Document Number
04-87
Tax Type
Retail Sales and Use Tax
Description
Cigarette manufacturer reclamation activity is industrial processing
Topic
Accounting Periods and Methods
Basis of Tax
Date Issued
08-30-2004

August 30, 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 assessment issued to ***** (the "Taxpayer") for the period February 1997 through December 1999. I apologize for the unusual delay in responding to your letter.
FACTS

The Taxpayer is a cigarette manufacturer that was audited by the Department. The Taxpayer is appealing an assessment of use tax on its purchase of Tersa Bale Heads. The Taxpayer maintains that the Tersa Bale Heads qualify for exemption from sales and use tax because they are used directly in industrial processing.

Based on information provided by the Taxpayer, Tersa Bale Heads are plywood boards that are used with metal straps to create an open container with a top and a bottom. The Taxpayer purchases and provides the Tersa Bale Heads, metal strapping and stretch wrap to a contractor that provides green tobacco leaf processing services. The contractor performs tobacco threshing and drying services to the Taxpayer's specifications.

During the processing performed by the contractor, the tobacco leaf is extruded between the Tersa Bale Heads. A large cube of tobacco ("Tersa Bale") is created that then moves down a conveyor line where another metal strap is placed around the leaf. The Tersa Bale is then wrapped with polyethylene. The contractor ships the Tersa Bale to the Taxpayer's Virginia facility, where it is stored and aged in the Taxpayer's storage sheds for 20 to 24 months. After aging of the tobacco leaf is completed, the Tersa Bales are shipped to the Taxpayer's cigarette manufacturing facility to be manufactured into cigarettes.

In addition to the storage of the Tersa Bales at its Virginia facility, the Taxpayer processes or "reclaims" tobacco from out-of-date and damaged cigarettes. The loose tobacco is then shipped to the Taxpayer's manufacturing plant and remanufactured into cigarettes. A small number of the Tersa Bale Heads are used in the Taxpayer's tobacco reclamation activity at the Virginia site. The Department has recognized the reclamation activity as industrial processing in previous audits.
DETERMINATION

Industrial Processing

The Taxpayer maintains that its Virginia facility is engaged in industrial processing and the Tersa Bale Heads are used directly in industrial processing. The Taxpayer conducts two main activities at its Virginia facility: (1) Tersa Bales are stored and aged at the facility and (2) the Taxpayer processes or "reclaims" loose tobacco from out-of-date and damaged cigarettes. The Department acknowledges that the Taxpayer's reclamation activity is industrial processing but takes the position that the Taxpayer's primary activity, tobacco storage and warehousing, is not industrial processing.

The Taxpayer suggests that the aging of the tobacco constitutes industrial processing and that the storage facility is a plant site used for the processing and manufacture of its tobacco products. For this reason, the Taxpayer argues that the Tersa Bale Heads are used directly in industrial processing and qualify for exemption.

Virginia Code § 58.1-602 states that the term "industrial in nature" shall include businesses classified in codes 10 through 14 and 20 through 39 of the Standard Industrial Classification (SIC) Manual. The Taxpayer's activities, with the exception of the cigarette reclamation activity, most closely resemble those described in the SIC Manual under Major Group 42, Motor Freight Transportation and Warehousing. Under Major Group 42, Industry Number 4221 includes tobacco warehousing and storage. This classification in the SIC Manual best describes the Taxpayer's activities and falls outside the statutory industrial manufacturing and processing classifications in codes 10 through 14 and 20 through 39.

The North American Industry Classification System (NAICS), U.S., 2002, has now replaced the SIC. The NAICS classifies businesses engaged in Farm Product Warehousing and Storage in Industry Group 493130. The Taxpayer's classification in the NAICS Manual is also not considered industrial manufacturing or processing. Based on this criterion, the Taxpayer's storage and warehousing of Tersa Bales does not qualify as industrial processing.

Tobacco reclamation operation

Title 23 of the Virginia Administrative Code (VAC) 10-210-920(B)(1) defines industrial processors as:
    • Establishments engaged in the treatment of materials, substances, or other products in such a manner as to render such products more useful or marketable. Products need not undergo a change in state or form in order for an establishment to be classified as an industrial processor.

