08-155 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Taxpayer manufactures and sells kitchen cabinets

Topic

Manufacturing Exemption

Property Subject to Tax

Date Issued

08-29-2008

August 29, 2008

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

Dear *****:

This is in response to your letter in which you request correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") for the audit period December 2002 through August 2005. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer manufactures and sells kitchen cabinets. The Taxpayer has four facilities in Virginia. At three of the Virginia facilities (the "Component Facilities"), the Taxpayer makes various component pieces for cabinets. These pieces are subsequently assembled into cabinets at the Taxpayer's assembly facilities, one of which is the fourth location in Virginia (the "Assembly Plant").

The Taxpayer contests five groups of items held in the audit as taxable purchases. The Taxpayer maintains that four of these items qualify for the industrial manufacturing exemption. As for the remaining item, the Taxpayer maintains that it is exempt certified pollution control equipment.

DETERMINATION

Virginia Code § 58.1-609.3 2 provides an exemption from the retail sales and use tax for "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." This statute further provides that "[m]achinery, tools and equipment, or repair parts therefor or replacement 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 B 2 defines the term "used directly' as follows:

- The term "used directly" refers to those 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 integrated manufacturing process noted above includes the production line of a plant, factory, mill, etc., starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished or completed for sale and conveyed to a warehouse at the same plant site, and also includes production line testing and quality control.

In Public Document (P.D.) 91-267 (10/23/91), the Department recognizes that a taxpayer may operate more than one plant site and, thus, enjoy the manufacturing exemption at multiple plant sites.

Lift Trucks and Shipping Lift

At one of its Component Facilities, the Taxpayer fabricates panels for cabinets. The Taxpayer represents that certain lift trucks and a shipping lift are used to move these panels from final processing to the staging area or directly onto trucks for shipment to the Assembly Plant. The Taxpayer maintains that these lifts move work in progress inventory through to the next stage of production and should, therefore, qualify for the industrial manufacturing exemption.

The industrial manufacturing exemption does not apply to any distribution of the products after completion of production. Although you cite P.D. 02-21 (3/7/02) to maintain that the manufacturing exemption continues until the final completed product is conveyed to storage at the final plant site, such determination was not intended to extend the industrial manufacturing exemption to any transportation activities occurring between plant sites. In this regard, P.D. 02-21 holds that "each plant site constitutes a separate manufacturing facility." As such, the distribution activities at each plant site are not part of the exempt manufacturing process.

Generally, production is completed when the product is conveyed to a warehouse (storage) at the production site. If the product is not stored prior to shipment, the Tax Commissioner determined in P.D. 05-22 (3/4/05) that production is also completed when the finished product is conveyed to a shipping area at the plant site. On the other hand, Title 23 VAC 10-210-920 C 3 treats tangible personal property used to remove or load finished (packaged) goods from storage at the plant site as a taxable distribution activity.

In this case, the Taxpayer contends that the lifts at issue were used to move panels from final processing to a staging area or directly onto a truck for shipment to an assembly plant. It is the auditor's understanding, however, that these lifts were used only in the shipping area. As such, I am concerned as to whether sufficient facts have been presented for this issue. For instance, the Taxpayer has not shown that it does not store any of the products prior to shipment, nor has the Taxpayer shown how much time each lift is used in the shipping area. Even if the Taxpayer's contention is correct, I am still concerned that the lifts may be used for dual purposes, i.e., in both a taxable and exempt manner. Pursuant to Title 23 VAC 10-210-920 D, dual use property of a manufacturer is subject to the preponderance of use rule. When a lift is used 50% or more of the time in non-exempt activities, it is taxable. On the other hand, the production exemption applies when a lift is used 50% or more of the time in exempt activities. In this case, no information has been provided to certify and establish the percentage of time each lift at issue was used in taxable activities versus exempt activities. Pursuant to Va. Code § 58.1-205, the Taxpayer has not met its burden of proof. Accordingly, the tax on these lift trucks is upheld.

Knife Grinder

The Taxpayer uses a molder to manufacture moldings for cabinets. A molder has a group of heads. Each head contains cutting knives to cut wood into decorative moldings. The Taxpayer uses the knife grinder to maintain or restore the cutting tolerances of the knives by re-sharpening the knives in each head. The grinder is also used to shape blank knives into usable knives and to reshape used knives into new forms for a different process.

The Taxpayer cites P.D. 96-140 (6/19/96), in which the Tax Commissioner determined that a roll grinding subsystem was used directly in an exempt subprocessing activity. Based on this determination and the facts presented, I find that the Taxpayer's knife grinder is similarly used and thus exempt of the tax. Accordingly, the knife grinder will be removed from the audit.

Hand-Held Bar Code Scanners and Accessories

The Taxpayer uses a bar coding system in all of its component and assembly facilities. When an order is processed at the Assembly Plant, the details of the transaction, such as style, model, material, type of finish, and shipping details, are entered into a computer and the appropriate Component Facilities are subsequently notified of the items ordered. At the beginning of production at the Component Facilities, a bar code is assigned to each ordered product. Bar codes are not physically attached to component pieces but remain with them throughout production. When shipping component pieces to the Assembly Plant or shipping the final product to the customer, new bar code labels are made and attached to the packaging used for shipment.

