August 11, 2020
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessments issued for the period March 2012 through February 2017. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is an airline catering company that contracts with airlines at major airports to provide specialized food service for in-flight meals. The Taxpayer prepares these meals in kitchens inside the airport and works collaboratively with airline chefs to create specialized menus specific to each airline’s standards and needs. The Taxpayer also maintains specialty kitchen facilities on-site that are equipped to process gluten-free, halal, vegan, and other specialty meals. The Taxpayer cooks and packages the products according to airline specifications and loads them onto the aircraft using lifts.
The Taxpayer contests certain findings resulting from the Department’s audit as follows:
- Tax assessed on service transactions
- Credit for taxes paid to another state
- Tax paid to the Virginia Department of Motor Vehicles
- Sales tax previously paid to vendors
- Use tax accrued and remitted
- Tax on real property improvements
- Tax on vehicles weighing over 26,001 pounds
- Duplicate audit exceptions
The Taxpayer also argues it should be eligible for the industrial manufacturing exemption set out in Virginia Code § 58.1-609.3 2 and, therefore, certain equipment should be exempt from the tax.
DETERMINATION
Non-Taxable Service Transactions
The Taxpayer argues certain exceptions held in the audit were for non-taxable services and should be removed from the audit. As the Taxpayer classified expenses by asset number and this is how the auditor categorized exceptions in the audit, it is difficult to determine whether the purchases in question were actually for non-taxable services. The Taxpayer has provided documentation to support its position. The documentation will be referred to the auditor for review. If the auditor concludes this documentation is sufficient evidence that the purchases related to the asset numbers in question are for non-taxable services, the transactions will be removed from the audit.
Credit for Taxes Paid to Another State
Virginia Code § 58.1-611 sets out that a “credit shall be granted against the taxes imposed by this chapter with respect to a person’s use in this Commonwealth of tangible personal property purchased by him in another state. The amount of the credit shall be equal to the tax paid by him to another state or political subdivision thereof by reason of the imposition of a similar tax on his purchase or use of the property. The amount of the credit shall not exceed the tax imposed by this chapter.”
Title 23 of the Virginia Administrative Code (VAC) 10-210-450 expands upon the statute and explains that:
Any person who purchases tangible personal property in another state and who has paid a sales or use tax to such state or its political subdivision or both on the property, is granted a credit against the us tax imposed by Virginia on its use within this state for the amount of tax paid in the state of purchase. This credit does not require that the state of purchase grant a similar credit for tax paid to Virginia. This credit does not apply to tax erroneously charged or incorrectly paid to another state.
The invoice numbers provided do not clearly correspond with the asset numbers in the audit exceptions list; therefore, the documentation will be provided to the auditor for review. Should the documentation provide sufficient evidence that the tax was correctly paid to another state on purchases of tangible personal property used by the Taxpayer in Virginia and assessed in the audit, a credit will be granted. The Taxpayer is advised that no credit is available if the tax at issue is erroneously charged or incorrectly paid.
Sales Tax Paid to Virginia Department of Motor Vehicles
The Taxpayer has provided documentation to suggest that sales tax has been paid on the purchase of a vehicle to the Virginia Department of Motor Vehicles. The purchase amounts in the documentation and those in the audit exceptions do not match; therefore, the documentation will be referred to the auditor for closer review. If the auditor finds that the motor vehicle sales and use tax has been paid, asset number 126593 will be removed from the audit.
Sales Tax Paid To Vendors
The Taxpayer has provided documentation to support its position that sales tax was previously paid to vendors for asset number 125640 and asset number 127716. This documentation will be provided to the auditor for review, and the asset numbers in question will be removed from the audit should the auditor confirm that sales tax was paid to vendors for these transactions.
Use Tax Accrued and Remitted
The Taxpayer has provided documentation to support its position that use tax was accrued and remitted to the Department for asset numbers 127714, 127715, and 127716. This documentation will be provided to the auditor for review and the asset numbers in question will be removed from the audit should the auditor confirm use tax was accrued and remitted to the Department for these asset purchases.
Real Property Improvements
The Taxpayer contests the taxability of a sprinkler system, boiler valve, air conditioning compressor, and feed water tank. The Taxpayer contends these items should be considered annexed to real property, as they are integral to the Taxpayer’s operations and are intended to be permanent fixtures in the airport.