The Department agrees that the Taxpayer is engaged in industrial processing with respect to the tobacco reclamation activity at its Virginia location. Tangible personal property used directly in this activity qualifies for the industrial processing exemption. The exemption is limited, however, to property that is used directly in this activity only. Property that is used by the Taxpayer in both taxable and exempt activities is exempt if the property is used 50% or more of the time in the exempt activity (the reclamation process.) The Taxpayer indicates that some of the Tersa Bale Heads are used in the reclamation process. If the Taxpayer can identify and demonstrate that some of the Tersa Bale Heads are used 50% or more of the time in its exempt reclamation process, the audit will be adjusted accordingly.

The Taxpayer should note that the conduct of the exempt reclamation activity does not make the Taxpayer's primary activity at this location, the warehousing and storage of processed tobacco, exempt from sales and use tax. While the storage of the Tersa Bales at the Taxpayer's warehouse facilitates the aging of the tobacco, there is no process or treatment being performed by the Taxpayer on the tobacco. The Tersa Bales merely sit in storage for a certain period of time prior to their shipment to the Taxpayer's cigarette manufacturing plant. The Taxpayer primarily uses the Tersa Bale Heads to facilitate the transportation and storage of tobacco leaf that has been processed and converted into Tersa Bales by the contractor at a separate plant site. The Tersa Bale Heads are used to ship the processed tobacco to the Taxpayer's storage facilities where the tobacco ages. The Tersa Bale Heads are then used to ship the Tersa Bales to the Taxpayer's cigarette manufacturing plant.

Title 23 VAC 10-210-920(B)(2) states that tangible personal property used in activities conducted away from the plant site or used to convey products or materials between two plant sites is not used directly in manufacturing or processing. This is an accurate description of the Taxpayer's use of the Tersa Bale Heads. With respect to the storage of the Tersa Bales, I cannot agree that the Taxpayer is engaged in industrial processing at the storage facility or that the storage facility constitutes a plant site where industrial processing takes place. Accordingly, the assessment of use tax on the Tersa Bale Heads is correct.

Packaging Materials Exemption

The Taxpayer also maintains that the Tersa Bale Heads qualify for the packaging materials exemption. Virginia Code § 58.1-609.3(2)(iv) provides a sales and use tax exemption for:
    • materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale.

This exemption is interpreted in Title 23 VAC 10-210-920 (A) to apply to the types of tangible personal property listed when used or consumed by industrial manufacturers and processors. The property may be returnable or nonreturnable. The Taxpayer must be engaged in industrial manufacturing or processing at its Virginia facility to qualify for this exemption. In addition, the regulation explains that the property must be used at a single plant site and must be used directly in industrial manufacturing or processing. For the reasons previously explained, the use of the Tersa Bale Heads to transport and store Tersa Bales is not industrial processing. Accordingly, the Tersa Bale Heads do not qualify for the packaging materials exemption.

The Taxpayer notes that it was informed by the Department that metal straps, boxes and stretch wrap are exempt from sales and use tax. Because these items are used with the Tersa Bale Heads, the Taxpayer suggests that this conflicts with the Department's position that the Tersa Bale Heads are taxable. The Department's position is that these items are exempt when used directly in the tobacco reclamation process or when used for the shipment of products and possession of the items is transferred to customers.

Conclusion

Based on the foregoing, use tax was properly assessed on the Taxpayer's purchase of the Tersa Bale Heads. As previously indicated, the Department will consider any documentation provided by the Taxpayer that shows some of the Tersa Bale Heads are used 50% or more of the time in its exempt reclamation process. The audit will be adjusted as appropriate based on a review of this documentation.

The Department's records indicate that the Taxpayer has a current balance due of *****. The Taxpayer may pay this amount within 30 days and avoid the accrual of additional interest on this assessment. Payment should be sent to: Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P. O. Box 1880, Richmond, Virginia, 23218-1880, Attention: *****.

The Code of Virginia sections and regulations cited are available on-line in the Tax Policy Library section of the Department's web site at www.tax.state.va.us. If you have any questions concerning this determination, or wish to provide documentation regarding the use of Tersa Bale Heads in the reclamation process, please contact ***** at *****.
                    • Sincerely,


                • Kenneth W. Thorson
                    • Tax Commissioner


AR/29142S

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46