With this bar coding system, customers can check on their orders at any stage of production. If a customer receives damaged goods or needs to reorder another cabinet in the same style and color, the customer may reorder using the bar code label that was packaged with the product. Based on these bar code label uses, the Taxpayer maintains that the bar code scanners and related accessories are used in exempt production activities.

I understand that the bar code scanners do not control any manufacturing equipment, nor do they produce supplies for use directly in the main manufacturing process. Rather, it is my understanding that the scanners read what is in stock, what is in production, what is finished, and what is shipped. These activities relate to tracking inventory and work in progress and serve an administrative purpose ¹

. Likewise, for reorders, scanning of bar coded labels of previously sold items to determine the nature of the order is a pre-production activity. See P.D. 95-52 (3/23/95), which holds that preparatory steps before actual production are not within the scope of the industrial manufacturing exemption. Based on the facts provided, I find that the contested scanners are not used in an exempt manner.

Moreover, none of the public documents cited by the Taxpayer are relevant to the scanner issue as explained below. The Taxpayer cites P.D. 95-52 (3/23/95), 97-72 (2/18/97), 99-301 (11/18/99), and 01-130 (9/14/01).

In P.D. 95-52 (3/23/95), a manufacturer assigned unique codes to final products to identify the contract destination and design of those products. This bar coding activity was exempted provided it was done prior to the conveyance of the final product to the finished goods inventory. This ruling does not address the scanning of bar codes. In the instant case, the Taxpayer uses scanners to read bar codes, not to assign bar codes to individual products. Furthermore, based on the limited facts presented and subsequent rulings by the Tax Commissioner in deciding between taxable and exempt usage of bar coding equipment, I must conclude that the bar coding activity in P.D. 95-52 does not involve any administrative use by the manufacturer.

The Taxpayer cites P.D. 97-72 (2/18/97) to claim that its bar coding activity is exempt when bar code labels become a component part of the manufactured product shipped to the customer. This situation occurs only at the Taxpayer's Assembly Plant. In contrast, the Taxpayer uses bar coding at its Component Facilities to track inventory throughout the production process and while under shipment to the Assembly Plant. Such use is not an exempt production use as described by P.D. 97-72. Based on the information provided, it appears that the scanners assessed in the audit were used only at the Taxpayer's Component Facilities and, therefore, only for administrative purposes.

In P.D. 99-301 (11/18/99), a bar code machine is used to read the bar code on envelopes and sort them by geographical areas prior to packaging into final printed products. In such instances, the bar code machine is used directly in the production process. This use contrasts with the Taxpayer's hand scanners, which are not used directly in any production process.

In P.D. 01-130 (9/14/01), the Tax Commissioner determined that a bar coding activity may constitute a production activity when customers require bar coding on products ordered from a manufacturer. Thus, the bar code in printed or other tangible form that is affixed to a product, or an insert (such as instructions), becomes a component or supplemental part of that product. Because the bar coding activity was performed for both production and administrative purposes, the Tax Commissioner concluded that the preponderance of use rule must apply. At issue in the instant case are scanners used at the Component Facilities. The preponderance of use rule does not apply to these scanners because they are only used for a taxable administrative purpose. While the scanners used at the Assembly Plant may serve a dual role purpose in administration and production, such scanners were not included in the audit.

Printers Used Predominantly to Produce Shipping Labels

Printers are used to produce new work in progress labels prior to shipping the finished components to the Assembly Plant. The Taxpayer indicates that the printers are used 95% of the time for processing of the labels and 5% of the time to process shipping reports. Accordingly, the Taxpayer claims that the printers are used predominantly in exempt production activities.

Although the components will undergo further processing at a different plant site (i.e., the Assembly Plant), I understand from the Department's auditor that the production process is completed before these labels are printed. As such, the shipping labels printed at the Component Facilities are used in distribution and administrative activities. Pursuant to Title 23 VAC 10-210-920 C 3, distribution is not a part of the manufacturing process. As such, the printers that print the shipping labels are not used in an exempt manner.

Pollution Control Equipment

Virginia Code § 58.1-609.3 9 (i) exempts from the retail sales and use tax "certified pollution control equipment and facilities as defined in § 58.1-3660." In order to qualify for this exemption, certification of the system's pollution control status must be obtained from the Department of Environmental Quality (DEQ). Also see Title 23 VAC 10-210-2090.

The Taxpayer uses a diverter system (diverter value and ductwork) to divert sawdust created by the production process directly to trailers for storage when the silos are full of sawdust. The Taxpayer maintains that such diverter system is exempt certified pollution control equipment based on the operating permits issued by DEQ.

The DEQ operating permits issued to the Taxpayer are not issued pursuant to Va. Code §§ 58.1-609.3 9 (i) or 58.1-3660. As such, they do not provide the required certification needed to obtain the exemption. Absent specific certification of the diverter system's pollution control status by DEQ in accordance with the above authorities, no pollution control exemption is available for the sawdust diverter control system.

CONCLUSION

The assessment will be revised in accordance with this determination. Upon revision, an updated bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges.

The Code of Virginia sections, regulations and public documents cited 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 about this determination, you may contact ***** in the Department's Office of Tax Policy, Appeal and Rulings, at *****.

- - - - Sincerely,

- - - - Janie E. Bowen
        Tax Commissioner

AR/1-1123499428.R

1Administrative items include "items used to record the quality and quantity of work in production or goods in storage, the flow of work, and the results of inspections." See Title 23 VAC 10-210-920 C 1.

Rulings of the Tax Commissioner