In Danville Holding Corp. v. Clement, 178 Va. 223, 16 S.E.2d 345 (1941), the Virginia Supreme Court (the "Court") set forth three general rules to be used in determining whether an article of tangible personal property is a fixture, and thus considered a part of the real estate for purposes of taxation, or remains personal property subject to taxation as business tangible personal property. The three tests are: (1) the annexation of the chattel (property) 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 parties, i.e., the intention of the owner of the chattel to make it a permanent addition to the freehold.
In order for the tests to apply, it is presumed that the property is annexed to the realty in some form. In its decision, the Court emphasized, "the intention of the party making the annexation is the chief test to be considered in determining whether the chattel has been converted into a fixture. Transcontinental Gas and Pipe Company v. Prince William County, 210 Va. 550, 555 (1970), citing Danville Holding Company.
Generally, to determine intent, the Department reviews documents such as lease agreements or contracts that indicate the purpose of the property and the intent of the parties. Because no documents or information beyond photos of the items in question have been provided, the Department cannot reasonably determine the intent of the parties, nor can the Department examine the nature of the property with respect to the building. In this instance, the Taxpayer has not provided detailed documentation sufficient to apply the above regarding the sprinkler system and the other items at issue. Therefore, asset numbers 126756, 127275, 127276,127332 and 127933 will remain in the audit.
Vehicles Weighing More Than 26,001 Pounds
The Taxpayer argues there are several assets that are not subject to the retail sales and use tax because they are vehicles that weigh over 26,001 pounds. For this analysis, the Taxpayer is utilizing the language from Virginia Code § 58.1-1737, which exempts “a truck, tractor truck, trailer, or semitrailer, as severally defined in § 46.2-100…with a gross vehicle weight rating or gross combination weight rating of 26,001 pounds or more, in which case no tax shall be imposed pursuant to subdivision A 1 of § 58.1-1736.” This statute addresses motor vehicle rental tax which was not assessed on the vehicles in question.
The auditor assessed use tax on the Taxpayer’s purchase of the vehicles. The documentation provided by the Taxpayer with its appeal includes Virginia Department of Motor Vehicles title documents for some of the vehicles at issue. However, it is not clear if the motor vehicle sales and use tax has been properly applied to the purchase of the vehicles in accordance with Virginia Code § 58.1-2400. Since this is not evident based on the documentation provided, these purchases will remain in the audit.
Duplicate Audit Exceptions
The Taxpayer contends certain asset numbers were duplicated in the audit exceptions. Upon review, it appears asset numbers 126539, 126594, and 126595 are duplicate exceptions. These exceptions will be removed from the audit.
Industrial Manufacturing Exemption
The Taxpayer contends that its food preparation process converts raw food materials into finished meals and is manufacturing in accordance with the exemption for such in Virginia Code § 58.1-609.3 2. The Taxpayer believes the exemption should apply to its purchases of blast chillers, a gas wok range, a cooler condenser replacement, and a food deliver and production system (refrigerated sandwich preparation). The Taxpayer further contends it is a manufacturer for sales tax purposes in other states and should be classified as such in Virginia. While the Taxpayer may be a processor or manufacturer in other states, in order to qualify for Virginia’s exemption, the Taxpayer’s operations must be industrial in nature.
Virginia Code § 58.1-609.3 2 (iii) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof . . . used directly, in processing, manufacturing, refining, mining or converting products for sale or resale . . . ." A number of Virginia court cases have interpreted this statute. There are two of noted significance in this instance. The Virginia Supreme Court in Golden Skillet Corporation v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973) held that the exemption was available only for processors of products for sale or resale in the industrial sense. Additionally, the Virginia Supreme Court in Commonwealth v. Orange-Madison Cooperative, 220 Va. 655, 261 S.E.2d 532 (1980) opined that not all processing qualifies for the industrial manufacturing exemption because the exemption is limited to processing operations that are industrial in nature.
