Tax Type
Retail Sales and Use Tax
Description
Computer aided design system (CAD)
Topic
Exemptions
Taxability of Persons and Transactions
Date Issued
01-04-1988
January 4, 1988
Re: §58.1-1821 Application/Sales and Use Tax
Dear*********************
This will reply to your letter of November 5, 1987, in which you submit an application for correction of sales and use tax assessed to**************as the result of a recent audit.
FACTS
****************Taxpayer), in connection with its production of marine equipment and other products, operated a computer aided design/computer aided manufacturing (CAD/CAM) system. The cost of the CAD/CAM system was included in a recent sales and use tax audit of the taxpayer. The taxpayer contests this assessment on the basis that the CAD/CAM system was used more than fifty percent of the time in exempt industrial manufacturing functions.
DETERMINATION
§58.1-608.1 of the Code of Virginia provides an exemption from the sales and use tax for "machinery...used directly in... manufacturing...products for sale or resale." The term "used directly" is defined in §58.1-608.22 as "those activities which are an integral part in the production of a product, including all steps of an integrated manufacturing...process, but not including ancillary activities such as general maintenance or administration." The term "manufacturing" is defined in §58.1-608.9 of the Code of Virginia as "the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site."
In this case, the taxpayer used its CAD/CAM system to perform a number of functions, including the design or redesign of products and the generation of computer software packages for direct use in the production process. Inasmuch as the industrial manufacturing exemption is limited by statute to the production line of a plant, steps that are preparatory to production, such as product design, are not within the scope of the exemption. on the other hand, Virginia Regulation 630-10-63.C.2 notes that "[t]he concept of the integrated manufacturing process includes within the scope of the ... exemption machinery...used to...manufacture exempt production machinery, tools or supplies." As such, the production of computer software that will be used directly in production activities is within the scope of the exemption.
When articles of tangible personal property are used in both exempt and nonexempt manufacturing activities, §58.1-608.1 of the Code of Virginia provides that the articles "shall be exempt if the preponderance of their use is used directly in... manufacturing products for sale or resale." This concept applies to property acquired on or after July 1, 1984. Prior to that date, the tax on such articles was computed based on the percentage of taxable usage to overall usage.
In support of its claim that the CAD/CAM system is used more than fifty percent of the time in exempt production functions, the taxpayer submitted a cost analysis showing that the estimated manufacturing savings represented 62 percent of overall estimated savings from the acquisition of a CAD/CAM system. It must be remembered, however, that the preponderance of use test is based upon actual usage rather than anticipated cost savings.
Based upon the foregoing, I cannot find any basis for the revision of the department's audit at this time. I am willing, however, to provide the taxpayer with additional time to furnish documentation to support its claims as to exempt usage. Furthermore, for any purchases of CAD/CAM system components prior to July 1, 1984, the taxpayer may submit information to enable the department to prorate the assessment based on percentages of exempt usage. All such information should be submitted to the department's Technical Services Section at P. O. Box 6-L, Richmond, Virginia 23282 within the next sixty days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner