Document Number
08-30
Tax Type
Machinery Tools Tax
Description
The Taxpayer is a manufacturer of food products challenge County assessments.
Topic
Appropriateness of Audit Methodology
Property Subject to Tax
Statute of Limitations
Date Issued
04-02-2008

April 2, 2008



Re: Appeal of Final Local Determination
Taxpayer: *****
Locality: *****
Machinery and Tools Tax

Dear *****:

This final state determination is issued upon the application for correction filed by you on behalf of ***** (the "Taxpayer") with the Department of Taxation. You appeal an assessment of Machinery and Tools (M&T) tax issued to the Taxpayer by ***** (the "County") for tax years 2001 through 2004.

The M&T tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 authorizes the Department to issue determinations on taxpayer appeals of M&T tax assessments. On appeal, a M&T tax assessment is deemed prima facie correct. That is, the local assessment will stand unless the taxpayer proves that it is incorrect.

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 is a manufacturer of food products. The Taxpayer filed an application for review and amended returns for its 2001 through 2004 assessments with the County's commissioner of the revenue in November 2004.

In its final determination, the County agreed to portions of the amended returns and refunded assessments on certain property, but declined to refund all the M&T tax requested by the Taxpayer. The Taxpayer appeals a number of adjustments the County made to its amended returns. Specifically, the Taxpayer's appeal addresses the County's decision to assess certain packaging assets, engineering-related costs, vendor support costs and the costs for equipment modification and refurbishment.

ANALYSIS


Jurisdiction

The County asserts that it did not have jurisdiction to consider the Taxpayer's appeal for tax years 2001 and 2002 under the provisions of Va. Code § 58.1-3983.1, and the Taxpayer cannot appeal the County's final determination with regard to those years to the Tax Commissioner.

Virginia Code § 58.1-3980 provides that any person aggrieved by an assessment of local taxes:
    • may, within three years from the last day of the tax year for which such assessment is made, or within one year from the date of the assessment, whichever is later, apply to the commissioner of the revenue or such other official who made the assessment for a correction thereof. [Emphasis added.]

It was under this provision that the Taxpayer filed its original appeal to the County for tax years 2001 and 2002.

Under this procedure, if the taxpayer disagrees in whole or in part with the local assessing officer's determination, the taxpayer may then take its grievance to the circuit court under the provisions of Va. Code § 58.1-3984.
    • Virginia Code § 58.1-3983.1 B 1 provides that any person assessed with a
    • local business tax as defined in this section may appeal such assessment within one year from the last day of the tax year for which such assessment is made, or within one year from the date of such assessment, whichever is later, to the commissioner of the revenue or other assessing official. [Emphasis added.]

Under this provision, if the Taxpayer's appeal is denied in part or whole by the local assessing official, the taxpayer may, within 90 days, appeal the assessment to the Tax Commissioner.

The administrative appeals process involving the Tax Commissioner is separate and distinct from the general appeals process afforded to taxpayers with local tax grievances under Va. Code § 58.1-3980. The procedures for the process are clearly defined in the statute. The process is time-bound and those boundaries must be followed.

When the County received the Taxpayer's initial amended return for the 2001 and 2002 tax years, it responded with requests for additional information, toured the plant, and examined the property at issue. The final local determination granted relief on some of the equipment changing the original assessments. The Taxpayer contends that this determination was in fact a new assessment and was appealable to the Tax Commissioner under Va. Code § 58.1-3983.1 D 1.

In the present case, the County changed the original assessment. The Department considers this to be a new assessment for purposes of Va. Code § 58.1-3983.1. Accordingly, the appeals for tax years 2001 and 2002 are eligible for the administrative appeals process.

Taxation of Machinery and Tools

All tangible personal property, unless declared intangible under the provisions of Va. Code § 58.1-1100 et seq., is reserved for local taxation by Article X, § 4 of the Constitution of Virginia. Included in the category of tangible property that is declared intangible and subject to state taxation only is "[c]apital which is personal property, tangible in fact, used in manufacturing (including, but not limited to, furniture, fixtures, office equipment and computer equipment used in corporate headquarters)." See Va. Code § 58.1-1101(A)(2).

