12-1 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Use tax on purchases of heavy equipment and repair and replacement parts

Topic

Appropriateness of Audit Methodology

Exemptions

Date Issued

01-12-2012

January 12, 2012

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

Dear *****:

This will reply to your letter in which you seek correction of the retail sales and use tax assessment issued to your client, ***** (the "Taxpayer”), for the period April 2007 through December 2009. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer engages in several business activities. The Taxpayer operates a mulch yard where it makes wholesale and retail sales of top soil, compost, mulch and other landscaping materials. The Taxpayer is a real property contractor that clears land and prepares sites for road and building construction projects. The Taxpayer removes trees, vegetation and debris from the job sites and grinds trees and other wood waste into chips at many of the sites. The wood chips are hauled from the job sites to the mulch yard for processing into mulch and other landscape materials. The Taxpayer also grinds wood materials into wood chips at the mulch yard.

The Taxpayer is contesting the assessment of use tax on several purchases of heavy equipment used in its operations. The Taxpayer also disputes the assessment of use tax on purchases of repair and replacement parts for the contested equipment.

DETERMINATION

Industrial Processing Exemption at Job Sites

The Taxpayer contracts to clear land and prepare sites for construction projects. The Taxpayer states that it uses various types of equipment to perform the contract work, including a grinder, front-end loader, excavators and an articulated truck. According to the Taxpayer, the equipment at issue is used to harvest trees, grind wood chips at job sites and load the wood chips into the articulated truck. The truck then transports the wood chips to the Taxpayer's mulch yard.

The Taxpayer maintains that the equipment used in harvesting and wood chip production activities at the job sites and the repair and replacement parts for the equipment qualifies for the industrial processing exemption under Va. Code § 58.1-609.3 2. The industrial processing exemption was not recognized in the audit based on the Department's policy as stated in Title 23 of the Virginia Administrative Code (VAC) 10-210-920 A and in a number of public documents issued by the Department. This policy limits the industrial processing exemption to activities conducted at a single plant site. The Taxpayer's use of mobile equipment to produce wood chips at multiple job sites was deemed taxable because these activities do not meet the single plant site requirement for the exemption.

The Taxpayer states that the Department's interpretation of the exemption statute is unreasonable because the single plant site policy discussed in Title 23 VAC 10-210-920 imposes an additional requirement for the exemption that is not present in the statute. The Taxpayer suggests that the Department is recognizing the form rather than the substance of its business activities because the nature of the business is to travel to various locations to conduct an integrated manufacturing process. Specifically the Department has focused on where the activity is conducted instead of the nature of the activity, which conflicts with the clear language of the statute. The Taxpayer states that limiting the exemption to a single plant site places an unreasonable burden on the business by requiring that harvested trees be hauled to a central location for processing. This unnecessarily creates the need for purchases of more machinery. Finally, the Taxpayer maintains that the Department erroneously relies on the Virginia Supreme Court case, Commonwealth, Department of Taxation v. Wellmore Coal Corp., 228 Va. 149, 320 S.E.2d 509 (1984), 511 (Va. 1984), to support the single plant site requirement of the exemption. The Taxpayer maintains that this court case actually supports an industrial processing exemption for processing activities conducted at multiple locations.

Virginia Code § 58.1-609.3 2 iii provides an exemption from 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 ...." Virginia Code § 58.1-602 defines manufacturing, processing, refining, or conversion 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 ....” Public Document (P.D.) 97-244 (5/27/97) explains that the Department has traditionally interpreted this statute to mean that the manufacturing and processing exemption in Va. Code § 58.1-609.3 2 is limited to production activities conducted at a single location. Thus, the Department's longstanding policy has been that mobile or portable equipment that is transported to and used at temporary sites to process products for sale or resale does not qualify for the industrial processing exemption because the activity must be conducted at a single plant site.

The Taxpayer asserts that the Wellmore Coal case supports an exemption for multiple processing sites and for transportation activities necessary to haul wood chips from job sites to the mulch yard for further processing. The Taxpayer is contesting the assessment of use tax on an articulated truck that is used to transport the wood chips produced at job sites to the mulch yard.

