Document Number
10-159
Tax Type
Retail Sales and Use Tax
Description
A furniture manufacturer assessed for untaxed purchases
Topic
Accounting Periods and Methods
Assessment
Date Issued
08-03-2010



August 3, 2010




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

Dear *****:

This is in response to the letter submitted by ***** seeking correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") for the audit period April 2003 through May 2006. I apologize for the delay in the Department's response.

FACTS


The Taxpayer is a furniture manufacturer. In addition, the Taxpayer has an advertising department that provides design and layout for brochures, tear sheets, and catalogs. The Department audited the Taxpayer's operations and issued assessments for untaxed purchases made during the audit period. The Taxpayer raises several issues relating to items assessed in the Department's audit.

DETERMINATION


Manufacturing

The Taxpayer contests the tax assessed on various purchases for use in its manufacturing facility and claims the items are used directly in the manufacturing process and exempt of the tax.

Virginia Code § 58.1-602 defines "manufacturing" to include "the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site . . . ."

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 replacement thereof, fuel power, energy; or supplies, used directly in processing, manufacturing, refining, mining, or converting products for sale or resale." [Emphasis added.] Virginia Code § 58.1-602 defines the term "used directly" to mean "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing or mining process, but not including ancillary activities such as general maintenance and administration." Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 interprets the above statutes, stating the following:
    • Items of tangible personal property which are used directly in manufacturing . . . are machinery, tools and repair parts therefor, fuel energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt production machinery. [Emphasis added].

Accordingly, the fact that an item is essential to production is not sufficient for exemption based on the Virginia Supreme Court's holding that "essential items which are not an immediate part of actual production are not exempt." See Webster Brick Company, Inc. v. Department of Taxation, 219 Va. 81, 245 S.E.2d 252 (1978).

Further, in the case of Commonwealth of Virginia v. Community Motor Bus Co. 214 Va. 155, 198, S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in a statute was intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products.

Keeping the above in mind, I will address the contested issues.

Adjustments

Based upon further review, the following items will be removed from the audit.

Project #***** - upgrade to packing heaters (Page 1, line item 10)
Project #***** - relocate air compressor air (compressor piping at Fiberboard
Plant) (Page 1, line items 13 and 14)

Project #***** - crating department upgrade (Page 2, line items 23-24)
blow guns (Page 3, Line item 10)
gefen productions (Page 8, line items 37 and 38)

Contested Assets

Project #***** - Cooling tower to cool air compressor (Page 1, line items 1-9)

These items represent piping for a cooling tower used in the operation of an air compressor. Based on the concept of direct use, and as set out in established tax policy as exhibited in Public Document P.D. 96-36 (4/3/96), the piping for the cooling tower at issue may be essential to the operation of the air compressor; however, it is not an immediate part of the production process as it merely prolongs the useful life of the equipment. Therefore, the auditor properly assessed the tax on the piping for the cooling tower in this instance.

Project #***** - Finish Room Air Makeup Upgrade (Sanding Room and Ruff Mill).
(Page 1, line items 11 and 12)

These items represent piping for the boiler condensate pump. The Taxpayer claims that the boiler provides steam to dry kilns and finishing ovens and the pump returns condensate to the boiler.

The auditor deemed the use of the air makeup system to be analogous to that of the air makeup system in P.D. 91-165 (8/13/91). In that case, the purpose of the air makeup system performed dual functions of providing clean air for both the furniture finishing process and also for general plant ventilation. The Tax Commissioner deemed the air makeup system taxable as the primary purpose of the air makeup system was to provide plant ventilation. Accordingly, there is no basis to revise the audit with regard to this issue.

Project #***** - Water Line Reservoir (Page 1, line item 15)

The Taxpayer states that the water line is for the cooling tower that is necessary for the operation of the air compressor.

As addressed above, the cooling tower is not an immediate part of the production process and is taxable because it merely prolongs the useful life of the equipment. The water line that provides water to the cooling tower is likewise taxable as it is not an immediate part of the production process.

Upholstery Table (Page 1, line item 16)

This item represents an upholstery table used to place furniture to be upholstered.

While I agree that the table may be essential, the upholstery table itself does not act upon the product, nor is it an immediate part of the actual production process. The auditor properly assessed the tax on the upholstery table.

Project #***** - Extended Chain Crating Department Upgrade (Page 2 Line items
17-19)

These items represent steel to make platforms used in the packaging department. The Taxpayer claims that furniture is removed from a conveyor and placed on the platforms to install hardware. Based on the auditor's review, the platform is used so employees do not have to lift boxes of packaged furniture from the conveyor to the crating chain. The auditor deemed the platforms to be facilitative and not directly used in manufacturing.