The opinions rendered in the cited court cases are reflected in the Department's manufacturing and processing regulation. Title 23 VAC 10-210-920 A states that for a business to obtain the exemption, it must be manufacturing or processing products for sale or resale. In accordance with the cited case law, such production must be industrial in nature. The Department's reliance on business classifications for purposes of determining whether manufacturing and processing activities are considered industrial in nature is based on the statutory definition of manufacturing and processing in Virginia Code § 58.1-602. Included in this definition is an explanation of the term "industrial in nature." As this term is defined, businesses are considered industrial in nature if classified in codes 10 through 14 and 20 through 39 in the SIC Manual for 1972 and in supplements issued thereafter. The SIC has been replaced by the North American Industry Classification System (NAICS). Both the SIC and NAICS assign industrial classifications according to the primary activity of the business. Unless the primary business activity is manufacturing or processing in accordance with these classifications, the Department does not consider the business activity to be industrial in nature. Thus, the business may not claim the manufacturing and processing exemption.
The Taxpayer has changed its code classification since the audit. The Taxpayer currently uses a NAICS code classification that falls between SIC codes 20 and 39. The Taxpayer contends that NAICS code 311991, Perishable Food Manufacturing, best describes the commercial operations of the Taxpayer. This classification includes “establishments primarily engaged in manufacturing perishable prepared foods, such as salads, sandwiches, prepared meals, fresh pizza, fresh pasta, and peeled or cut vegetables,” A tour and other available information regarding the Taxpayer’s operations indicate the processing of food occurs in large kitchens housed in airport facilities. These kitchens are segregated by airline and specialty food type, among other designations, and are manned by chefs who operate ovens, stoves, and other appliances found in a commercial kitchen.
The Taxpayer does engage in processing prepared foods. However, airline food service contractors are classified under NAICS code 722310, Food Service Contractors. This classification includes “establishments primarily engaged in providing food services at institutional, governmental, commercial, or industrial locations of others based on contractual arrangements with these types of organizations for a specified period of time. The establishments under this classification provide food services for the convenience of the contracting organization or the contracting organization's customers.” As an airline food service contractor, this is the more appropriate classification of the Taxpayer’s commercial operations.
After reviewing the available information and the SIC and NAICS code classifications, the process of providing, cooking and hand packaging meals within commercial kitchens for contracting airlines is not within the codes that would deem the Taxpayer’s operations as industrial in nature. Therefore, I find no basis for granting the industrial manufacturing exemption to the Taxpayer.
The Taxpayer cites Public Document 12-52 (4/23/2012) to support its position based on the Taxpayer’s similarity to that of the taxpayer in the document regarding food production by mixing various ingredients together. The public document does not apply here as the taxpayer in that instance is classified as a manufacturer of food sufficient to be deemed industrial in nature and, therefore, qualifying for Virginia’s manufacturing exemption.
Penalty
Title 23 VAC 10-210-2032 allows for the alternative method computation of a taxpayer’s compliance ratio if the auditor’s computation indicates a taxpayer has failed to meet the required compliance ratio for sales or use tax. The Taxpayer utilized the alternative method to calculate the compliance ratio and argues that because it is above the 85% threshold for second generation audits, the penalties associated with the audit should be abated.
The Taxpayer used the alternative sales tax calculation to compute its compliance ratio while already achieving a 100% compliance ratio with regard to sales tax. The Taxpayer’s use tax compliance ratio was 10% and no alternative method calculation, nor supporting documentation, has been provided by the Taxpayer to calculate a higher use tax compliance ratio. As such, the use tax compliance ratio remains 10% as calculated by the auditor, and the penalty was properly applied and will remain in the audit.
CONCLUSION
Based on this determination, the audit will be returned to the appropriate field audit staff for review of documentation and revisions. The Taxpayer is given 60 days from the date of this letter to provide additional documentation. Should the Taxpayer fail to provide additional documentation, the auditor will review only the documentation provided upon appeal and adjust the audit accordingly.
After the revisions are complete and adjustments have been made to the audit assessments, revised bills will be mailed to the Taxpayer. No additional interest will accrue provided the assessments are paid within 60 days of the dates of the bills. Please remit payment within 60 days from the date of the bill to: Virginia Department of Taxation, 600 E. Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *****. If you have any questions concerning payment of the assessments, you may contact ***** at (804) 225-2596.
The Code of Virginia sections, regulations and public document 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 about this determination, you may contact ***** in the Department’s Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1866L