Document Number
06-102
Tax Type
Retail Sales and Use Tax
Description
Application of the audiovisual and manufacturing exemptions
Topic
Exemptions
Date Issued
10-05-2006


October 5, 2006


Re: Request for Ruling: Retail Sales and Use Tax

Dear *****:

This will reply to your letter in which you request a ruling on the application of the audiovisual and manufacturing exemptions to the business activities of your client, ***** (the "Taxpayer"). I apologize for the delay in responding to your letter.

FACTS


The Taxpayer produces and distributes educational audio and video products that are sold to end users such as educational institutions, libraries and individuals. The Taxpayer does not provide educational instruction in classrooms, over the Internet, or by any other means. The Taxpayer does not produce educational courses that are customized in any way for customers. The Taxpayer's products are sold through sales catalogs and the Internet in both video and audio formats including audiocassettes, VHS tapes, DVDs, and compact discs. The products are sold in a tangible form only and are not transferred to customers over the Internet or by other electronic means.

The Taxpayer seeks a ruling on the application of the audiovisual exemption to the production of master copies of audio and video products. In addition, the Taxpayer seeks a ruling on the application of the manufacturing exemption to the mass production and packaging of the audio and video products it sells. The Taxpayer submits that this ruling request serves as a protective claim for refund to preserve its right to refunds of sales and use taxes paid on machinery, equipment, and other items that may qualify for exemption as a result of this ruling.

RULING


Audiovisual Exemption

Virginia Code § 58.1-609.6 6 provides the following exemption from the Virginia sales and use tax, effective until July 1, 2009:
    • a. (i) The lease, rental, license, sale, other transfer, or use of any audio or video tape, film or other audiovisual work where the transferee or user acquires or has acquired the work for the purpose of licensing, distributing, broadcasting, commercially exhibiting or reproducing the work or using or incorporating the work into another such work; (ii) the provision of production services or fabrication in connection with the production of any portion of such audiovisual work, including, but not limited to, scriptwriting, photography, sound, musical composition, special effects, animation, adaptation, dubbing, mixing, editing, cutting and provision of production facilities or equipment; or (iii) the transfer or use of tangible personal property, including, but not limited to, scripts, musical scores, storyboards, artwork, film, tapes and other media, incident to the performance of such services or fabrication; however, audiovisual works and incidental tangible personal property described in clauses (i) and (iii) of this subdivision shall be subject to tax as otherwise provided in this chapter to the extent of the value of their tangible components prior to their use in the production of any audiovisual work and prior to their enhancement by any production service; and
    • b. Equipment and parts and accessories thereto used or to be used in the production of such audiovisual works.

The application of this exemption depends upon the type of audiovisual work produced. If the audiovisual work is produced for licensing, distribution, broadcast, commercial exhibition, reproduction or incorporation into another work, the audiovisual work qualifies for the exemption. The various production services, incidental tangible personal property, and equipment, parts and accessories used in producing the work are exempt.

The Taxpayer produces dub masters of educational courses that are used to mass produce audio and video products for sale and distribution to the general public. The audiovisual works produced by the Taxpayer qualify for the audiovisual exemption as described above. The exemption is limited to those activities directly related to the production of qualifying audiovisual works.

The Taxpayer uses a screening process to select the course instructors and the courses it will produce. The Taxpayer records sample videos of potential instructors teaching their courses and provides the videos to focus groups for viewing and evaluation. The Taxpayer uses the evaluations to determine which instructors will be offered contracts to produce an educational audiovisual product. The screening and selection activities occur prior to the actual production of qualifying audiovisual works. For this reason, the Taxpayer's purchases and use of tangible personal property and taxable services for screening and selection purposes do not qualify for the audiovisual exemption.

Manufacturing Exemption

The Taxpayer maintains that the industrial manufacturing and processing exemption applies to the replication and packaging of the video and audio products that it produces for sale. The Taxpayer operates a production facility with a production line consisting of materials handling equipment, tape replication devices, packaging equipment and storage racks for raw materials and finished products. The production facility also has high-speed duplicators that are used to print course guidebooks and product packaging. The Taxpayer replicates videotapes and audiotapes by copying the dub masters it has produced to blank tape media. The Taxpayer outsources the replication of CD and DVD products ("disc products") to a third party. While the Taxpayer's disc product sales currently represent less than one-half of its gross product sales, the Taxpayer expects disc product sales to exceed one-half of gross product sales in the future.

After the tape and disc products have been replicated, the products are packaged for sale at the Taxpayer's facility. The Taxpayer applies printed product labels to the tapes and their vinyl protective shells and inserts the tape and disc products into the protective shells with the course guidebooks. The products are then packaged for distribution to customers and conveyed to finished goods storage racks at the facility to await shipment.

Virginia Code § 58.1-609.3 2 provides, in part, the following exemption from the retail sales and use tax:
    • (i) Industrial materials for future processing, manufacturing, refining, or conversion into articles of tangible personal property for resale where such industrial materials either enter into the production of or become a component part of the finished product; (ii) industrial materials that are coated upon or impregnated into the product at any stage of its being processed, manufactured, refined, or converted for resale; (iii) machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in processing, manufacturing, refining, mining or converting products for sale or resale; (iv) materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale . . . . Machinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in processing, manufacturing, refining, mining or converting products for sale or resale.

Title 23 of the Virginia Administrative Code (VAC) 10-210-920 A states that a business must meet two criteria to qualify for the industrial manufacturing and processing exemption. The business must be manufacturing or processing for sale or resale and the manufacturing or processing activities must be industrial in nature. Virginia Code § 58.1-602 defines "industrial in nature" as including "businesses classified in codes 10 through 14 and 20 through 39 published in the Standard Industrial Classification Manual for 1972 and any supplements issued thereafter."

