June 29, 2017
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 your client, ***** (the “Taxpayer”), with the Department of Taxation. You appeal assessments of Machinery and Tools (M&T) tax issued to the Taxpayer by the ***** (the “City”) for the 2010 through 2015 tax years.
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, i.e., 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, regulation and public documents cited are available on-line in the Laws, Rules and Decisions section of the Department's web site, located at www.tax.virginia.gov.
FACTS
The Taxpayer operated a printing facility in the City. Printing was performed using the rotogravure process. A copper coating was applied to cylinders, and images were engraved on the surface. The raw paper rolls were transported by forklifts, carts and elevators to the printing presses where the engraved cylinders applied the images to the paper. Once printing was complete, the printed materials were transported to a bindery area where various processes occurred, depending on the product, to construct the printed materials into finished products. The products were then moved to the shipping area and placed on pallets.
The Taxpayer filed amended M&T tax returns for the 2010, 2011 and 2012 tax years to remove certain equipment from its list of taxable assets and claim refunds. The City then audited the Taxpayer to determine the extent the Taxpayer's property was subject to the M&T tax. In December 2014, the City issued a final determination covering these years and also the 2013 and 2014 tax years, for which returns had been filed while the audit was being conducted. The City classified certain categories of equipment as taxable and requested that the Taxpayer file amended returns consistent with the City's determination. The Taxpayer did not agree with all of the City's conclusions, however, and filed an appeal with the Department.
In Public Document (P.D.) 15-105 (5/12/2015), the Department returned the case to the City to correct the M&T tax assessments for the 2010 through 2014 tax years based on its determination. In response, the City issued a final determination in June 2016 with respect to those years and also the 2015 tax year, concluding that certain categories of equipment at the Taxpayer's facility remained subject to the M&T tax. These categories were: (1) equipment used to prepare the cylinders for the printing process; (2) printers used to place addresses on the products; (3) equipment used to transport materials between different stages of the manufacturing process; and (4) certain items mostly related to facility safety.
The Taxpayer appealed to the Department. The Taxpayer contends that the categories of equipment described above were not subject to the M&T tax because they were not used in the manufacturing process. The Taxpayer also asserts that the taxable machinery and tools should have been valued using the Taxpayer's acquisition costs rather than the original costs to the first owner. The City, however, objects to the Department's jurisdiction over the valuation issue, contending that it was not properly raised in the local appeal.
ANALYSIS
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 also 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 City of Winchester v. American Woodmark, 250 Va. 451, 458, 464 S.E.2d 148, 152 (1995), the Virginia Supreme Court (the “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.” The Court also cited previous opinions of the Attorney General in deriving the meaning of “used in manufacturing.”
In The Daily Press, Inc. v. County of Newport News, 265 Va. 304, 576 S.E.2d 430 (2003), the 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.
The Attorney General has consistently opined that “machinery and tools” used in a particular manufacturing business are the machinery and tools that are necessary in the particular manufacturing business and which are used in connection with the operation of machinery that is actually and directly used in the manufacturing process. Id., citing 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317; see also 1987-1988 Att'y. Gen. Ann. Rep. 590. Id.
This language does not imply that each piece of machinery or each tool used directly in the manufacturing process must be directly connected to the complete transformation of a material into something substantially different in character. In P.D. 04-39 (8/2/2004), the Department found equipment and tools that did not directly transform or even touch the product being produced could be used directly in the manufacturing process. The question, therefore, is not whether a particular piece of machinery transforms a product, but whether such machinery or tool is used directly in a manufacturing process.
Manufacturing Process
Rotogravure Cylinders
The Taxpayer contends that preparing the rotogravure cylinders was not a manufacturing process. The Taxpayer compares the cylinder preparation process to the pre-press activities in The Daily Press which the Court held were not part of the manufacturing process. The City's position, however, is that materials were transformed into something of a substantially different character when the cylinders were prepared for printing. Thus, the City concluded that the equipment was subject to the M&T tax because it was used directly in the manufacturing process.