The Wellmore Coal case involved a coal mining and processing business. As a result of the Wellmore Coal decision, the Department issued Virginia Tax Bulletin 84-23 (11/23/84). The bulletin notes that the court's decision applies to mining operations only. The decision to allow an exemption for the transportation of mined materials from the mining site to a processing facility was based on language in the Department's mining regulation, § 1-63, which was published January 1, 1979. At that time, this regulation was applicable to both the manufacturing and mining industries. The regulation stated that the mining exemption did not end at the mining site if the ore or mineral was subject to further mining processing. The court relied on this regulation to extend the mining exemption to transportation activities related to further processing of mined materials. A separate mining regulation was later published that reflected the court's ruling on this issue. However, the language relied on by the court in Wellmore Coal was removed from the new manufacturing regulation.

In the instant case, the Taxpayer is not engaged in mining operations and the decision of the court in Wellmore Coal does not apply to the Taxpayer's transportation activities. The Taxpayer does not transport wood chips to the mulch yard for further mining processing activities; thus, the machinery and equipment used in transportation activities do not qualify for exemption. This conclusion is supported by P.D. 92-205 (10/16/92), in which the Tax Commissioner determined that the Wellmore Coal case did not apply to transportation activities conducted by a business that used barges to transport mined gravel between two processing sites.

Further, I am not persuaded that Wellmore Coal supports an industrial processing exemption for multiple plant sites. Again, the court's decision was based on language from a regulation that applied to mining activities only. The Taxpayer is not a mining business. As such, Wellmore Coal has no application to the multiple plant site issue raised by the Taxpayer. In addition, the Virginia courts have consistently required strict construction of sales tax exemptions, i.e., where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. In Winchester TV Cable Co., v. State Tax Commissioner, 216 Va. 286, 217 S.E.2d 885 (1975), the court stated that when a statute is subject to two interpretations, one granting exemption and the other denying exemption, the latter will be chosen.

Based on the above, the industrial processing exemption does not apply to the machinery and equipment used by the Taxpayer to grind wood chips at job sites and used to transport the wood chips to the mulch yard. I must also note that the equipment for which the Taxpayer is claiming the industrial processing exemption is used to perform its contract work at the job sites. The Taxpayer's processing of severed trees into wood chips at the job sites is incidental to the Taxpayer's contracts to clear land and prepare sites for the construction projects.

Industrial Processing Exemption at Mulch Yard

The Taxpayer hauls the wood chips produced at job sites to its mulch yard. In some cases, wood chips may be produced at the mulch yard. A front-end loader is used at the mulch yard to load chips into a screen drum and to turn soil during the composting process. The screen drum removes debris from the wood chips. After screening, the front-end loader piles the wood chips into wind rows. The Taxpayer claims that the industrial processing exemption applies to the front-end loader and the screen drum used at the mulch yard.

P.D. 91-99 (6/14/99) addresses a business that transported a mobile bandsaw to its customers' premises and cut wood into planks and beams. The Tax Commissioner ruled that the activity of cutting or fabricating wood with the mobile bandsaw qualified for the manufacturing and processing exemption if the activity was performed at a fixed plant site. Further, the Tax Commissioner ruled in P.D. 99-41 (3/31/99) that certain machinery, tools and equipment used by a business to produce wood chips for fuel at two separate fixed woodyard sites qualified for the manufacturing exemption.

Based on the Department's policy as set out in the cited public documents, the processing of wood chips at the Taxpayer's mulch yard is an exempt activity under Va. Code § 58.1-609.3 2. However, the exemption is limited by the statute, which states that "[m]achinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in processing, manufacturing, ... for sale or resale." Title 23 VAC 10-210-920 D interprets the preponderance of use requirement in the statute and states:

- When a single item of tangible personal property is put to use in two different activities, one of which is an immediate part of the industrial production process (exempt) and the other of which is not (taxable), the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in non-exempt activities. Likewise, the item will be totally exempt if the preponderance of its use is in exempt production activities.

Based on information provided by the auditor and in the Taxpayer's letter, the preponderance of use of the equipment used at the Taxpayer's mulch yard must be examined to determine if the industrial processing exemption applies. I understand that the equipment is used in various activities, some of which are taxable. For example, the front-end loader is used to load customers' trucks with the Taxpayer's products. Also, the screen drum is sometimes transported to and used at job sites. Consistent with P.D. 99-41 and other public documents, the Taxpayer must provide the Department with detailed information on the use of the equipment at issue to determine the preponderance of the equipment's use. The equipment used at the mulch yard will be removed from the audit if it is determined that it was used fifty percent or more of the time in exempt industrial processing activities.