The Taxpayer meets the first criteria because it produces audio and video tape products for sale to the general public. The North American Industry Classification System ("NAICS") replaced the Standard Industrial Classification Manual in 1997. The NAICS classifies establishments that mass reproduce audio and video products on tape and on disc under Industry Code 334612, which is a manufacturing code. Based on this classification, the Taxpayer's production of tape products is industrial in nature. The Taxpayer, however, does not mass reproduce the disc products it sells. A third party performs this function. For this reason, the Taxpayer's activities conducted with respect to its disc products are not industrial in nature. As it meets both of the necessary criteria, the Taxpayer qualifies for the industrial manufacturing and processing exemption only with respect to the production of tape products.

The exemption for industrial manufacturers and processors applies to purchases of tangible personal property that are "used directly" in manufacturing or processing activities. Title 23 VAC 10-210-920 B 2 states that the term "used directly" refers to:
    • activities that are an integral part of the production of a product, including all steps of an integrated manufacturing process, but not including incidental activities such as general maintenance, management, and administration.

The materials handling equipment, storage racks for raw materials, video replication devices, blank media, and other items that the Taxpayer uses directly to manufacture tape products qualify for the manufacturing and processing exemption. The Taxpayer should provide vendors with a fully completed Form ST-11 exemption certificate to make qualifying purchases exempt from the sales and use tax.

The Taxpayer's printing activities constitute industrial manufacturing. The printing activities are an integral part of the Taxpayer's production process, and the printed materials are packaged and sold with the tape and disc products. The Taxpayer produces printed materials such as course guidebooks, product labels and packaging labels using high-speed duplicators, which are similar in function to a printing press. The duplicators are used primarily for this purpose. The printed labels are placed on the recorded media and on the protective shells. The recorded media and course guidebooks are inserted in the protective shells. The products are then packaged and labeled to prepare them for retail sale.

The packaging of the tape products is a continuation of and integral part of the Taxpayer's tape production process. A third party replicates the Taxpayer's disc products and returns these products to the Taxpayer's production facility for packaging. As noted above, because the Taxpayer does not manufacture the disc products, it does not qualify for the industrial manufacturing exemption with respect to the packaging of its disc products. I recognize that the packaging of the disc products is essential to the Taxpayer's business operation and prepares the disc products for sale. The packaging of the disc products, however, is not a continuation of or an integral part of a manufacturing process performed by the Taxpayer. The third party has already manufactured the disc products. This is in contrast to the Taxpayer's production of tape products, in which the packaging process is integrated into a complete manufacturing process that is considered industrial in nature.

While the manufacturing exemption does not apply to the Taxpayer's packaging of disc products, the resale exemption applies to the packaging materials that are marketed with the Taxpayer's products and that become the property of the purchaser.

Preponderance of Use

In situations where an industrial manufacturer uses a single piece of equipment in both a taxable and an exempt manner, the law provides that the preponderance of use rule is applied in determining the tax application. See Va. Code § 58.1-609.3 2. This rule is explained in Title 23 VAC 10-210-920 D.
    • When a single item of tangible personal property is put to use in two different activities, one of which is an immediate part of the industrial production process (exempt) and the other of which is not (taxable), the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in non-exempt activities. Likewise, the item will be totally exempt from the tax if the preponderance of its use is in exempt production activities.

While the industrial manufacturing exemption may not apply to the Taxpayer's packaging of disc products, the property used to package these products will qualify for the exemption if the property is used fifty percent or more of the time to package tape products. The Department agrees that the production of tape products, including related packaging activities, qualifies for the industrial manufacturing exemption. The Taxpayer must document to the Department that the packaging equipment is used fifty percent or more to package tape products. If the preponderance of use of the packaging equipment is fifty percent or more to package disc products, the manufacturing exemption will not apply to such equipment. If the Taxpayer's disc product sales become greater than its sales of tape products, the Taxpayer may wish to request a new ruling to address this change in its business operations.

Protective Claim for Refund

The Taxpayer seeks confirmation that the definition of "person assessed with any tax" in Va. Code § 58.1-1820 permits the Department to issue direct refunds of sales and use taxes to consumers that have paid the tax to dealers. The Taxpayer requests that the Department issue direct refunds of sales and use taxes paid on equipment and supplies that are deemed exempt as a result of this ruling, rather than requiring the Taxpayer to seek the refunds from its vendors.
    • Title 23 VAC 10-20-160 C 3 states:
    • When a consumer is applying for a refund of sales or use tax assessed against a dealer or contractor, the consumer shall identify the dealer or contractor, explain the circumstances surrounding the payment by the consumer and explain why the claim for refund could not, or would not, be made by the dealer or contractor.

This regulation illustrates that the Department's sales and use tax refund policy does not interpret the definition of "person assessed with any tax" to allow for direct refunds of sales and use tax paid by consumers to vendors. As the regulation notes, consumers may request refunds directly from the Department only when the payment cannot or will not be made to the consumer by a dealer or contractor.

Nevertheless, based on the facts and circumstances of this case, I will allow the Taxpayer to provide the Department documentation showing sales and use tax overpayments made within the statute of limitations established by the filing of this protective claim for refund. The three-year statute of limitations applies to overpayments of tax made on or after August 1, 2001. I will have a representative from the Department's Northern Virginia Office contact the Taxpayer to arrange a mutually agreeable time to review purchase records and confirm that the Taxpayer's purchases qualify for exemption. The Department will refund any overpayments to the Taxpayer based on this review.

This ruling 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, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions concerning this ruling, please contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
                • Sincerely,

                • Janie E. Bowen
                  Tax Commissioner



AR/52373S

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46