09-16 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Design, fabricate and install exhibits and the display structures for the exhibits

Topic

Classification

Manufacturing Exemption

Tangible Personal Property

Date Issued

02-04-2009

February 4, 2009

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

Dear *****:

This is in response to your letter in which you seek correction of the retail sales
and use tax assessments issued to ***** and ***** (collectively, the "Taxpayer") for the periods of April 2001 through March 2004 and January 2003 through March 2004, respectively. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer contracts with museums, visitor centers and similar establishments to design, fabricate and install exhibits and the display structures for the exhibits. The Taxpayer also designs, fabricates and installs trade show exhibits. The Taxpayer's exhibit services include scenic and art production, construction and fabrication, audiovisual systems engineering, multimedia development and artifact mounting. In addition, the Taxpayer fabricates and sells custom furniture, graphics and signs. Many of the Taxpayer's customers are not located in Virginia.

The Taxpayer was audited and treated as a real property contractor for much of the fabrication and installation work performed for its customers. This treatment resulted in the assessment of use tax on the Taxpayer's purchases of materials that became a component part of the exhibits, furniture, graphics and signs. Use tax was also assessed on equipment, tools and supplies used to fabricate and package the exhibits, furniture, graphics and signs. The Taxpayer contends that it should be classified as a retailer and a manufacturer rather than a using and consuming contractor. This classification would allow the Taxpayer to claim the resale and manufacturing exemptions on many of the purchases held taxable in the audit.

DETERMINATION

Real Property versus Tangible Personal Property

Museum, Visitor Center and Trade Show Exhibits

The Taxpayer's classification in the audit as a real property contractor is based on the auditor's determination that many of the exhibits became real property when they were installed by the Taxpayer. The Taxpayer contends that the exhibits remain tangible personal property after installation. Thus, the Taxpayer's sale and installation of the exhibits are retail sales and the purchases of materials that became a component part of the exhibits qualify for the resale exemption.

The exhibit work performed by the Taxpayer can be divided into two components. The Taxpayer fabricates and installs walls, platforms, rails, pedestals, artifact and display cases, shelves and similar items that serve as a structural medium to support and display the actual exhibits. Some of the exhibit structures, such as false walls, partitions and rails, are often attached to the walls, ceilings or floors of buildings to anchor them. This is done primarily for support and safety. The Taxpayer also fabricates the actual exhibits, which consist of dioramas, murals, graphics, signs, plaques, models, audiovisual devices and interactive displays that are mounted on, attached to or placed in the support or display structures. Exhibit items are also hung on building walls or ceilings by using wood pinch cleats, picture hangers or wire.

The auditor concluded that the manner in which the exhibits were attached to real property and the useful life of the exhibits demonstrated that the intent of the Taxpayer's customers was to make the exhibits part of real property. These factors led the auditor to treat the Taxpayer as a real property contractor. In cases where contracts indicated that particular exhibits were temporary, i.e., trade show or traveling museum exhibits, the auditor treated the Taxpayer as a retailer making retail sales of the exhibits.

In Danville Holding Corp. v. Clement, 178 Va. 223, 232, 16 S.E.2d 345, 349 (1941), the Virginia Supreme Court (the "Court") recited three factors for determining whether property used in connection with realty is a fixture. They are: "(1) Annexation of the chattel to the realty, actual or constructive; (2) Its adaptation to the use or purpose to which that part of the realty to which it is connected is appropriated; and (3) The intention of the owner of the chattel to make it a permanent addition to the freehold." The Court noted that "[t]he intention of the party making the annexation is the paramount and controlling consideration."

Based on the information presented, certain components of the exhibits remain tangible personal property when installed. The actual exhibit items, such as graphics, maps, murals, plaques and photographs are hung on or attached to walls, ceilings or other support structures using cleats, picture hangers, cables or wires. Some models and artifacts are not attached to display structures. They are placed in display cases, bookshelves or floor standing pedestals. Dioramas, maps and similar items may be placed in glass or plexiglass enclosures. Based on the types of items described and the methods used to display the items, these items fail the first test in Danville Holding Corp. v. Clement and remain tangible personal property when installed by the Taxpayer.