Title 23 VAC 10-210-920 B 2 specifically lists platforms as used indirectly in production and therefore taxable. As a result, the Department has consistently held that catwalks, mezzanines and other platforms or devices that provide convenient access to production machinery do not constitute an integral part of production. Although the platforms are essential to the Taxpayer's operation, they are not an immediate part of actual production. Accordingly, the steel used to make the platforms is taxable.

Project #***** - Bander/Sander (Page 2 Line item 20)

The Taxpayer claims this item represents moulder steel used to cut profiles into wood to make mouldings for the furniture. According to the auditor, the Taxpayer was asked to provide documentation for the purchase; however, the information was never provided. If the Taxpayer can provide documentation that the moulder steel is used directly in manufacturing, the item will be removed from the audit.

Project #***** - Crating Chain (Page 2, line items 21 and 26)

According to the auditor, the crating chain line carries furniture both throughout the production process and packaged goods to a staging area for loading onto trucks.

This item represents switches and electrical used to start and stop the crating chain. According to the auditor, the switches are used in the distribution area after completion of the manufacturing production. Accordingly, these items are used in a post production activity. Therefore, I find no basis to remove these items from the audit.

Project #***** - Lighting-Finishing Department Upgrade (Page 2, line item 22)

The Taxpayer claims that the item represents conduit for an air compressor at the Fiberboard Plant used to provide compressed air to various production equipment. The auditor held taxable the conduit because the project folder indicates the conduit was used in the lighting upgrade in the finishing department for general plant lighting.

Title 23 VAC 10-210-920 C.2 defines those items used in manufacturing activities that are deemed to be taxable. The subsection specifically states that "tangible personal property used for general plant lighting, heating, air conditioning, ventilation, etc., unless such property is specifically designed to protect the integrity of products" is subject to tax.

In this instance, there appears to be a discrepancy on where the contested conduit is located. The only way to resolve this issue is for the auditor to revisit the Taxpayer's facility and determine if the contested conduit is used in the Fiberboard Plant or the Finishing Department. Once it is determined where the item is located and its use, the Department will make a determination if the item was properly taxed or should be removed from the audit.

Project #***** - Crating Chain Conduit (Page 2, Line item 25)

This project consisted of platforms installed in the warehouse, heater elements, and relocating a crating chain to the warehouse, packaging area, and finished foods storage area. The auditor deemed these items used in the taxable distribution of products after the production has ended. Based on this information, I find no basis to adjust the audit with regard to these items.

Contested Expense Purchases

Software (Page 2, line item 1)

It is the Department's long-standing policy that the sale of prewritten software delivered electronically to customers does not constitute the sale of tangible personal property and is generally not subject to sales and use taxation. See Va. Code § 58.1­609.5 1 and P.D. 05-44 (4/4/05). This policy is conditioned on the fact that no disc, tape or other tangible medium is provided to the customer before or after the electronic download of the software.

It is my understanding that the auditor requested a copy of the invoice; however, the Taxpayer has not provided the copy. As such, the Taxpayer has not provided documentation to support its contention that the invoice should not be taxed. Therefore, the assessment with respect to this transaction is considered correct. If the Taxpayer can provide documentation to support its claim that the software was downloaded and no property was received, I will remove the item from the audit.

Samples (Page 2, line items 2-6), (Page 3, line items 11, 12, 14, 15)

These items represent untaxed samples, sample swatches, glass and imported goods charged to expense accounts. The Taxpayer claims these items were resold. According to the auditor, the Taxpayer provided no evidence to support its claim that the items were resold. Lacking the documentation to show that the items were resold, I find that the auditor was correct in holding these transactions taxable in the audit. If the Taxpayer can provide documentation that the items were resold, I will agree to remove them from the audit.

Fasteners (Page 2, line items 7-9)

The Taxpayer claims that these items are fasteners used to repair production equipment and the press at the Fiberboard Plant. In addition, the Taxpayer claims the fasteners are used on the manufactured products.

According to the auditor, the Taxpayer agreed that 20% of the fasteners are used for general maintenance. The assessment with regard to the fasteners represents 20% of the total invoice as fasteners used in general maintenance. In addition, the auditor assessed the tax to a Phillips zinc pan head machine screw. The auditor deemed the zinc pan head screw used for general maintenance and assessed the tax at 100%.