Harvesting Exemption

The Taxpayer asserts that the machinery, equipment and repair parts used at job sites qualify for the forest products harvesting exemption. Virginia Code § 58.1-609.2 6 provides an exemption from the retail sales and use tax for:

- Machinery or tools and repair parts therefor or replacements thereof, fuel, power, energy or supplies, used directly in the harvesting of forest products for sale or for use as a component part of a product to be sold. Harvesting of forest products shall include all operations prior to the transport of the harvested product necessary for (i) removing timber or other forest products from the harvesting site, (ii) complying with environmental protection and safety requirements applicable to the harvesting of forest products, (iii) obtaining access to the harvesting site, and (iv) loading cut timber or other forest products onto highway vehicles for transportation to storage or processing facilities.

Title 23 VAC 10-210-700 interprets this exemption and defines various terms for purposes of administering the exemption. The terms "direct use" and "directly used" are defined by the regulation to include "items that are both indispensable to the harvesting of forest products and which are used immediately in the harvesting of forest products."

The statute limits the scope of the exemption to items that are used directly to harvest forest products and to operations that are necessary to accomplish the four types of activities listed in the statute. Title 23 VAC 10-210-700 C explains that "[a] harvester's use of machinery and tools, fuel, power, energy, or supplies indirectly in the harvesting of forest products or in any other activity is subject to the tax."

Based on a review of the four activities listed, I do not agree that wood chipping or grinding is an operation that is necessary to accomplish any of these activities. The forest products can be removed from the harvesting site without grinding or chipping the harvested product. The Taxpayer has not provided evidence that grinding or chipping is an environmental protection or safety requirement. The grinding and chipping activities are not necessary to access the harvesting site. This activity occurs after access to the site has been created. Finally, it is not necessary to grind or chip the severed trees prior to their transport to the Taxpayer's mulch yard.

Further, the machinery and equipment used in grinding and chipping activities are not directly used to harvest forest products. Applying the definition of direct use from Title 23 VAC 10-210-700, the machinery and equipment are not indispensable to and are not used immediately in the harvesting of forest products, as this term is defined in the regulation. The chipping and grinding of trees and wood materials are activities that are performed at job sites to facilitate the Taxpayer's production of mulch and other landscape materials at its mulch yard. These activities are not necessary for the harvesting of forest products to take place. I must conclude that the grinding and chipping activities conducted by the Taxpayer do not qualify for the exemption under Va. Code § 58.1-609.2 6.

The auditor agreed during the audit that the Taxpayer is a harvester of forest products. I understand that the auditor identified and excluded from the audit certain purchases of machinery, equipment and tools that were used directly by the Taxpayer in harvesting activities at job sites. Two grapple skidders and a knuckleboom loader are among the items that were excluded from the audit. The auditor also offered to review and determine if the Taxpayer's use of other equipment at the job sites qualified for the harvesting exemption. The Taxpayer did not provide information to the auditor for any of the machinery or equipment that remained in the audit.

Title 23 VAC 10-210-700 D provides that harvesting equipment and supplies used in both exempt and taxable activities requires the proration of the tax due on these items based on the percentage of the items' use in harvesting and taxable activities. If the percentage of use cannot be determined, the items are subject to the tax. I will agree to allow the Taxpayer to provide documentation that identifies and supports a prorated exemption for specific machinery, equipment and repair parts that are included in the audit and qualify for the harvesting exemption.

CONCLUSION

The Taxpayer will be allowed 45 days from the date of this letter to provide the Department documentation that supports adjustments to the audit for equipment used at the mulch yard and for equipment used in harvesting activities. The Taxpayer will be issued revised bills based on the adjustments made to the audit. If the Department does not receive any information for review within 45 days, the assessment will be considered correct. The Taxpayer will be issued bills with updated interest that should be paid within 30 days to avoid the accrual of additional 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 the Taxpayer has documentation to submit or has any questions concerning this response, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Craig M. Burns
        Tax Commissioner

AR/1-4697116106.S

Rulings of the Tax Commissioner