January 11, 2022
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** (the “Taxpayer”), appealing the retail sales and use tax assessments issued to the Taxpayer as a result of an audit for the period June 2010 through March 2015. I note that the assessments are paid in full, and I apologize for the delay in responding to your letter.
FACTS
During the audit period, the Taxpayer, a cold storage facility, provided various services such as freezer, cooler and dry storage, blast and room freezing, product tempering, import and export, and packing and labeling. The Taxpayer received chilled and frozen food products from various manufacturers at its facility. Upon receipt, the food products are removed (uncrated) from shipping containers and placed onto pallets. The palletized products are then shrink-wrapped and placed into a cold storage area until shipped to a final destination. The Department’s audit resulted in the assessment of consumer use tax on untaxed purchases of tangible personal property used in the Taxpayer’s service operations.
The Taxpayer filed an appeal contending it was eligible for an exemption as an industrial processor because it's controlled temperature applications did not merely maintain the food products received from manufacturers but also reduced and destroyed bacteria growth. Under these circumstances, the Taxpayer also claims that its purchase of pallets should be treated as exempt packaging materials, and disagrees with the auditor’s classification of the pallets as capital assets. In the alternative, the Taxpayer contends the purchase of pallets was eligible for the resale exemption.
DETERMINATION
Industrial Manufacturing and Processing Exemption
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 of the Virginia Administrative Code (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 since 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.
Although it appears to be an issue of first impression in Virginia, the freezing or chilling of food has been considered industrial processing in cases from other states. See, e.g., Fischer Artificial Ice & Cold Storage Company vs. Iowa State Tax Commissioner, 81 N.W.2d 437 (Iowa 1957) and Hudson Foods vs. Director of Revenue, 924 S.W.2d 277 (Mo. 1996). In addition, NAICS industry group 3114 include establishments that freeze food and those that use preservation processes, such as pickling, canning or dehydrating, both of which begin their production process with inputs of vegetable or animal origin. The categorization of such businesses as manufacturing or processing by the NAICS is consistent with the case law cited.
It has been held, however, that merely maintaining an already frozen product in its frozen state does not constitute processing. See Wetterau, Inc. v. Director of Revenue, 843 S.W.2d 365 (Mo. 1992). This is also consistent with the NAICS classification 493120, Refrigerated Warehouse and Storage. This industry comprises establishments primarily engaged in operating refrigerated warehousing and storage facilities. The services provided by these establishments include blast freezing, tempering, and modified atmosphere storage services. This is not a manufacturing or processing business classification.
The Taxpayer relies heavily on the case of City of Richmond v. Richmond Dairy Co., 156 Va. 63, 157 S.E.2d 728 (1931) to support its claim that it should be considered an industrial processor. The Taxpayer asserts that although the Court did not find that the taxpayer in that case was a manufacturer, it nonetheless concluded that the taxpayer was a “processor.” This case was a local license tax case, and the Court was not evaluating whether the taxpayer should be considered a processor for purposes of the sales and use tax exemption at issue in this case. In addition, the Department has held that the local taxes are separate and distinct from Virginia’s retail sales and use tax. See Public Document (P.D.) 09-93 (6/11/2009).
Further, the Department can find no mention of the term “processor” in the case at all. The case does refer to the pasteurization “process” in a general sense. It does not follow, however, that if a taxpayer is conducting a “process” it should be considered an industrial processor for purposes of the sales and use tax exemption. Virtually any activity a business performs with respect to a product could be called a “process” in a general sense, rendering the exemption absurdly broad. The Virginia Supreme Court has ruled that statutes should not be interpreted in a manner that would make a portion of it useless, repetitious or absurd. See Jones v. Conwell, 227 Va. 176, 181, 314 S.E.2d 61, 64 (1984).
The Taxpayer also observes that it is conducting activities that are considered “processing” under 21 CFR 123.3(k)-(1). This Code of Federal Regulations citation addresses the regulation of fish and fishery products by the federal Food and Drug Administration. While sometimes instructive, terms defined for purposes of regulatory framework managed by another government agency has no bearing on the interpretation of such terms in the Code of Virginia.
Consistent with the distinction set forth above between freezing and mere refrigeration, the Department recognizes that the Taxpayer was performing some processing activities at its facility to the extent it was chilling or freezing products. It appears, however, that the Taxpayer was also performing cold storage of products, maintaining them at the temperatures to which they were lowered until they were ready to leave the facility. Such an activity is not considered an industrial processing activity. The Taxpayer classified itself under NAICS code 493120, Refrigerated Warehousing and Storage and is not a manufacturing or processing business classification. Clear and cogent evidence must be presented to justify applying a different classification.
