Tax Type
BTPP Tax
Description
County to re-evaluate production and manufacturing portions of a business.
Topic
Classification
Date Issued
08-23-2006
August 23, 2006
Re: Final Local Determination
Taxpayer: *****
Locality: *****
Business Tangible Personal Property Tax
Dear ********:
This final state determination is issued upon the application for correction filed by you on behalf of the ***** (the "Taxpayer") with the Department of Taxation. You appeal a denial of a request for refund of certain business tangible personal property (BTPP) taxes made by the Taxpayer to the ***** (the "County") in tax years 2001, 2002, 2003 and 2004.
The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site.
FACTS
The Taxpayer produces and sells a variety of educational audio-visual and audio course materials for general consumption. The Taxpayer independently contracts with nationally known professors to produce course material on a wide array of subjects. More than 1,000 copies of each course are made in each of the following formats: VHS tapes, audiocassettes, DVDs and CDs. The Taxpayer also prints guidebooks that are written by the professors of the materials, and Taxpayer offers printed transcripts of taped lectures.
The recording of the productions, both audio and visual, is performed in the Taxpayer's production studio. After the filming and recording of the presentation aspect of the productions, the audio and visual components of the materials are edited and used in the creation of VHS tapes, audiocassettes, DVDs and compact disc "dub masters" that are used to mass produce the Taxpayer's final products. The VHS tapes and audiocassettes are produced in-house. The production of the disc products has been outsourced since 2002. All products are labeled, packaged and stored for distribution in-house.
Pursuant to Daily Press v. City of Newport News, 265 Va. 304, 576 S.E.2d 430 (2003), the Taxpayer asserts that the screening and selection of the lecturers, the development of the productions' content and the shooting and printing of the dub masters are preproduction activities. The Taxpayer contends that the tangible personal property associated with these activities is distinguishable from machinery and tools used in the Taxpayer's manufacturing activities.
The Taxpayer asserts that the following activities comprise its manufacturing process and the machinery and tools used in these activities are subject to the machinery and tools (M&T) tax: the handling and storage of the raw materials; the replication of the products; the production and affixation of labels to the media forms; the printing of course outline and guidebooks and transcripts; the packaging of the media materials (both in-house and outsourced) into vinyl shells; and the final packaging of the audio or video product and related course materials for distribution to the retail purchasers.
The Taxpayer utilizes more than 400 machines for video production and numerous other machines for the production of its audio products. The Taxpayer states its capital investment in its manufacturing plant and equipment was ***** in 2004.
ANALYSIS
Is the Taxpayer a Manufacturer?
The local business tax statutes do not define the term "manufacturer." The Supreme Court of Virginia (the "Court"), however, has developed a test involving three essential elements to use in determining whether a manufacturing activity is being undertaken. These elements are: (1) original material, referred to as raw material; (2) a process whereby the original material is changed; and (3) a resulting product, which by reason of being subject to such processing is different from the original material. See Prentice v. City of Richmond, 197 Va. 724, 90 S.E.2d 839 (1956). That is, for local business tax purposes, a manufacturer means one engaged in a processing activity whereby the original materials are transformed into a product that is substantially different in character from the original materials.
This was further clarified in the 2000 BPOL Guidelines, Appendix B, pg. 69, (the "Guidelines"), which provides that the "mere manipulation or rearrangement of the original materials is not sufficient" for a business activity to be classified as manufacturing. The Guidelines state, "There must be a substantial, well signified transformation in form, usability, quality and adaptability rendering the original material more valuable for use than it was before."
In this case, the original materials, the blank tapes and discs, are transformed into audio-visual tapes, audiocassettes and discs with useable content-- tangible personal property that is significantly different and of far greater use and value than the original blank tapes and discs. This is analogous to an example in the Appendix B Guidelines dealing with the manufacture of computer software:
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- Engineering, design, research and development, and computer software development typically are not manufacturing. However, the actual production of tangible products based on engineering, design, research and development can be manufacturing. [Emphasis added.]
In this case, it can be said that while the actual development of the courses is not manufacturing, the production of the tangible products (the VHS tapes, audiocassettes, DVDs, and DVDs) can be manufacturing.
In Daily Press, the Virginia Supreme Court drew a clear line of demarcation between capital that is used directly in the manufacturing process and capital that is intangible. Virginia Code § 58.1-1101 provides that capital which is personal property, tangible in fact, used in manufacturing businesses shall be classified as intangible and exempt from personal property taxation. The machinery and tools of such businesses shall not be defined as intangible personal property for purposes of local taxation and shall be taxed locally as tangible personal property.
The machinery and tools used in the pre-press activities, including the making of the press plates, were found to be intangible capital because they were not directly used in the manufacturing process. In the present case, that analysis would apply to the making of the "dub masters." The machinery and tools used in the preproduction process would be regarded as capital that is considered intangible for purposes of local taxation. The machinery and tools used in making the VHS tapes, audiocassettes, DVDs and CDs would be regarded as machinery and tools used in manufacturing and assessed accordingly.