Based on the audit report, the auditor did not include in the audit assessment items used directly in the production process. The contested items assessed at 20% are deemed general maintenance and taxable. Accordingly, I find no basis for adjusting the audit regarding this issue.

With regard to the zinc pan head machine screw, if the Taxpayer can provide documentation to the auditor indicating the zinc pan head machine screw is used as a repair or replacement part to replace worn or damaged parts on exempt production machinery, this item will be removed from the audit.

Forklift (Page 3, Line item 10)

The Taxpayer claims this item is a hose for a forklift used in production. It is my understanding that the Taxpayer has several forklifts that are used in both taxable and exempt: activities. According to the auditor, the Taxpayer agreed upon a percentage of taxable and exempt use to be applied on all fuels, parts, lubricants, and other expenses charged to forklifts. This method was developed to relieve the Taxpayer from maintaining detailed records to determine taxable and exempt use for each forklift. This method has been utilized in prior audits. According to the auditor, the audit was revised to reflect 10% of the contested invoice for taxable general plant use. I find no basis to adjust the audit with regard to this item.

Power Module (Page 3, Line item 13)

This item represents a 15 V power module. The power module was charged to an expense account for maintenance and repair. The Taxpayer claims the power module is used for production equipment.

As noted above, the manufacturing exemption does not apply to incidental activities such as general maintenance. Further, Title 23 VAC 10-210-920 C 2 provides that the tax applies to items "used in the repair, servicing, and maintenance of production machinery; however, replacement parts for exempt production machinery are exempt from the tax . . . ."

The Taxpayer has provided no evidence to support its claim that the contested item is a replacement part for exempt production machinery. Accordingly, I find no basis to revise the audit with regard to this item.

Tow Motor (Page 3, Line item 16)

According to the audit, this item represents a tow motor charged to expense account *****, vehicle maintenance and repair. The Taxpayer claims that this item represents parts for a forklift used in production. The Taxpayer has provided no documentation to support its claim. If the Taxpayer can provide documentation or sufficient evidence that the parts are used in the forklift, the Department will review such information and adjust the audit accordingly.

Contested Pcard Purchases

Air Screwdrivers, Nailers, Alarm Monitoring Service, Belts, and Rubber Bands (Page 3, line items 1, 2, 5, and 14)

The auditor requested additional information about these items; however, the information was not provided. Accordingly, the Taxpayer must provide additional documentation or sufficient evidence to support its claims that such items are exempt from the tax. Lacking such evidence, I find no basis to adjust the audit with regard to these items.

Thermostat, Humidifier and Humidity Control (Page 3, line items 3, 4 and 9)

The Taxpayer claims that these items are needed to keep constant humidity levels to prevent wood from splitting and serve an exempt quality control function.

Virginia Code § 58.1-602 includes equipment and supplies used directly in production line quality control within the scope of the manufacturing exemption. Based on the auditor's research, the auditor believes the equipment at issue is used in non­production activities. If the Taxpayer can establish that the items are needed to keep constant humidity levels to prevent wood from splitting for quality control of the Taxpayer's products on the production line, the items will be removed from the audit.

Lubricants (Page 3, Line items 6, 7 and 11)

The Taxpayer states that this item represents lubricants used for production equipment. The Taxpayer contends such lubricants qualify for the manufacturing exemption and may be purchased exempt from the tax.

As noted earlier, "general maintenance" is excluded from the statutory definition of "used directly." Thus, maintenance that is of a routine nature, such as the periodic lubrication of equipment, does not fall within the scope of the industrial manufacturing exemption. In such cases, the maintenance activities touch only indirectly on the production of products by an industrial manufacturer.

According to the auditor, the lubricants are manually applied to production equipment and are used for general maintenance. Based on this information, the auditor correctly assessed the tax in this instance.

Strainers for Cooling Water (Page 3, Line items 12 and 13)

This item represents micron mesh filter bags. The Taxpayer claims that the strainers are used for the cooling water necessary for the operation of the press at the Fiberboard Plant.

In this case, the strainers are essential to the functioning of the press but only in a maintenance capacity as opposed to being an immediate part of production or having any direct relationship to the protection of the integrity of the product itself. Therefore, the strainers do not qualify for the manufacturing exemption.

Contested Sample Purchases

(Page 4, Line items 13 and 14, Page 5 Line items 15 and 16)

The Taxpayer contends that purchase invoices included in the September 2004 sample period were paid outside this sample period and should be removed from the sample.