The machinery and tools, motor vehicles and delivery equipment of a manufacturing business are not defined as intangible personal property. Such property is to be taxed locally as tangible personal property. Virginia has elected to create a separate classification of tangible personal property for machinery and tools used in manufacturing. Virginia Code § 58.1-3507(A) provides:
    • Machinery and tools . . . used in a manufacturing . . . business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only.

"Used" in Manufacturing

In presenting its appeal, the Taxpayer relies on two cases: City of Winchester v. American Woodmark Corp., 250 Va. 451, 264 S.E.2d 148, (1995) ("American Woodwork") and The Daily Press, Inc. v. City of Newport News, 265 Va. 304, 576 S.E. 2nd 430 (2003) ("Daily Press"). In American Woodmark, the Virginia Supreme Court stated, "Since 1950, the Tax Commissioner has opined that the phrase 'machinery and tools' contained in Va. Code § 58.1-1101(A)(2) and its precursors means machinery used in the actual process of manufacturing." American Woodmark, 250 Va. 451, 458, (1995). The Court also cited previous opinions of the Attorney General in deriving the meaning of "used in manufacturing:"
    • The Attorney General has consistently opined that 'machinery and tools' used in a particular manufacturing business are the machinery and tools which are necessary in the particular manufacturing business and which are used in connection with the operation of machinery which is actually and directly used in the manufacturing process. Id., citing 1985-11986 Att'y Gen. Ann. Rep. 316 at 317; see also 1987-1988 Att'y. Gen. Ann. Rep. 590. Id.

In Daily Press, the Virginia Supreme Court amplified the principles set forth in American Woodmark.
    • The principle gleaned from American Woodmark can be simply stated: personal property that may be essential to the overall operations of a manufacturing business is not 'machinery and tools' subject to local taxation unless the property is actually and directly used in the manufacturing process where new materials are transformed into a substantially different product or the property is connected with the operation of machinery actually and directly used in the manufacturing process. 265 Va. 304, 311. [Emphasis added.]

This language does not imply that each piece of machinery or tool used directly in the manufacturing process must be directly connected to the complete transformation of a material into something substantially different in character. The Taxpayer has identified four specific kinds of assets, the classification and assessment of which are the subject of the appeal.

Packaging assets

The County ruled that the food product is not a finished product until such time as it has passed through multiple layers of conveyor systems "where divisions of the product are made based on the many different sizes sold of every item." Accordingly, the County upheld its assessment of all of the machinery used in both the cartoning and the case packing areas.

The Taxpayer maintains that the machinery and tools used in both cartoning and case packing were not used "directly" in manufacturing, should be classified as intangible property subject only to state taxation, and not subject to the M&T tax.

In Public Document (P.D.) 04-39 (8/02/2004), the Department ruled that machinery used for packaging the product is not directly used in the manufacturing process. In that case, the primary purpose of the packaging was for shipping purposes rather than an integral part of transformation of materials into a substantially different product. Based on the ruling in P.D. 04-39, the Taxpayer's packaging equipment was used primarily to prepare products for shipment would be exempt from the M&T tax.

Because almost all food products are not marketable without some kind of packaging, the Department must consider whether some packaging is an integral part of the making of a substantially different product. In considering this issue, the Department finds there are three main factors that contribute to how food is packaged. These include government regulations, industry practices, and market or consumer demands. Thus, to the extent the packaging has to meet performance (industry standards), sanitation (government regulations), or product quality (consumer demands) standards, equipment used for such packaging is considered to be used directly in the manufacturing process.

In the case of the Taxpayer, once the preparation of the food product is completed, it is mechanically measured and placed into wrappers, bags, or boxes. Most of the products go through several stages of packaging before being placed into cases for shipping. Some equipment is used to place wrapped products into multi-packs while other equipment places products in bags for sale in various quantities. Still other equipment is used to fill boxes used to display the product at a retail store. On some lines, the products are grouped into additional packaging and then put into display boxes. In almost all of these lines, the packaging has to meet government, industry, or market standards in order to make the product available for retail sale.