The tax treatment of the exhibit display structures fabricated and installed by the Taxpayer is not as clear. Many of the display structures are attached to real property in some manner and appear to meet the first and second tests in Danville Holding Corp. v. Clement. However, under the third test, it is difficult to determine the intent of the parties that contracted with the Taxpayer to purchase the exhibits. This is not stated in the contract language. The intention of a party that annexes tangible personal property to realty can sometimes be determined by whether the party owns or leases the building or property where the annexation occurs. The lease agreement may state whether title to annexed property passes to the owner of the realty at the end of the term of the lease. In this case, it is not known if the Taxpayer's customers own or lease the buildings and property where the exhibits are installed. Further, there is no other information available to determine the intent of the parties that purchased the exhibits.

The Taxpayer maintains that, by their nature, visitor center or museum exhibits are temporary because they can be replaced at any time. Therefore, a museum or visitor center cannot have the intent to make an exhibit a permanent part of real property. The auditor noted that many of the exhibit display structures were attached in some fashion to the real property and many of the exhibits were referred to as "permanent exhibits" by the Taxpayer's customers. The auditor also confirmed that some of the exhibits are still in use several years after opening. The auditor concluded that exhibits installed for their useful life implies intent by the museums and visitor centers to make the exhibits a permanent part of realty.

In John Wesley Mullins, et al. v. L.E. Sturgill, et al., 192 Va. 653, 66 S.E. 2d 483 (1951), citing 22 Am. Jur., Fixtures, Sec. 6, p. 719, the Court noted that the intention of the party making the annexation is not always determinative. The Court stated:

- in cases of doubt it [the intention of the party making the annexation] has a controlling influence and must be considered. However, in order that a chattel may be converted into a fixture, the intention to make it a permanent accession to the realty must affirmatively and plainly appear; if the matter is left in doubt and uncertainty, the legal qualities of the article are not changed, and it must be deemed a chattel. [Insert and emphasis added.]

Based on the facts of this case, the intent of the parties to make the exhibits purchased from the Taxpayer a permanent part of the realty is not affirmatively and plainly apparent. The Taxpayer's customers are primarily located in other states and there is little information available to realistically determine the intent of the customers. In accordance with the Court's opinion in John Wesley Mullins, et al. v. L.E. Sturgill, et al., there is sufficient doubt and uncertainty as to the parties' (the customers) intentions to conclude that the legal qualities of the exhibits and display structures are not changed and that these items remain tangible personal property, even if attached to the realty in some manner.

This conclusion is further supported by the fact that many of the exhibits are attached to the realty in a way that allows removal without injury to the exhibits or the real property to which they are attached. Additionally, in Public Document ("P.D.") 06-142 (12/8/06), the Tax Commissioner ruled that there was no legal basis to rely solely on federal depreciation classifications to distinguish tangible personal property from real property for local property tax purposes. Further, the Court in Danville Holding Corp. v. Clement did not establish that the useful life of property could be used to determine a party's intent to annex that property to realty. While the useful lives of the exhibits can be considered when determining intent, I am not persuaded in this case that it supports treating the exhibits installed by the Taxpayer as real property.

Traveling Museum and Trade Show Exhibits

The Taxpayer fabricates "traveling" museum exhibits and trade show exhibits. These exhibits are temporary in nature, as the exhibits are displayed at a particular museum, visitor center or trade show for a designated time period and are then dismantled, transported from the location and either set up at a new location, placed in storage or discarded. The Taxpayer has provided contracts that contain language that clearly demonstrates there was no intent by either party to make the exhibits part of the customer's real property. The contracts state the exhibits must be constructed in such a manner as to allow them to be easily disassembled and packaged for shipment. The terms in some of the contracts require the Taxpayer to provide shipping crates, pallets, containers and similar devices to facilitate the packaging and shipment of exhibit items. Based on these factors, transactions in which the Taxpayer provides traveling exhibits or trade show exhibits are retail sales of tangible personal property.

Custom Furniture

The Taxpayer fabricates and constructs custom furniture such as desks, lecterns, tables, benches, cabinets, bookcases, display cases and similar items. The Taxpayer may deliver and install the furniture for its customers. Generally, the furniture is not attached to real property and there is no evidence of any intent by the Taxpayer's customers to make the furniture part of the realty. Based on the information presented, the sale of custom furniture is a retail sale of tangible personal property. The Taxpayer's purchases of materials that become a component part of the furniture transferred to customers qualify for the resale exemption and are not subject to Virginia use tax. These items will be removed from the audit and the assessment adjusted accordingly.

