Tax Type
Retail Sales and Use Tax
Description
Industrial manufacturing and research and development activities exemptions
Topic
Appropriateness of Audit Methodology
Exemptions
Date Issued
03-19-2004
March 19, 2004
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *************:
This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") for the audit period July 1997 through December 2002. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a manufacturer of fuel injectors and fuel rails for the automotive industry. The Taxpayer also builds and sells prototypes of the same. The prototypes are built to customer specification. Once the customer is satisfied with the prototype, the Taxpayer manufactures the product in accordance with the prototype design. You maintain that the industrial manufacturing exemption applies to the equipment used in the Taxpayer's prototype lab and on the Taxpayer's production line. You also believe the equipment at issue is used in exempt research and development activities.
DETERMINATION
Research and Development Exemption
Virginia Code § 58.1-609.3(5) provides a sales and use tax exemption for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense. [Emphasis added].
Title 23 of the Virginia Administrative Code (VAC) 10-210-3070(A) provides that research and development means a systematic study or search directed toward new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process. Research and development must have as its ultimate goal: (i) the development of new products; (ii) the improvement of existing products; or (iii) the development of new uses for existing products. Research and development does not include the modification of a product merely to meet customer specifications unless the modification is carried out under experimental or laboratory conditions in order to improve the product generally or to develop a new use for the product.
Title 23 VAC 10-210-3071(B) provides that when a single item is used both in exempt and nonexempt activities, it is not used exclusively in research activities and is taxable.
In this instance, once the prototype is built for the Taxpayer's customers, the Taxpayer continues to modify the prototype to meet its customers' specifications. The modifications are not carried out to improve the product generally or to develop a new use for the product as required by Title 23 VAC 10-210-3070. Additionally, the Taxpayer indicates that the equipment at issue is used 60% to 70% of the time for prototype production. Thus, the equipment is not used exclusively for research and development activities as required by Title 23 VAC 10-210-3071. Finally, the testing conducted by the Taxpayer with regard to the prototypes is not considered research pursuant to the provisions of Title 23 VAC 10-210-3070. Accordingly, the research and development exemption does not apply to the equipment used to build the prototypes.
Industrial Manufacturing Exemption
Virginia Code § 58.1-609.3(2)(iii) and Title 23 of the Virginia Administrative Code (VAC) 10-210-920(A) provide that the retail sales and use tax does not apply to machinery, tools or repair parts, fuel, power, energy or supplies used directly in manufacturing or processing. Pursuant to Title 23 VAC 10-210-920(C)(2), equipment used for production line testing or quality control is classified as exempt production equipment. Testing for the purpose of improving administrative efficiency or any other testing not relating to quality control is taxable.
Prototype lab
Pursuant to Public Document (P.D.) 99-21 (3/4/99), the Department's long-standing policy is that preproduction activities are taxable because they are not an immediate part of actual production. In P.D. 99-21, a computer aided design (CAD) system used to make drawings used in the design of a manufactured part was deemed taxable, as the system was used to make preproduction drawings determined not to be a part of actual production.
In accordance with P.D. 99-21, the items of tangible personal property used in the Taxpayer's prototype lab are used for preproduction activities. The prototypes developed by the Taxpayer are not an immediate part of the actual production of the end product that is produced by the Taxpayer for its clients. The items of tangible personal property purchased for use in the Taxpayer's prototype lab are subject to the tax.
Exempt items
As a manufacturer, the Taxpayer is eligible for the industrial manufacturing exemption with regard to some items of tangible personal property. As previously mentioned, the items of tangible personal property purchased by the Taxpayer and used directly in production or production line testing are exempt from the tax. Specifically, the following items are removed from the audit assessment because they qualify for the industrial manufacturing exemption: Line items 1, 4, 6, 25, 64, 66, and 68. Line item 86 remains in the assessment because this item of tangible personal property is not used directly in production.
Line items 52 and 78 are removed from the audit assessment because these items of tangible personal property are located in other states and not used in Virginia.
Conclusion
Based on this determination, the items used directly in the industrial manufacturing process (as specified above) qualify for exemption and will be removed from the audit. In all other respects, the assessment is correct. A revised audit and updated bill with interest accrued to date will be mailed shortly to the Taxpayer. No additional interest or penalties will be assessed if the outstanding balance is paid within 30 days of the date of the updated bill.
The Code of Virginia sections, regulations and public documents cited, along with other reference documents, 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 about this response, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
-
-
-
-
-
-
-
- Sincerely,
-
-
-
-
-
-
-
-
-
-
-
-
-
- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
-
-
-
-
-
-
AR/45973P
Rulings of the Tax Commissioner