After the food product cartons are mechanically weighed and labeled, the cartons proceed on a conveyor belt to the packing case area, where employees place the cartons into cases for shipment. The cases are then loaded on pallets and moved by forklift to the shipping area. As stated in P.D. 04-39, this type of packaging has nothing to do with the transformation of the original material into a new product that is substantially different in character.

While I find the machinery used in the cartoning process to be a part of the Taxpayer's manufacturing process, I agree with the Taxpayer that machinery used for packaging the product in cases is not directly used in 'the manufacturing process. Although the two types of machinery are both located in the same area of the plant, only the machinery and tools used in the cartoning process are subject to the M&T tax.

Engineering Related Costs

The question of engineering costs was addressed by the Virginia Supreme Court in County of Chesterfield v. Brown Boveri, Inc., 238 Va. 64, 380 S.E.2d 890, (1989). In that case, the Court considered whether the design and engineering stages of a manufacturing job constitute manufacturing. The Court found that the design and engineering were integral parts of the taxpayer's manufacturing activity, and as such that work was properly classified as manufacturing.

In the instant case, I find that the machinery and tools used in the engineering process are directly used in the manufacture of the food product, and are therefore subject to local M&T taxation.

Vendor Support Costs

These costs consist primarily of vendor oversight when a new piece of machinery is installed. Installation costs have traditionally been regarded as part of the costs of business tangible personal property, or in this instance, part of machinery and tools. See P.D. 07-103 (6/23/2007). I see no reason to segregate these costs from the "original cost" used as the basis for calculating the M&T tax.

Vendor support costs also include training costs associated with instructing the Taxpayer's employees on the operation of newly installed machinery. Assets associated with training, however, are not directly involved in the manufacture of the food products, and therefore should be intangible capital for purposes of the M&T tax.

Modification Costs

The Taxpayer asserts that the assessment of certain capitalized modification or refurbishment costs results in some equipment being taxed both on the original cost and the rebuilding cost, which is essentially double taxation. The Taxpayer asserts that certain capitalized modifications made to its machinery should be classified as repairs for purposes of the M&T tax and not recorded as new "original costs." The County finds that in some instances, the modifications to the machinery in question were so dramatic that they actually resulted in a "new" piece of machinery, and assigned the machinery a new "original cost" for purposes of property taxation.

Fair market value (FMV) is the Constitutional requirement for valuation of tangible personal property. The valuation of machinery and tools must reasonably approximate FMV. See Tuckahoe Women's Club v. County of Richmond, 119 Va. 734, 101 S.E.2d 571 (1958). If the valuation methodology employed by a locality results in an assessment well above FMV, the locality may use another methodology prescribed in Va. Code § 58.1-3507 B. See P.D. 05-129 (8/3/2005).

In some cases, repairs to an asset may make the FMV of that asset greater than the actual assessed value. Historically, the Court has recognized that property is often assessed at less than fair market value and has not objected to such assessments so long as they are applied uniformly. See Norfolk and Western Railway Company v. Commonwealth of Virginia, et al. 211 Va. 692, 179 S.E.2d 623 (1971). In such instances, the assessment will stand. Again, the locality is responsible for finding a methodology for reasonably approximating the FMV of an asset for property taxation.

DETERMINATION


After careful review of the facts presented on appeal, it is my determination that the cartoners, the engineering related costs, and most of the vendor support costs are integral to the manufacture of the Taxpayer's product and as such, are subject to the M&T tax. Machinery associated with case packing is not used directly in manufacturing and, therefore, is found to be intangible. The remaining equipment in dispute that benefited from the capitalized modification costs should be reexamined by the County in order to determine the appropriate value.

If you have any questions regarding this determination, you may call Office of Tax Policy, Appeals and Rulings at *****.
                • Sincerely,

                • Janie E. Bowen
                  Tax Commissioner


AR/1-1012308318H


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46