June 2, 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 revised retail sales and use tax assessments issued for the period January 2010 through December 2012. The assessments at issue have been paid in full. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer operates ***** food processing facilities in Virginia. An audit by the Department resulted in the assessment of consumer use tax on purchases of tangible personal property used in the Taxpayer’s operations. Maintaining that the industrial manufacturing exemption applied to the purchases at issue, the Taxpayer appealed the assessments. A determination letter was issued to the Taxpayer on April 11, 2016, informing the Taxpayer that a plant tour by the Department’s auditor was required in order for the Department to verify the facts presented in the Taxpayer’s appeal. The Taxpayer was further instructed to provide documentation to support its contention that certain items held taxable in the audit are not subject to the tax.
Following the plant tour and a review of documentation provided by the Taxpayer, the auditor revised the audit for the period at issue. The Taxpayer is contesting certain purchases of tangible personal property that remain taxable in the revised audit.
DETERMINATION
Virginia Code § 58.1-609.3 2 provides, in part, an exemption from the retail sales and use tax for:
(i) Industrial materials for future processing, manufacturing, refining, or conversion into articles of tangible personal property for resale where such industrial materials either enter into the production of or become a component part of the finished product; (ii) industrial materials that are coated upon or impregnated into the product at any stage of its being processed, manufactured, refined, or converted for resale; (iii) 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; (iv) materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale; or (v) equipment, printing or supplies used directly to produce a publication described in subdivision 3 of § 58.1-609.6 whether it is ultimately sold at retail or for resale or distribution at no cost. Machinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in processing, manufacturing, refining, mining or converting products for sale or resale. [Emphasis added.]
Virginia Code § 58.1-602 defines the phrase “used directly” when used in relation to manufacturing as referring to “those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing…process, but not including ancillary activities such as maintenance or administration.”
Linear Bar Code Verifier
The Taxpayer provides that the verifier is used to read the UPC code assigned to each lot of meat produced during the manufacturing process. The Taxpayer further states that the verifier ensures movement of the product from one stage of production to the next stage through to final completion. The Taxpayer contends that the verifier is part of the manufacturing process and that the manufacturing exemption applies to the purchase of the verifier.
The verifier was not contested in the Taxpayer’s original appeal and, therefore, was not addressed in the prior determination letter. However, based on a finding by the auditor during the plant tour that the bar code printers are part of the production process, I find that the verifier is likewise a part of the production process in accordance with Virginia Code § 58.1-609.3 2. Accordingly, the verifier will be removed from the audit.
Sanitization Production Machinery, Equipment, Repair Parts, Chemicals and Clothes
Following the plant tour, the auditor determined that all of the cleaning processes employed by the Taxpayer are taxable maintenance activities. The auditor found that the cleaning processes occur away from the production lines, and the items at issue are not used directly in the Taxpayer’s meat processing operation. Accordingly, the various items of tangible personal property used for sanitization by the Taxpayer were deemed taxable following the plant tour and remain in the audit.
The Taxpayer states that the first step in the manufacturing process is the sanitization of all the production machinery and equipment. The Taxpayer contends that the contested tangible personal property used in its sanitization process is used directly in its meat processing operation. The Taxpayer requests that these items be removed from the revised audit.
The information provided by the Taxpayer in support of its contention that the sanitization items be removed from the revised audit is the same information that was provided with the Taxpayer’s initial appeal. The Taxpayer has not refuted the auditor’s findings following the plant tour that the sanitization items are used for general maintenance (cleaning of production machinery and equipment) and are not used directly in the Taxpayer’s meat processing operation. Accordingly, I find that the sanitization items at issue are properly held taxable in the audit and removal of such items is not warranted. I note that the chemicals and most of the utility carts and buckets at issue were removed from the audit when the audit was revised.
Repair Parts and Cutting Coolant for Knife Grinding Machine
In the audit, repair parts and cutting coolant for a knife grinding machine were held taxable. The Taxpayer contends that the knife grinding machine is used directly in its meat processing operation and requests that the repair parts and cutting coolant at issue be removed from the audit.
During the plant tour, in order to determine if the manufacturing exemption applies to the repair parts and cutting coolant, the auditor evaluated the use of the knife grinding machine to determine if it qualified for the manufacturing exemption. Based on this evaluation, the auditor concluded that the knife grinding machine is not used directly in the Taxpayer’s meat processing operation, and the manufacturing exemption does not apply to this machine. The auditor also concluded that the repair parts and cutting coolant used with the knife grinding machine are not used directly in the Taxpayer’s meat processing production, and the manufacturing exemption does not apply.
