Tax Type
Machinery Tools Tax
Description
Coal and oil-fired electric generating facility, manufacturing equipment
Topic
Local Power to Tax
Property Subject to Tax
Date Issued
08-18-2004
August 18, 2004
Re: Appeal of Assessment: Final Local Determination
Taxpayer: *****
Locality Assessing Tax: *****
Machinery and Tools (M&T) 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") valuation of certain properties for purposes of the M&T tax. I apologize for the delay in the Department's response.
The M&T tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 (D) authorizes the Department to issue determinations on taxpayer appeals of M&T tax assessments. On appeal, a M&T tax 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 the question of whether or not the cost basis utilized by the City was correct for the valuation of the property in question for tax year 2001.
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's property is a coal and oil-fired electric generating facility located in the City. It was purchased in December 2000 from another entity, along with three power plants in another state, a production service center, ash storage sites, rail cars and an oil pipeline. The assets in question were valued by the City for tax year 2001 by applying a depreciation factor of 20 percent to the original cost of ***** as reported on the Taxpayer's "Schedule B" of the City business personal property tax return form. Schedule B is for "Manufacturing Equipment Only (Machinery and Tools)." [Emphasis added.] Taxpayers must attach a federal Form 4565 to the City's business personal property return. Furthermore, all personal property "must be substantiated through the following documentation: Assets or Equipment Journal, Federal Form 4562 or Federal Schedule L of Form 1120." The depreciation schedule for machinery and tools as listed on the City's "Return of Business Personal Property" lists 80 percent of the original cost of machinery and tools used in manufacturing and purchased in calendar year 2001.
The Taxpayer contends that the tax should be computed by applying the 20 percent depreciation factor to the Taxpayer's allocated tax basis of ***** as reported on the Taxpayer's amended federal income tax return. The Taxpayer states that it included out-of-market contracts in its original filing of the City tax return, and these contracts do not constitute machinery and tools. Rather, the Taxpayer states that the allocated costs reported on its amended federal return, which was filed subsequent to the filing of its City return, represent the true "original cost" of the machinery and tools located at its facility in the City.
Specifically, the Taxpayer asserts that the inclusion of out-of-market contracts on the book basis effectively results in the inclusion of intangible property, which, in fact, is exempt from local taxation pursuant to Va. Code § 58.1-1100, et. seq. The Taxpayer included these contracts in its reporting of "original costs" in its initial filing of the M&T tax returns with the City.
In response to this, the City contends that "[i]f the subsequent tax treatment of the 'out-of-market' contracts created a deferred liability or asset, that should have been taken into effect in determining the book basis of the assets and thus would have been considered in the fair market value of the assets acquired."
To summarize, the questions presented to the Tax Commissioner by the Taxpayer are:
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- 1. Is the City correct in utilizing original cost as a basis for the valuation of machinery and tools for the purposes of local M&T taxation?
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- 2. Are the out-of-market contracts included in the original cost, as reported by the Taxpayer, tangible personal property or in fact intangible and, therefore, segregated for state taxation only (i.e., exempt from local M&T taxation)?
ANALYSIS
Original Cost as Basis for Valuation
The Code of Virginia is quite explicit on the authority of localities to impose a tax on machinery and tools used in manufacturing. Virginia Code § 58.1-3507(A) states that certain machinery and tools are to be segregated for local taxation only.
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- Machinery and tools, except machinery and equipment used by farm wineries as defined in § 4.1-100, used in a manufacturing, mining, water well drilling, processing or reprocessing, radio or television broadcasting, dairy, dry cleaning or laundry business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only. [Emphasis added.]
The generation of electricity is recognized as a manufacturing process. Virginia Code § 58.1-3507(B) states that such "[m]achinery and tools . . . other than energy conservation equipment of manufacturers, shall be valued by means of depreciated cost or a percentage or percentages of original total capitalized cost excluding capitalized interest." [Emphasis added.]