In The Daily Press, the taxpayer had machines and equipment to gather and store news and advertisements and to determine the content of the newspaper and its physical layout. Such equipment included computers, servers, modems and other equipment linked in a local area network (LAN) as well as photography equipment. Negatives of each page were created electronically or by photographing the page, and the images were cast onto aluminum press plates. In the pressroom, the printing press transformed a large news print roll into a newspaper using the press plates, ink, and a water fountain solution mix. Citing County of Chesterfield v. BBC Brown Boveri, 238 Va. 64, 69, 380 S.E.2d 890, 893 (1989), the Court defined the term “manufacturing” as “the transformation of new material into an article or a product of substantially different character.” Applying this definition, the Court found that the only place where manufacturing had occurred was in the pressroom where the raw paper rolls were transformed into the newspaper.
The City argues that P.D. 15-212 (11/24/2015) is directly on point and controls the analysis. In P.D. 15-212, a business casted metal products in a series of steps that involved manufacturing wax patterns, ceramic molds and then ultimately finished cast metal products. The Department concluded that in each step, raw materials were being used to create products of a substantially different character, and thus all of the equipment involved in such processes was directly used in the business's manufacturing process.
The Department recognizes that the inquiry concerning the extent materials need to be transformed into something of a substantially different character in order for manufacturing to exist can be challenging. The Department, however, does not believe that the process of preparing the cylinders is entirely analogous to the facts of P.D. 15-212. In that case, distinct products were being created at each stage of the manufacturing process. In this case, however, the cylinder preparation process began with a cylinder and ended with a cylinder covered with a recyclable coating. Unlike the products made in P.D. 15-212, the coating did not exist separate from the cylinder itself. Thus, the cylinder preparation process more closely resembled the pre-press process of preparing the aluminum press plates in The Daily Press which the Court held was not manufacturing.
Ink Jet Printers
The Taxpayer used ink jet printers to print mailing addresses on the outside of the products and customer-specific information on order forms placed in the inside. The printers operated on the bindery lines, where various processes occurred to construct the products once the printing process was finished.
The Taxpayer argues that the printers were used for mailing purposes and were not used directly in the manufacturing process. The City agrees that the printers were used for mailing purposes in part, but the City argues that because the printers were also used to print information inside the catalogues, they were partially used in manufacturing. The City cites P.D. 08-88 (6/16/2008) for the rule that as long as a substantial portion of the machinery's use was for manufacturing purposes, it is subject to the M&T tax.
Generally, the Department considers machinery used for packaging a product for shipping purposes as not directly used in the manufacturing process and, therefore, not subject to the machinery and tools tax. See P.D. 04-39. The Department, however, has recognized an exception for packaging used for food products. To the extent such 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. See P.D. 08-30 (4/2/2008). The Taxpayer argues that its products already satisfied all three factors prior to packaging and shipping.
Because the Taxpayer did not manufacture food products, the criteria established by P.D. 08-30 are of limited relevance. Even if printing the address labels on the outside was a non-manufacturing shipping process, the printers also printed customer-specific information on the inside. The City observed that the printers could be used for both functions interchangeably, and it was not possible to determine to what extent the printers were used for each purpose. In addition, the printers were used during the binding process when the products were still being constructed, and the parties agree that the binding process was a manufacturing process. Typically, machinery that is strictly used for packaging a product for shipping purposes is employed once the manufacturing process is completed. The fact that the printers were used while a manufacturing process was still occurring strongly suggests that they were also used directly in the manufacturing process to some extent.
Transportation Equipment
The Taxpayer argues that hand lifts, forklifts and cranes were not subject to the M&T tax because they were not used to transform materials while they moved products between different stations of the manufacturing process. Alternatively, the Taxpayer argues that the City did not meet its burden of establishing the taxable status of each piece of transportation equipment.
In its final determination, the City determined that whatever equipment was used to transport either (1) raw materials to the printing press; or (2) partially completed catalog sections or other unfinished materials to the next step in the manufacturing process constituted taxable machinery and tools. The City also determined, however, that any transportation equipment used to move completed catalogs in the shipping area was used after the manufacturing process was complete and thus was not subject to the M&T tax.