Graphics and Signs

The Taxpayer also fabricates and sells graphics and signs such as art reproductions, plaques, photographic prints and similar items. The application of the tax to the Taxpayer's sale and installation of graphics and signs is based upon whether the graphics and signs become real property or remain tangible personal property when installed. The Taxpayer states that the graphics and signs are normally installed using picture hangers or pinch cleats. Based on the method of installation and applying the three tests set out in Danville Holding Corp. v. Clement, graphics and signs installed using picture hangers, pinch cleats or similar methods remain tangible personal property when installed. Transactions involving the sale and installation of these items are retail sales. The audit will be adjusted to remove purchases of materials that became a component part of graphics and signs that were sold at retail.

Due to a legislative change, the application of the tax to manufactured signs has changed effective July 1, 2005. This law change amended the definition of tangible personal property in Va. Code § 58.1-602 to include manufactured signs. As a result, the sale and installation of manufactured signs is a retail sale regardless of whether the sign becomes part of real property upon installation.

Classification of the Taxpayer

Based on the determination that the Taxpayer is making retail sales of exhibits, furniture, graphics and signs, the Taxpayer is properly classified as a retailer and not a real property contractor. Virginia Code § 58.1-603 imposes a retail sales tax on every person who engages in making retail sales in Virginia. The term "retail sale" is defined, in part, in Virginia Code § 58.1-602 as "a sale to any person for any purpose other than for resale ...." Based on this definition, the Taxpayer's purchases of materials that become a component part of exhibits, furniture, graphics and signs that are sold at retail qualify for the resale exemption and are not subject to Virginia use tax. The audit will be adjusted to remove purchases of materials, supplies and other items that were transferred to its customers as part of such sales. The Taxpayer should provide its suppliers with Form ST-10, Resale Exemption Certificate, when making exempt purchases of materials for resale.

Real Property Work Performed by Taxpayer

The Taxpayer notes in its letter that parts of some exhibit jobs did involve improvements made to real property. For example, the Taxpayer installed signs that were attached to real property and were intended to remain a permanent part of the real property. Virginia Code § 58.1-610 A provides that a person who contracts to perform construction, reconstruction, installation, repair, or any other service with respect to real estate or fixtures thereon and who furnishes tangible personal property is deemed to have purchased the tangible personal property for use or consumption. Title 23 of the Virginia Administrative Code (VAC) 10-210-410 further provides that "the law treats every contractor as the user or consumer of all tangible personal property furnished to him or by him in connection with real property construction, reconstruction, installation, repair, and similar contracts."

A contractor who enters into a real estate construction contract to furnish and install construction materials does not resell the construction materials. Rather, the contractor is deemed to be the final user or consumer of the materials purchased for installation. In this case, the Taxpayer has furnished and installed tangible personal property, which upon installation became a part of the realty. Based on the provisions of Title 23 VAC 10-210-410, the Taxpayer agrees that it is liable for the use tax on its purchases of certain materials that were incorporated into real property.

The Taxpayer has provided information with the appeal that shows a breakdown of various audit items furnished for each job that it has classified as real or personal property. While I appreciate the Taxpayer providing this information, the Department will need to verify the information prior to accepting it. During the audit, the Department's auditor was not allowed access to drawings and plans for the Taxpayer's projects. Thus, the Department must verify the information provided by the Taxpayer through a review of shop drawings, plans or similar information related to the type and scope of work for the projects included in the audit.

The Taxpayer should refer to Title 23 VAC 10-210-410 E for guidance on the application of use tax to the purchase, fabrication and use of materials that become real property when installed by businesses that operate in a dual role of fabricating tangible personal property for retail sale and for their own use in real property construction.

