05-105 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Issues related to tax on purchased items for manufacturing

Topic

Appropriateness of Audit Methodology

Assessment

Date Issued

07-05-2005

July 5, 2005

Re: § 58.1-1821 Application: Retail Sales and Use Tax

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

This is in reply to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the Taxpayer), for the period October 1999 through June 2003. I note that the assessment is paid. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a manufacturer of toner powders and photo transfer tubes (or drums) for use in copy machines. As a result of the Department's audit, the Taxpayer was assessed tax on sales and certain items purchased during the audit period. The Taxpayer raises several issues related to the assessment of tax on purchased items. Each issue will be addressed separately below.

DETERMINATION

Production Line Testing

The Taxpayer purchases paper for use in testing the production standard of toner and cartridges. As the toners and the cartridges are being manufactured, random samples are taken from the production line for testing. The testing is performed to determine if the toner or cartridge is causing copies to smear. The Taxpayer contends that the paper purchases are exempt because the paper is used to test and inspect products on the production line for quality control purposes. The Taxpayer paid the tax on these purchases to its vendors, and the vendors have denied the Taxpayer's refund requests.

Virginia Code § 58.1-609.3 2(iii) provides an exemption from the sales and use tax for "machinery or tools or repair parts therefore or replacements thereof, fuel, power, energy, or supplies, used directly in processing, manufacturing, refining, mining or converting products for sale or resale." The regulation in Title 23 of the Virginia Administrative Code (VAC) 10-210-920 discusses the manufacturing exemption and provides in section C 2 that the exemption applies to "[t]angible personal property used to test and inspect products on the production line for quality control purposes." Based on the regulation and the information provided, the Taxpayer's purchases of paper for use in production line testing for quality control purposes qualify for the exemption.

Because the vendors have denied the Taxpayer's refund requests, the Department will issue refunds directly to the Taxpayer for tax paid on paper purchased for use in production line testing for quality control purposes. The refunds will be issued less the dealer's discount. The amount representing the dealer's discount cannot be refunded to the Taxpayer because the Department did not receive such funds.

Research and Development

It is my understanding that the Taxpayer maintains a Development Center in which copy machines are run continuously to determine the number of copies that can be produced. The Taxpayer uses this data to formulate chemicals that are coated upon aluminum drums to produce more copies than the original equipment. The drums are then placed in various machines and run continuously until the drums break down (unable to transfer an image to paper). If the drum lasts for a number of copies higher that the number run on the original equipment, the drum is considered acceptable for production. The Taxpayer follows a similar procedure for its production of toner powders. The Taxpayer purchased paper and toner for use in the above process and believes these purchases are used in exempt research and development activities.

Virginia Code § 58.1-609.3 5 provides an exemption from the sales and use tax for "tangible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense."

Title 23 VAC 10-210-3070 defines research and development to mean "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." The regulation also defines basic research as "a systematic study or search in a scientific or technical field of endeavor with the ultimate goal of advancing knowledge or technology in that field." The regulation goes on to say that "[r]esearch 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." Further, research does not include testing or inspection of materials or products for quality control.

The auditor concluded that the activities performed in the Taxpayer's Development Center are those of product testing to determine the compatibility of the Taxpayer's product with various types of copy machines. The research and development exemption does not apply to such activities. Based on the limited information provided, I find no basis to overturn the auditor's finding. The Taxpayer has not provided evidence to show the contested items are used directly and exclusively in research and development activities.

Self-Assessed Tax Payments

The Taxpayer seeks a credit for the tax paid on purchases used in production and in the Taxpayer's Development Center. Based on the above decision regarding the research and development exemption, the Taxpayer is not entitled to a credit for purchases used in the Development Center. Any adjustments for purchases used in production will be reviewed by the auditor.

Contested Items

The Taxpayer disputes the tax assessed on a number of items and provides invoices and other documentation to support that the tax does not apply. Based upon the information provided, it appears that the tax may not apply to some of the transactions. The auditor will review this information and remove those items for which the Taxpayer has provided verification that the tax does not apply or has been paid.

Refund Interest

The Taxpayer has obtained vendor refunds for the overpayment of the tax on other purchases. The Taxpayer questions whether it is entitled to interest on the overpayment of the tax.

Virginia Code § 58.1-1833 provides that "[i]nterest shall be allowed and paid upon the overpayment of any tax administered by the Department, the refund of which is permitted or required under the provisions of this article, or on moneys improperly collected from the taxpayer and refunded pursuant to § 58.1-1822, at a rate equal to the rate of interest established pursuant to § 58.1-15." Interest accrues from a date sixty days after payment of the tax, or sixty days after the last day prescribed by law for such payment, whichever is later, and ends on a date determined by the Department preceding the date of the refund check by not more than thirty days." In accordance with the statute, the Taxpayer is entitled to receive interest on its overpayments of tax. In order to compute the interest amounts, the Taxpayer will need to provide detailed documentation such as invoices and check copies indicating the amount of tax paid, the date of payment of the tax to the vendors, and the date of receipt of the refunds. This information should be provided to the auditor in order to verify the overpayments of the tax.

Application of the Tax to Competitors

The Taxpayer asserts that the Department may have granted to its competitors the manufacturing and research and development exemptions for certain activities that have been deemed taxable to the Taxpayer. The Taxpayer requests a visit from Department personnel to determine if the exemptions apply to certain areas of its operation.

The Department has previously audited the Taxpayer and has consistently applied the sales and use tax to the Taxpayer's activities. If the Taxpayer has concerns about the application of the tax and any resulting advantage for its competitors, the Taxpayer should identify those competitors and the Department will review their operations to ensure consistent application of the tax.

CONCLUSION

The information provided with the Taxpayer's appeal will be forwarded to the auditor for review. The auditor will contact the Taxpayer within 30 days to address the issues as indicated in this letter. After the appropriate adjustments are made, the auditor will process any refunds that are warranted. At this time, the Taxpayer should provide the identity of its competitors to the auditor. For questions regarding the audit adjustments, please contact the auditor, ***** at *****.

The Code of Virginia sections and regulations cited, as well as other reference documents, are available on-line in the Tax Policy Library section of the Department's website, located at www.policylibrary.tax.virginia.gov. If you have 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/48733J

Rulings of the Tax Commissioner