05-45 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Research and Development Exemption

Topic

Clarification

Exemptions

Date Issued

04-05-2005

April 5, 2005

Re: Request for Ruling: Retail Sales and Use Tax

Dear *****:

This is in reply to your letter in which you request a ruling on behalf of your client (the "Taxpayer") regarding the application of the retail sales and use tax to the research and development of new packaging materials and new manufacturing and packaging equipment. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a manufacturer and wholesaler of food products. You represent that the Taxpayer has undertaken a project to research, design and develop new customized packaging for its product. The new packaging will be made of a different material, will create a different shape to the product package and will also enhance consumer protection. You state the end result of the project is the improvement of the product's performance in the market place.

In developing the new packaging, the Taxpayer is working with its ultimate packaging suppliers. So as to retain proprietary rights to the package and equipment design, the Taxpayer "purchased all new and additional tooling required for the design and development of the manufacturing equipment by the supplier(s)."

You seek a ruling that the Taxpayer's development of the new packaging and packaging equipment is exempt research and development.

RULING

Research and Development

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."

Interpreting this statute, Title 23 of the Virginia Administrative Code (VAC) 10-210-3070 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." "Research and development" is defined as "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 further states that the 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."

The regulation also states, "Tangible personal property must be purchased or leased by the person, firm, corporation, or other entity that actually will perform research activities in order to qualify for the tax exemption for items used directly and exclusively in research."

In the situation presented, the Taxpayer's purchase of the tooling is a measure taken by the Taxpayer for the retention of the proprietary rights to the packaging and equipment designs. Based on the information provided, the Taxpayer's role in research and development is more supportive and secondary to that of the primary role taken by the Taxpayer's suppliers, who are developing the new packaging, as well as designing and developing new manufacturing equipment. Accordingly, while the Taxpayer's purchases of the packaging materials and tooling could be considered a part of research and development of new packaging and manufacturing equipment, the Taxpayer is not the entity actually performing the research activities. Therefore, the Taxpayer's purchases do not qualify for the research and development exemption in Va. Code § 58.1-609.3 5.

Manufacturing

Virginia Code § 58.1-609.3 2(iii) provides a sales tax exemption for "machinery or tools . . . fuel, power, energy, or supplies, used directly in processing, manufacturing . . . products for sale or resale." Virginia Code § 58.1-602 defines manufacturing and "processing" to include "equipment and supplies used for production line testing and quality control."

Product testing and quality control functions qualify for the manufacturing exemption, provided these functions are completed on the production line. In this case, the Taxpayer states that it will test the new equipment to determine if mass production of the new packaging will be successful. It is not clear, however, if the new equipment will be installed on the production line when the testing of the machinery is done. Thus, if the quality control function is not performed on the production line as mandated in the statute, the manufacturing exemption is not available.

Based on the information provided in your letter, I cannot agree that the Taxpayer's purchases of materials, equipment and supplies are exempt from the tax under the research and development exemption or the industrial manufacturing exemption. Rather, it appears that the Taxpayer is essentially supplying materials to its suppliers, who may be involved in certain exempt activities.

This response is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections and regulations cited are available on-line in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.virginia.gov. If you have any questions regarding this response, please contact in the Office of Policy and Administration, Appeals and Rulings, at *****@tax.virginia.gov or at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/50292Q

Rulings of the Tax Commissioner