In addition, while recognizing the chilling or freezing of food products was performed to destroy, or control the growth of, microorganisms that would affect the quality of the food, the Department is not persuaded that the ongoing control of the growth of such organisms in the same frozen or refrigerated state over time renders the mere maintenance of such temperature a processing activity. As explained above, case law consistent with the NAICS industry classifications has created a distinction between the freezing and chilling process and mere cold storage. Implied in that distinction is that the products have to be maintained in such a state to eliminate or reduce spoilage caused by environmental factors such as microorganism growth.
Finally, while Virginia Code § 58.1-609.3 2 (iv) provides an exemption from the retail sales and use tax for “materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale,” the exemption is not available to the Taxpayer because it was not engaged as an industrial manufacturer or industrial processor. The Taxpayer’s arguments that the pallets constituted exempt packaging material and that the packaging activity did not have to occur at the manufacturing site to qualify for the exemption are rendered moot by the preceding analysis.
Resale
The Taxpayer also argues that the purchase of the pallets were exempt under Title 23 VAC 10-210-400 because the pallets for resale. This regulation addresses the application of the tax to packaging materials and transportation devices generally. As set out in subsection A of such regulation, pallets are deemed transportation devices when used to brace or secure cargo for transport. Subsection B of the regulation states that “[t]ransportation devices are not packaging materials and may not be purchased tax exempt unless purchased for resale.” Subsection C of the regulation sets out taxable uses as follows:
Packaging materials and transportation devices, the ownership of which remains with the seller and does not pass to the customer are taxable. Persons who provide packaging and transportation services must pay the tax on all material used in providing such services unless the materials are resold to a customer and no transportation services are provided therewith.
For those businesses that are not an industrial manufacturer or an industrial processor, the first sentence of this regulation is intended to demonstrate that the tax applies to returnable transportation devices and returnable packaging materials as defined in subsection A of the regulation. The second sentence holds that the tax will not apply when the packaging materials or transportation devices are resold without transportation services. Thus, the resale of materials is permitted by the regulation if no transport use is made by the seller.
As the operator of a cold storage facility, however, the Taxpayer provides services in addition to packaging and transportation services. Because its circumstances differ from those the regulation addresses, and it is necessary to examine whether the Taxpayer used the pallets in its provision of services beyond transportation uses.
Virginia Code §58.1-623 provides that:
If a taxpayer . . . makes any use of [resale] property other than an exempt use or retention, demonstration, or display while holding property for resale . . ., such use shall be deemed a taxable sale by the taxpayer as of the time the property . . . is first used by him, and the cost of the property to him shall be deemed the sales price of such retail sale.
Further, Virginia Code § 58.1-602 defines “use” to mean “the exercise of any right or power over tangible personal property incident to the ownership thereof, except that it does not include the sale at retail of that property in the regular course of business.”
The Taxpayer indicates that some customers were invoiced for all outgoing pallets while frequent customers were permitted to pay for their pallets in kind by exchanging them for an equal number of pallets. Based on the invoices provided, pallets were itemized on customer invoices at least some of the time. It appears that the customer was charged for pallets on invoices that covered outbound services that occurred for a time period prior to billing. In addition, the Taxpayer had a line item for pallet sales on its profit and loss statement to show that the Taxpayer resold the pallets.
The Taxpayer, however, also used the same pallets in the process of unloading products from the shipping containers and storing them at its facility. As such, there appears to have been an intervening storage use of the pallets prior to resale. Such use would have made the pallets taxable on a cost basis even if there was a resale.
CONCLUSION
Based on this determination, the Taxpayer is not a manufacturer or processer in the industrial sense as required by the cited case law, statutory and regulatory authorities. The Taxpayer is deemed a service provider, and as such is considered the user and consumer of all tangible personal property used and provided in connection with the provision of packaging, cold storage and shipping services. Even though the pallets may have been resold to customers, the Taxpayer also used the pallets in its provision of storage services. Such use rendered the pallets taxable. Accordingly, the Department's assessments are correct and a refund is not warranted.
The Code of Virginia sections, regulations, 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 matter, please contact ***** in the Department’s Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/658.M