Manufacturing Exemption

The Taxpayer maintains that certain machinery and tools held taxable in the audit qualify for the manufacturing exemption. Virginia Code § 58.1-609.3 2 (iii) provides an exemption from the sales and use tax for machinery, tools, repair parts, fuel, power, energy or supplies used directly in the manufacture of tangible personal property for sale or resale. Title 23 VAC 10-210-920 interprets the manufacturing exemption and provides that for a business to obtain the exemption it must (1) be manufacturing or processing products for sale or resale and (2) its production must be "industrial in nature." The definition of "manufacturing, processing, refining or conversion" in Va. Code § 58.1-602 states that "industrial in nature" includes, but is not limited to, "those 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."

Generally, businesses engaged in manufacturing and classified in the Standard Industrial Classification ("SIC") codes enumerated above are involved in transforming raw materials into useful and marketable products within a factory, plant or mill environment using power-driven machinery and materials handling equipment. Manufacturing and production is usually carried on for the wholesale market, for interplant transfer or "to order" for industrial users, rather than for direct sale to domestic consumers. This interpretation was substantiated by the Virginia Supreme Court, in Golden Skillet Corporation v. Commonwealth, 214 Va. 276, 199 S.E. 2d 511 (1973), which held that the cited statute was intended "to provide exemption for machinery and tools used in ... manufacturing ... products for sale or resale only in the industrial sense."

The Taxpayer notes that the Court in Prentice v. City of Richmond, 197 Va. 724 (1956), set out a definition of manufacturing that supports the position that it is a manufacturer. The Taxpayer meets the first criteria in Title 23 VAC 10-210-920 because it produces exhibits, furniture, graphics and signs for retail sale. However, the Court's decision in Prentice v. City of Richmond defines manufacturing for local license tax purposes and does not address manufacturing in the industrial sense. For sales and use tax purposes, there must be manufacturing or processing that is industrial in nature. The Golden Skillet case emphasizes this distinction between "manufacturing" for local license tax purposes and "industrial manufacturing" for sales and use tax purposes. Therefore, the manufacturing exemption is available if the Taxpayer's business activities are industrial in nature.

Museum, Visitor Center and Trade Show Exhibits

Museums, visitor centers and similar establishments employ the Taxpayer for its engineering skills, artistic ability, expertise and knowledge needed to design and create dioramas, models, murals, maps, graphics and similar items that become the exhibits. Many of the activities performed by the Taxpayer are commonly found in SIC and NAICS classifications that are not manufacturing activities. The exhibits are custom designed and fabricated for specific customers and purposes. The exhibits are not mass produced and are not inventoried or stocked for sale. The Taxpayer sells the exhibits at retail to end users.
The Taxpayer's exhibit fabrication operation, which is its primary activity, is classified under SIC Industry Number 7389, Miscellaneous Business Services - the building of exhibits by industrial contractors. This is a non-manufacturing code and it applies to the Taxpayer's predominant or primary business activity. The North American Industry Classification System ("NAICS") replaced the SIC Manual in 1997. Many business activities formerly classified in SIC code 7389 are now classified under NAICS industry code 54149, which is also a non-manufacturing code. However, the NAICS does not contain a classification similar to the SIC classification for industrial contractors that build exhibits.

Based on the above, I do not agree that the Taxpayer's fabrication of museum, visitor center and trade show exhibits is industrial in nature. In accordance with Title 23 VAC 10-210-920, Va. Code §§ 58.1-602 and 58.1-609.3 2 and the Department's existing policy, the Taxpayer does not qualify for the manufacturing exemption with respect to fabrication of exhibits. This determination is consistent with P.D. 96-73 (5/1/96), in which a taxpayer that fabricated and installed museum exhibits was deemed to be engaged in activities that were not industrial in nature. The taxpayer's business operations in P.D. 96-73 are very similar to the Taxpayer's operations and that taxpayer did not qualify for the manufacturing exemption. There is no basis to remove the machinery, equipment and tools used by the Taxpayer in its exhibit fabrication activities from the audit.

Custom Furniture

The Taxpayer's furniture fabrication activities are a minor part of the Taxpayer's overall business. As is the case with the fabrication of exhibits, the furniture is not massproduced but is custom built to customers' specifications. The furniture is sold to end user customers. The Department has ruled in P. D. 06-90 (9/19/06) and P. D. 02-32 (3/15/02) that the predominant nature of the sales of a business should be examined when determining whether it is an industrial manufacturer or a retailer. If a business manufactures or fabricates products that are primarily sold at retail to end users, the manufacturing activities of the business are not industrial in nature and the manufacturing exemption does not apply.