The Taxpayer also is engaged in the business of printing its guidebooks, bound transcripts, labels and other printed materials used in the packaging of its products, and the final packaging of the finished products for distribution. The Department has held job printers and other printers to be manufacturers. See Public Documents (P.D.) 99-200 (7/23/1999), 99-239 (8/23/1999) and 99-296 (11/17/1999).
The County, in denying the Taxpayer's appeal to be classified as a manufacturer, relied on P.D. 97-362 (9/8/1997), which found a producer of videos for sale at wholesale to retail outlets was not a manufacturer. In P.D. 97- 362, the Tax Commissioner found that the making of copies of the taxpayer's productions to be subordinate to the principal activity of producing video entertainment. The Tax Commissioner also noted, however, that a business engaged solely in the business of producing video copies for other video producers, depending on the facts and circumstances, could be considered to be a manufacturer.
The Tax Commissioner's opinion in P.D. 97-362 was based in part on the fact that the replication of video materials was not considered industrial manufacturing under the Standard Industrial Classification (SIC) system that was in place in 1997. In 1997, the SIC system was replaced by the North American Industrial Classification System (NAICS), although the NAICS was not published until 1998. 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. The NAICS is used in determining a Taxpayer's business for income tax and sales and use tax purposes. While not the determinative factor to be used in classification for local tax purposes, it is instructive. See 2000 BPOL Guidelines § 2.13.
Substantiality
In County of Chesterfield v. BBC Brown Boveri, 238 Va. 64, 380 S.E.2d 890 (1989), the Court held that after it is determined that a taxpayer is engaged in a manufacturing activity, the taxpayer's manufacturing activities must meet the test of substantiality. "When a party is engaged in both manufacturing and non-manufacturing activities, it will nonetheless be classified as a manufacturer for tax purposes if the manufacturing portion of its business is substantial." Id. pg. 70.
In BBC Brown Boveri, the Court offered several constructive measures to be used in determining whether a business should be classified as a manufacturer for local business tax purposes. These are: (1) the manufacturing component's financial receipts or proportion of total corporate income; (2) the percentage that manufacturing equipment, inventory, etc., comprises of the total capital investment; (3) the number of employees working in the manufacturing component as compared with the total number of employees; or (4) the ratio of manufacturing activities to the entire business. That is, "to be considered substantial, the manufacturing component of a business must not be de minimis, merely trivial, or only incidental to its principal business." See 2000 BPOL Guidelines, Appendix B, pg. 69
The Taxpayer states more than 40% of its workforce was involved in manufacturing, more than 53% of its capital investment was in manufacturing property and equipment, and materials used in the manufacturing process comprised approximately 94% of its inventories in tax year 2004.
In this case, I find that the Taxpayer is engaged in two different, yet fully integrated business activities, that of the production of educational audio-visual material, and the manufacture of VHS tapes and cassettes, printed guidebooks, bound transcripts, labels and other packaging materials. The question to be determined is whether the manufacturing component of the Taxpayer's business is substantial enough to classify the Taxpayer as a manufacturer for BTPP tax purposes.
It should be noted that the Taxpayer outsources the manufacture of its disc products. These products are returned to the Taxpayer for packaging, and shipping. The packaging and shipping of these products constitutes a business service. See 2000 BPOL Guidelines § 5.5.2. Therefore, the gross receipts attributed to the sales of the disc products cannot be considered in the calculation of the substantiality of the Taxpayer's manufacturing business. If it is determined that the production, labeling and production of the VHS tapes and audiocassettes constitutes a substantial portion of the Taxpayer's business activity, all of the Taxpayer's tangible personal property will be classified as either machinery and tools or as intangible, depending upon its use. See P.D. 06-51 (4/24/2006).
If it is determined that a substantial portion of the Taxpayer's business is manufacturing, the Taxpayer must be classified as a manufacturer. Unlike the circumstances in Coca-Cola Bottling Company of Roanoke, Inc. v. County of Botetourt, 259 Va. 559, 526 S.E.2d 746 (2000), in which the selling of the product from vending machines was considered to be a separate business, the Taxpayer's business activities are fully integrated. The question is which of the Taxpayer's business activities should determine the classification of the Taxpayer's business activities for purposes of the tangible personal property tax - the design, filming and editing of the courses or the manufacturing of the VHS tapes, cassettes, and printed course materials.
DETERMINATION
The Taxpayer is clearly engaged in some manufacturing activities. I disagree with the County's determination that the production of VHS tapes and audiocassettes is not manufacturing. The question to be determined by the local commissioner of the revenue is if the production and labeling of the VHS tapes and audiocassettes constitutes a substantial portion of the Taxpayer's business activity. Accordingly, I am returning this case to the County to reevaluate the Taxpayer's production and manufacturing portions of the business. In so doing, the County can then determine whether the manufacturing portion of the Taxpayer's business meets the test of substantiality as set forth in BBC Brown Boveri.
If the County determines the Taxpayer is a manufacturer, the County and the Taxpayer must determine which property is subject to the machinery and tools tax, and which property is classified as intangible under the provisions of Va. Code § 58.1-1101 A 2.
If you have any questions regarding this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings at *****.
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- Sincerely,
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Janie E. Bowen
Tax Commissioner
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AR/56411H
Rulings of the Tax Commissioner