May 12, 2015
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 assessments issued to ***** (the "Taxpayer") for the period January 2008 through December 2013. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is an electrical contractor that primarily provides services to customers in the coal mining industry (the "Customers"). Prior to the audit period, some of the Customers issued the Taxpayer direct payment permits. The Taxpayer was audited by the Department and assessed use tax on untaxed purchases of materials and supplies used to perform contract work for the Customers that issued the direct payment permits. The Taxpayer contests the assessment of use tax on chemicals purchased for the maintenance of coal haul roads and at mine sites. The Taxpayer also contests use taxes assessed on purchases of utility poles and accessories installed to transmit electric power to a mine site and on the purchase of fence materials installed around a generator at a mine site.
DETERMINATION
Virginia Code § 58.1-609.3 2 (iii) provides a sales and use tax exemption 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...." The term "used directly" is defined in Va. Code § 58.1602 as:
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 or administration. When used in relation to mining, it shall refer to the activities specified above, and in addition, any reclamation activity of the land previously mined by the mining company required by state or federal law.
Title 23 of the Virginia Administrative Code (VAC) 10-210-960 sets out the application of the retail sales and use tax to mining and mineral processing. Subsection A of this regulation states that "[d]irect use in mining begins with the drilling of the shaft in deep mining or the removal of the overburden in strip mining, auger mining or quarrying and ends with the conveyance of the mined product to storage or stockpile at the mine site." Subsection A concludes by stating that the fact that property may be considered essential to the conduct of the business of mining because its use is required either by law or practical necessity does not, of itself, mean that the property is used directly in mining operations.
Title 23 VAC 10-210-960 E states that the mining exemption extends to persons engaged in any phase of mining, provided such activities qualify for exemption as set out in subsections A and B of the regulation. As such, the mining exemption extends to the Taxpayer if it performs the qualifying activities set out in subsections A and B.
Maintenance Chemicals
The Taxpayer contracted with some of the Customers to provide vegetation maintenance services. The Taxpayer purchased various chemicals that were used to control vegetation growth at a mine site and along coal haul roads. The Taxpayer contests the inclusion of the untaxed chemical purchases in the audit on the basis that the chemicals are used directly in exempt mining activities. The Taxpayer cites the Virginia Supreme Court case, Commonwealth, Department of Taxation v. Wellmore Coal Corp., 228 Va. 149, 320 S.E.2d 509, 514 (1984), to support its position.
The Taxpayer states that clearing vegetation at the mine site is an exempt repair and maintenance function of mining in accordance with the Department's mining regulation. Title 23 VAC 10-210-960 A 3 e states that repair and maintenance includes "maintenance of offices, outbuildings, and other real or tangible personal property connected with the operation of the mine." The Taxpayer states that the maintenance of coal haul roads is subject to the rules and regulations of the Mine Safety Health Administration. The Taxpayer has provided excerpts from the Mine Safety Health Administration's Haul Road Inspection Handbook that discuss health and safety requirements for maintaining coal haul roads. Vegetation control is a safety activity discussed in the Haul Road Inspection Handbook.
In Wellmore Coal, the Virginia Supreme Court ruled that materials used to construct and maintain coal haul roads are used directly in the mining process and qualify for exemption from sales and use tax. However, this interpretation of the exemption is limited in scope. The Court's 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. 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. Relying on this regulation, the Court concluded that the mining exemption extended to transportation activities when such activities are related to further processing of mined materials. Title 23 VAC 10-210-960 A 2 reflects the Department's current policy on this issue and states, in part:
Mining and processing are separate and distinct activities. The mine site and the processing site constitute separate plant sites unless both are owned and operated by the same person and connected by a private transportation system, such as a conveyor or private roadway. If the mine and the processing plant are owned by different entities, private transportation systems, including hauling vehicles, between the two sites will be exempt only if owned by the processing plant operator. (Emphasis added.)
The Taxpayer has not provided evidence that the coal haul roads at issue were exempt private transportation systems in accordance with the regulation. Moreover, I am not persuaded that the use of chemicals to manage vegetation growth at mine sites or along coal haul roads is an exempt maintenance activity as contemplated in the Wellmore Coal case. The Court ruled that materials which facilitate the transportation of coal from the mines to the tipple are used directly in mining and processing. However, I do not agree that vegetation maintenance facilitates the transportation of the coal. The auditor also notes that some of the coal haul road maintenance was actually performed along the sides of the roads and not on the haul roads themselves.
I agree with the Taxpayer that the maintenance of vegetation growth on coal haul roads and at the mine site is a repair and maintenance activity under Title 23 VAC 10-210-960 A 3. However, this subsection of the regulation does not state that all repair and maintenance activities are exempt. The regulation provides both taxable and exempt examples of various activities that are part of the repair and maintenance function of mining operations. The second paragraph of this subsection states that repair and maintenance activities are not mining. Tools, supplies, machinery and equipment used in performing repair and maintenance work are subject to the tax.