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, which 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's valuation method of applying a rate of 80 percent of original cost to machinery and tools is in accordance with the prescribed method as provided for in Va. Code § 58.1-3507(B). What is in question are those capitalized costs that can be properly included as "machinery and tools." Can the Taxpayer's out-of-market contracts, which were initially included in both the Taxpayer's original City and Federal tax returns as part of its original cost, be included or are they intangible property?
The Taxpayer amended its tax returns because it regarded its out-of-market contracts as intangible property, and contends that as such these costs cannot be included for purposes of the M&T tax. A prior Opinion of the Attorney General found that "Under § 58.1-3507(B), capitalized interest must be excluded but other capitalized costs for installation, engineering and construction should be included" as assessable under the M&T tax. 1991 Att'y. Gen. Ann. Rep. 297, 301 (1991). The opinion did not address the issue of out-of-market contracts. A more recent decision of the Virginia Supreme Court clearly defines what constitutes machinery and tools. Citing previous opinions of the Attorney General, the Court stated:
- [T]he Attorney General has consistently opined that machinery and tools used in a particular manufacturing business "are the machinery and tools which are necessary in the particular manufacturing business and which are used in connection with the operation of machinery which is actually and directly used in the manufacturing process." City of Winchester v. American Woodmark Corp., 250 Va. 451 (1995).
Out-of-Market Contracts: Tangible or Intangible Property
The Taxpayer contends that its out-of-market contracts do not constitute machinery and tools. The Taxpayer maintains that the contracts are intangible property and, therefore, are not subject to the machinery and tools tax. It is, therefore, useful to review the definitions of tangible property and intangible property.
Tangible property is generally defined as property that "is capable of being handled, felt or touched, and may be evaluated by its physical senses; it is property having substance or body and which is capable of being possessed or realized." American Jurisprudence, Second Edition, Vol. 63C § 9. Lawyers Cooperative Publishing, Rochester New York, 1997.
Black's Law Dictionary defines tangible personal property as "property such as a chair or watch which may be touched or felt in contrast to a contract." Black's Law Dictionary, Fifth Edition. West Publishing Company, St Paul Minnesota, 1979. [Emphasis added.]
Intangible property, on the other hand, consists of rights not related to physical things, but merely are relationships between persons, natural or corporate, which the law recognizes by attaching to them certain sanctions enforceable in the courts. Intangible property may be evidenced by a document with no intrinsic value, such as a stock certificate. According to this widely accepted definition, contracts fall under the definition of "intangible property."
Pursuant to Va. Code § 58.1-3500, tangible personal property consists of all personal property not otherwise classified by Va. Code § 58.1-1100 as intangible personal property or by Va. Code § 58.1-3510 as merchants' capital. Such tangible personal property is segregated for and subject to local taxation only. Intangible personal property, including capital of a trade or business of any person, firm or corporation, except for merchants' capital as defined in Va. Code § 58.1-3510 that is subject to local taxation, is segregated for state taxation only. Virginia Code § 58.1-1100.
Machinery and tools used in the manufacturing process are clearly tangible property and, therefore, subject to the local M&T tax. A contract for the provision of services cannot be considered a tangible part of the manufacturing process.
DETERMINATION
It is clear from both the Code of Virginia and the City's business personal tax return forms that the M&T tax applies to manufacturing equipment only. The Taxpayer erroneously included the value of the contracts it acquired in its initial calculation of "original cost" for purposes of reporting its M&T tax due the City. Therefore, I am returning this matter to the City with the instruction to recalculate the M&T tax due on the basis of 80 percent of the original cost of the machinery and tools used in the Taxpayer's manufacturing process. The cost of the out-of-market contracts should not be included. Only the "original cost" of the machinery and tools at the time of acquisition is to be used as the "original cost" basis. Contracts are considered intangible property and, therefore, are not be subject to the machinery and tools tax.
If you have any questions regarding 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/40339
Rulings of the Tax Commissioner