As stated above, the question is not whether the particular piece of machinery transformed a product, but whether it was used directly in a manufacturing process. In P.D. 04-39, the Department determined that equipment that was used to transport goods from one stage of the manufacturing process to another was being directly used in the manufacturing process. Forklifts used in the shipping area, however, were not used directly in the manufacturing process because shipping was not a manufacturing process.
The City informed the Taxpayer that it would consider transportation equipment used in the shipping area to be non-taxable and removed one piece of equipment from the list of taxable assets when it learned that it was used in the shipping area. The Taxpayer has had an opportunity to demonstrate what items of transportation equipment were used in the shipping area.
Safety Equipment
The Taxpayer contends that certain items throughout the plant that were designed to facilitate the manufacturing process, such as splashguards, walking surfaces, enclosures and guardrails were not used directly in the manufacturing process and thus were not subject to the M&T tax. The Taxpayer also asserts that fire and safety equipment was not used in the manufacturing process. The City's position is that some of the items were attached to and a necessary part of the functioning of the machinery. In addition; according to the City, it has already determined that the Taxpayer's fire systems were not taxable.
To support its argument, the Taxpayer cites the following passage from P.D. 14-37 (3/19/2014):
Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items which 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. Furthermore, the fact that the use of a particular item, such as firefighting and safety equipment, may be required by federal, state or local law is not, by itself, dispositive of direct usage in manufacturing or processing.
This ruling was citing Title 23 of the Virginia Administrative Code (VAC) 10-210920 B 2, governing the manufacturing exemption for purposes of the Virginia retail sales and use tax. The Department does not apply retail sales and use tax regulations to local tax appeals. See P.D. 09-139 (9/21/2009) and P.D. 16-118 (6/13/2016).
The City states that the Taxpayer used machine guards and splash guards while the manufacturing machinery was operating and these items were frequently attached to the machines themselves to make the equipment safe or more efficient to use.
Valuation of Machinery and Tools
The City requests that the Department disregard the valuation issue because the Taxpayer did not raise it in its local appeal. The Taxpayer asserts that the City has had opportunities to make a determination on the valuation issue after being presented with cost information during the local appeal process. The Department observes that administrative appeals to localities are required to describe each alleged error in the assessment. See Va. Code § 58.1-3983.1 B 2.
DETERMINATION
The Department finds in favor of the Taxpayer on several issues. First, in the Department's opinion, the machinery involved in coating and engraving the cylinders prior to printing was not directly involved in the manufacturing process. In addition, it appears that walking surfaces and handrails served to facilitate the movement of people who worked in the facility and were not directly involved in the manufacturing process. In addition, the enclosures served merely to separate different equipment areas and reduce noise. As such, none of these items were subject to the M&T tax.
The Department also finds the city correctly held a number of items subject to the M&T tax. The Department agrees with the City that, at a minimum, using the printers to print material on the inside of the products while the bindery processes were occurring was part of the manufacturing process. The Taxpayer has provided no evidence that such use was insubstantial. In addition, the Taxpayer has failed to demonstrate what additional pieces of transportation equipment, if any, operated in the shipping area and thus would have been non-taxable. Further, taking the City's observations of fact as prima facie correct, the Department concludes that the machine guards and splash guards were used directly in the manufacturing process.
Because the Taxpayer did not raise valuation as an error in its local appeal and because the City did not address it in its final determination letter, the Department declines to issue a determination on that issue. The Taxpayer and the City, however, may wish to review 2009 Op. Va. Att'y Gen. 177, 2014 Va. AG LEXIS 20 (6/26/2014), P.D. 12-27 (3/6/2012) and P.D. 13-20 (2/15/2013), which address the valuation issue raised.
The City is instructed to adjust the assessments for the 2010 through 2015 tax years in accordance with this determination and issue refunds or revised assessments, as warranted.
If you have any questions regarding this determination, you may contact *****in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1276.M