The Taxpayer's primary business is the design, fabrication and installation of exhibits, which is not industrial in nature. The building of custom furniture is an incidental part of the Taxpayer's overall business of exhibit design and fabrication. Based on these facts and that the Taxpayer's furniture sales are predominantly to end users, the Taxpayer does not qualify for the manufacturing exemption with respect to its furniture fabrication activities. The machinery, tools and equipment used by the Taxpayer in its furniture fabrication activities were properly held taxable in the audit.

Graphics and Signs

The information provided shows that the Taxpayer's sales of graphics and signs consist primarily of graphics products. In Exhibit E provided with the Taxpayer's appeal, jobs in this category included photographic print production, mounting and laminating, the production of graphics for murals, the production of plaques and some repair work to the types of items listed. Some of the work in this category appears to be repairs to or replacements of exhibit items. I have previously ruled that exhibit fabrication does not qualify for the industrial manufacturing exemption.

Based on the information presented, I do not agree that the Taxpayer's graphics and signs work qualifies for the manufacturing exemption. Businesses engaged in graphics design services are classified under NAICS Code 541430, which is a nonmanufacturing classification. This appears to be an appropriate classification for this part of the Taxpayer's business. In addition, any actual graphics and sign fabrication work performed by the Taxpayer is incidental to the Taxpayer's primary business of exhibit design and fabrication, which is not industrial in nature. The graphics and signs products are sold to end users. Consistent with my determination on the Taxpayer's furniture fabrication activities, the machinery, tools and equipment used by the Taxpayer to fabricate graphics and signs were properly held taxable in the audit.

Packaging Exemption

Virginia Code § 58.1-609.3 2 (iv) provides a sales and use tax exemption for "materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale." The Taxpayer cites this exemption to support the removal from the audit of packaging materials such as bubble wrap, shrink wrap, packing tape and sealing tape. This exemption is interpreted by Title 23 VAC 10-210-920 A to apply to the types of tangible personal property listed when used or consumed by industrial manufacturers and processors. To qualify for exemption, a business must be an industrial manufacturer or processor.

Based on my determination in this letter, the Taxpayer's operations are not industrial manufacturing and processing. Accordingly, the Taxpayer does not qualify for the packaging materials exemption that is available to manufacturers. However, in accordance with Title 23 VAC 10-210-400, the resale exemption applies to packaging materials that are marketed with the product sold and become the property of the purchaser. Therefore, packaging materials may qualify for the resale exemption when marketed with exhibits, furniture, graphics, signs and other items if the packaging materials become the property of the purchaser. If the Taxpayer can provide documentation showing that the packaging materials at issue were transferred to customers as part of the sale, the materials will be removed from the audit.

The Taxpayer should note that packaging materials and transportation devices that are used to ship products to customers and do not transfer to the customer or are used by the seller to perform transportation services in its own vehicles do not qualify for the resale exemption and are taxable. For example, a business places its products in boxes for shipment to customers. The business places the boxed products on pallets and delivers the products in its trucks. The boxes that contain the products are transferred to customers but the business retains possession of the pallets. The boxes qualify for the resale exemption but the pallets do not.

CONCLUSION

The Taxpayer has provided schedules showing a breakdown of the taxable and nontaxable items in the audit based on the arguments presented in its appeal letter. The Department's auditor will review the schedules and supporting documentation and adjust the audit based on this determination. As previously stated, the Taxpayer should be prepared to provide plans and drawings or any other documentation needed to facilitate the auditor's review and revision of the audit. The items in question will be deemed taxable if the required information is not provided.

The audit assessment will be adjusted to reflect the results of the audit revision. An updated bill, with interest accrued to date, will then be mailed to the Taxpayer and should be paid within 30 days from the date of the bill notice to avoid the accrual of additional interest. Unless there are items addressed in this appeal that are included in the audit of ***** the Taxpayer may wish to pay the current balance of that assessment to avoid the continual accrual of interest.

The Code of Virginia sections, regulations and public documents 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 determination or the assessments, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Janie E. Bowen
        Tax Commissioner

AR/55340S

Rulings of the Tax Commissioner