in which the Tax Commissioner found that, for purposes of the sales and use tax, "machinery, tools and supplies used directly in the production of microfilm and microfiche copies for sale or resale qualify for the industrial manufacturing exemption." The Taxpayer suggests that the re-creation of data is analogous to its activities. It is important to note that local taxes have their own characteristics, separate and distinct from the sales and use tax. There are occasions in which the facts of the case are such that the provisions of the sales and use tax law and the BPOL law are quite similar for purposes of the application of the law. See, for example, P.D. 99-200 (7/23/99). The facts of each situation determine the extent to which the situations are analogous for purposes application of the BPOL, the BTPP or the machinery and tools tax law. It is my opinion that the facts of this case do not merit drawing such an analogy.

Furthermore, the Attorney General has noted that the BTPP tax is a tax on property, with specific exemptions that are not related to either the sales tax or the income tax. [See 1983-1984 Report of the Att'y Gen. 373 (December 28, 1983), in which the Attorney General emphasized that the definitions of words and phrases in Va. Code § 58.1-602 apply only to that Chapter of the Code of Virginia].

DETERMINATION

For the reasons stated above, I agree with the County's finding that the Taxpayer is a provider of business services. Accordingly, the County's final local determination is upheld.

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/40748H

¹Furthermore, the County noted that the Taxpayer had filed its business license with the Town of Warrenton (the "Town") as a "business service in order to comply with the Town's zoning ordinance which prohibits manufacturing enterprises from operating in the Town's central business district." The County suggests that the Taxpayer cannot claim to be a business service in one jurisdiction and a manufacturer in another.
2American Heritage College Dictionary, 3rd Edition. Houghton Mifflin Company, Boston, (2000).

Rulings of the Tax Commissioner