The Taxpayer has not refuted the auditor’s findings following the plant tour regarding the repair parts and cutting coolant at issue. The Taxpayer has not demonstrated that the knife grinding machine is used directly in manufacturing and that the manufacturing exemption applies to the knife grinding machine and the related repair parts and cutting coolant. Similarly, the Taxpayer has not demonstrated that the items at issue are for use beyond a general maintenance function. Accordingly, these items will remain in the revised audit.
Public Document 02-17 (1/1/2002) supports this determination. In the public document, the knife sharpening operation occurred every four hours. The Tax Commissioner determined in that instance that the removal of the knives for the purpose of maintenance or resharpening was a function that was not an immediate part of the production process. Accordingly, the knife sharpening activities were deemed to be taxable maintenance activities.
Knife Sharpeners and Honing Wheels
The Taxpayer maintains that these items are similar to the sharpening steel that was previously contested and removed in the revised audit following the plant tour. The Taxpayer states that these items are used directly on the production line by manufacturing personnel to sharpen knives used for hand cutting meats. The Taxpayer asserts that other knife sharpeners were deemed exempt in the revised audit, and these items were missed by the auditor when the revisions to the audit were made.
Based on the Taxpayer’s description of how these items are used, it appears they are similar to the sharpening steel that was removed in the revised audit. However, in order to determine whether these items can be removed from the audit, the auditor will need to verify whether the knife sharpeners and honing wheels at issue are used directly in the Taxpayer’s meat processing operation. If such use is confirmed, these items will be removed from the revised audit.
Penalty Waiver
The Taxpayer maintains that the sanitization machinery, equipment, repair parts, chemicals, clothing, face shields/brackets and the ***** knife sharpener were not held taxable in the prior two audits, and these are new areas of taxation that should not be penalized in accordance with Title 23 of the Virginia Administrative Code (VAC) 10-210-2032 B 8. The Taxpayer further provides that it deemed the sanitization process as being an exempt part of its meat processing operation based upon guidance received from the prior two audits. The Taxpayer requests that the penalty assessed in the audit be waived.
Title 23 VAC 10-2032 B 8 states that:
Penalty generally will not be applied to audit deficiencies occurring in new areas not covered by prior audit(s), provided the application of the tax is not clearly established under existing law, regulations or other published documents of which the taxpayer reasonably should have had knowledge, or areas where the taxpayer has relied on prior correspondence with the department that has not been superseded by a law change, a change in regulations, or other published documents of which the taxpayer reasonably should have had knowledge. Deficiencies in these areas will not be included in compliance ratio computations. Notwithstanding the above, items of like class or similar nature may be subject to penalty even though the specific item was not addressed in the previous audit(s) if the general class of items was held taxable in previous audit(s). The application of penalty to audit deficiencies will not be waived on second and subsequent audits for other than exceptional mitigating circumstances.
The exception regarding new areas not covered by prior audits does not apply in this instance. The Taxpayer maintains that it relied on guidance from two prior Department audits when purchasing these items exempt of the tax, pursuant to the manufacturing exemption. The audit comments on file with the Department for the audit conducted for the period July 1999 through December 2002 do not specifically state that property purchased for sanitization was used directly in the Taxpayer’s meat processing operation, or that such property was eligible for the manufacturing exemption. The comments do not specifically state that a Pieco knife sharpener was deemed part of the Taxpayer’s meat processing operation in the prior audit, or that the sharpener was eligible for the manufacturing exemption. Further, there is no indication that items similar to these were at issue in the prior audit.
Title 23 VAC 10-210-2032 B 1 provides that the application of penalty to audit deficiencies is mandatory and its application is generally based on the percentage of compliance determined by computing the dealer’s compliance ratio. Subsection B 5 provides that for all third and subsequent generation audits, the penalty will generally be applied unless the taxpayer’s compliance ratios meet or exceed 85% for sales tax and 85% for use tax, as computed by the auditor or under the alternative method.
The audit at issue is the third Department audit for the Taxpayer. In this instance, the Taxpayer’s use tax compliance ratio does not meet or exceed 85% as required by the regulation. Accordingly, the penalty was properly assessed in the audit and cannot be waived. Further, in accordance with Subsection B 8 of the regulation, the application of the penalty to the audit deficiencies cannot be waived for other than exceptional mitigating circumstances because the audit at issue is a third generation audit. The Taxpayer has not presented any exceptional mitigating circumstances that would warrant waiving the penalty. Accordingly, I find no basis to abate any portion of the penalty assessed in the revised audit.
CONCLUSION
The revised assessment is upheld as issued, with the exception of the revisions that are provided for in this determination. The auditor will make the revisions and verification required by this determination. Once complete, the Taxpayer will be issued a refund, plus refund interest.
The Code of Virginia sections, regulation and public document cited 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 Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1377P