Finally, the fact that the maintenance of vegetation on or along coal haul roads is required in accordance with the Mine Safety Health Administration's Haul Road Inspection Handbook is not dispositive of this activity's exemption status. As previously cited, Title 23 VAC 10-210-960 A states that the use by a mine operator of property which is required either by law or practical necessity does not mean that the property is used directly in mining operations. This fact is noted in the Wellmore Coal case, as well. Although the chemicals at issue may be essential to the conduct of the Customers' mining businesses, this does not mean that the chemicals are used directly in mining by the Taxpayer and qualify for exemption.
In 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. Thus, the exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in production. Based on the cited authorities, the use tax assessed on the Taxpayer's chemical purchases during the audit period is correct.
Utility Poles and Related Supplies
The Taxpayer furnished and installed utility poles for the transmission of electric power to a new mine site. Use tax was assessed on purchases of the poles and on items installed with the poles, such as steel crossarms, brackets, tags and mounting hardware. The Taxpayer contends that the installation of the utility poles is a site preparation function for mining and qualifies for exemption from sales and use tax.
Title 23 of the VAC 10-210-960 A 3 b discusses site preparation activities conducted by mining operations and states that site preparation activities such as the removal of overburden, grading the area at the mine site and the construction of tunnels, shafts, and passageways in underground mines are all exempt activities. However, Subsection A 3 b states that other land clearing activities at the mine site or well location, such as the construction of office buildings and the construction and maintenance of roads or private transportation systems, are not a part of mining. Property used in such activities is taxable. The regulation is clear that not all property used for site preparation activities qualifies for the mining exemption.
While the mining regulation does not specifically address the installation of utility poles for the transmission of electricity, P.D. 02-49 (4/8/02) discusses a mining business that operated an electrical substation that stepped down the voltage of electricity received from a public utility. The electricity was then transmitted through private lines to gas well sites. In the Department's audit of the mining business, the purchase of the lines used to transmit the electricity from the substation to the mine site was deemed to be taxable. The mining business contended that the lines for transmitting electricity to the mine site qualified for the mining exemption. The Tax Commissioner determined that the transmission lines were not used directly in the mining operation and did not qualify for exemption from sales and use tax.
I find that the use of the utility poles and related items is analogous to the electric lines addressed in P.D. 02-49 (4/8/02). While the mining exemption applies to power that is used directly in mining operations, P.D. 02-49 states that the exemption does not extend to the transportation of an exempt power source. As with the electric lines, the poles themselves are not electric power. The poles facilitate the transmission of electric power. While I agree that the utility poles are necessary for the transmission of electricity to the mine site, the poles and related items are not used directly in mining activities and do not qualify for exemption. The use tax assessment on the poles and related items installed by the Taxpayer is correct.
Fencing
The Taxpayer furnished and installed a fence around a deep mine power substation. The Department assessed use tax on the purchase of the fence materials. The Taxpayer states that the substation itself is an integral part of the mining process. Since the fence protects the substation, the Taxpayer asserts that, like the substation, the fence is used directly in the mining process and qualifies for exemption.
As with the utility poles, the fence is not used directly in the mining process. The fence itself is not power and is not necessary for mining production. The fence protects the substation but is not an integral part of the mining process. P.D. 91-5 (1/23/91) discusses a similar issue in which a public utility contested an audit assessment of use tax on fences placed around substations for purposes of safety and to protect the substations from animals. The public service corporation exemption that was in effect at that time was denied on the basis that the fences were not used directly in the rendition of the utility's public service. Similar to the mining exemption statute, the public service corporation exemption statute required that property be used directly in the rendition of the public service to qualify for exemption. Thus, the determination in P.D. 91-5 that fences are not used directly by the public utility is analogous to the contested fence purchased and installed by the Taxpayer.
Direct Payment Permits
The Taxpayer notes that the Customers for which it performed contract work provided direct payment permits. The Taxpayer bills the Customers itemized charges for the labor and the materials used to provide its contract services. The Taxpayer claims that the separately stated materials are sold at retail to the Customers and that the sales are exempt based on the direct payment permits received.
Virginia Code § 58.1-624 sets out the provisions for direct payment permits. Subsection D provides that upon receipt of a direct pay permit number, a dealer is absolved from all duties and liabilities for the collection and remittance of the tax with respect to transactions with the permit holder including sales, distributions, leases, or the storage of tangible personal property. In this case, the Taxpayer is not a dealer making retail sales of tangible personal property. Rather, the Taxpayer is a provider of exempt services and is the user and consumer of the tangible personal property purchased for use in the provision of the services. The acceptance of direct payment permits from the Customers does not relieve the Taxpayer of its responsibility to pay or remit the sales or use tax on purchases of materials used in connection with the contract work. This is true regardless that separately stated charges for materials are invoiced to the Customers that provided direct payment permits.
The Department has issued several public documents that state contractors cannot accept and use a customer's direct payment permit to make exempt purchases of materials for use in performing real property or other exempt services for that customer. P.D. 06-92 (9/19/06) and P.D. 07-21 (3/27/07) are on point with this issue.
CONCLUSION
The audit assessments are correct. The Department's records indicate that the Taxpayer has paid the assessments in full.
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 Laws, Rules and Decisions section of the Department's web site. If you have any questions concerning this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5810123170.S