Based on the Taxpayer's accounting records, the contested purchases were recorded as September 2004 transactions. Each item of tangible personal property purchased was listed in the audit based on separate journal entries obtained from the Taxpayer's records. Unless the Taxpayer can provide documentation establishing that the purchases took place prior to September 2004, its burden of proving the transactions occurred outside the sample period has not been met.

Contested Advertising

In-house Advertising (various line items)

The Taxpayer contests the additional tax assessed on advertising materials and contends that the audit should be adjusted down to the 15 percent taxable amount initially agreed upon. The Taxpayer claims that the auditor unexpectedly revised the audit, giving the Taxpayer only a few days to meet the 90-day provision to appeal the contested items.

A review of the audit workpapers shows that in letter to the Taxpayer dated February 16, 2007, the auditor requested additional information regarding the Taxpayer's advertising activities. Based on the information available during the audit, the auditor taxed the catalogs and other printed materials at 15 percent of the invoice amount to estimate the printed advertising materials distributed within Virginia and those remaining in Virginia for more than twelve months. Other advertising was assessed at 100 percent. Because the Waiver of Time Limitation on Assessment of Taxes was about to expire and the information regarding the advertising activities had not been provided, the Taxpayer and auditor agreed that an assessment would be made and the Taxpayer would have 90 days to provide the requested information.

Subsequent to the assessment, the Taxpayer provided the additional information previously requested by the auditor regarding the Taxpayer's advertising activities. Based on this information, the auditor determined that the Taxpayer, is providing in-house advertising and is subject to the tax on tangible personal property used to advertise its products. In the auditor's letter dated May 2, 2007, the auditor explained in detail that the Taxpayer's purchase of advertising materials fall under Title 23 VAC 10-210-43 and are subject to the tax. In addition, the auditor informed the Taxpayer that the audit had been revised to include 100 percent of the cost for the printing of posters, tear sheets and brochures used in the Taxpayer's in-house advertising that was initially assessed at 15 percent. Because the Taxpayer did not provide the requested information on catalogs shipped outside Virginia, the auditor advised the Taxpayer that the bulk purchases of catalogs would remain taxable at 15 percent.

Based on the Taxpayer's advertising activities, the Taxpayer is providing in-house advertising and is subject to the tax on purchases in accordance with Title 23 VAC 10-210-43. Therefore, I find no basis to adjust the audit regarding the contested purchases used in the Taxpayer's in-house advertising. If the Taxpayer provides the requested information regarding the distribution of catalogs in Virginia and those remaining in Virginia for more than twelve months, the audit will be adjusted accordingly.

Warranty Brochures (Page 4, Line items 3 and 6)

Warranty brochures serve an administrative purpose similar to product invoices shipped with the product and are subject to the tax. The warranty brochures were properly held taxable in the audit. This conclusion is supported by the decision in P.D. 99-291 (11/12/99).

Credits (Page 8, Line items 10-40)

The Taxpayer argues that credit given in the audit for overpayments to the Department should have been included in the audit sample.

According to the audit comments, the Taxpayer reported a fixed amount of tax on its monthly sales and use tax return for expense purchases rather than the actual total value of tangible personal property used under the Taxpayer's direct payment permit. This resulted in the overpayment of use tax. In addition, the auditor found that the overpayment of use tax was not consistent throughout the audit period. For example, the Taxpayer did not report any tax on expense purchases for the period March 2004 through September 2004 and February 2006 through May 2006. Because the overpayments were not consistent throughout the audit period, the auditor determined theses credits would skew the sample and nullify its validity. Therefore, the auditor gave credit for the tax paid in the months that it was reported.

Based on the information provided in your appeal and the manner in which the sample was conducted, I find no basis to invalidate the auditor's methodology. The sample and the error factor extrapolated over the audit period were computed properly, and the credits at issue were properly applied.

CONCLUSION


The audit will be returned to the Department's auditor to make the adjustments set out in this determination. With regard to the contested issues requiring additional documentation, the Taxpayer is given 60 days from the date of this letter to submit the necessary documentation to the auditor. If this documentation is not received within the allotted time, no additional adjustments will be made to the audit report. A revised bill with interest accrued to date will be mailed to the Taxpayer and should be paid within 30 days of the bill date to avoid the accrual of additional interest. The Taxpayer should remit payment to: Virginia Department of Taxation, 600 E. Main Street, 15th Floor, Richmond, Virginia 23219, Attention: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.

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 of Taxation's web site. If you have questions regarding this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,


                • Craig M. Burns
                  Acting Tax Commissioner



AR/1-1406803501.T


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46