Tax Type
Retail Sales and Use Tax
Description
Computer software and hardware used to track production process
Topic
Taxability of Persons and Transactions
Date Issued
03-08-1988
March 8, 1988
Re: §58.1-1821 Application/ Sales and Use Tax
Dear*************
This will reply to your letters of September and October 1987 contesting sales and use tax assessments issued to the************ (taxpayer), for various periods between November 1983 and May 1987. This also has reference to a letter from a representative of one of the taxpayer's divisions, dated January 27, 1987. Although separate appeals were filed by the taxpayer for each of its divisions, this response will address all of the issues raised in the appeals.
FACTS
The taxpayer provides nuclear fuel and related products and services to the government, the domestic electric utility industry, and private entities through three divisions located in Virginia. In connection with these activities, the taxpayer was recently audited and held liable by the department for a variety of untaxed purchases of tangible personal property which were deemed by the department's auditor not to be used directly in exempt manufacturing activities.
DETERMINATION
On a separate basis, I will discuss each of the issues raised by the taxpayer:
Commercial Nuclear Fuel Plant
The taxpayer contests the use by the auditor of two separate error factors (rather than a single factor), applied over two periods of the audit, and the application of these factors to average rather than actual purchases to derive the taxable measure. According to the taxpayer, this methodology skewed the audit results in a manner disadvantageous to this division.
Based on the information presented, I agree to the recomputation of the error factor requested by the taxpayer with respect to this division. Accordingly, this division's audit will be revised to reflect a single error factor applied over the entire audit period using actual rather than average purchases.
Nuclear Power Generation Division
The taxpayer contests the application of the tax to certain computer purchases in this division which it contends were used directly in support of its exempt manufacturing, testing and storage of nuclear fuel and related products, primarily under classified contracts with the United States Government.
In a letter dated January 27, 1987, one of the taxpayer's representatives indicated that the contested computer equipment was used approximately 80% of the time in support of its nuclear fuel production and assembly operation including the following functions: the scheduling or tracking of component parts in production, the production of criticality reports for each part used in production (to meet government contractual and licensing requirements), and to provide documentation of each step of its nuclear fuel manufacturing process and all components used in this process. Based on this usage, the taxpayer contends that the computer equipment should be deemed fully exempt. As further support for its contention, the taxpayer notes that in two prior audits, the department allowed it to prorate its computer purchases as 70% exempt, based on the percentage of time the computers were used in exempt activities.
§58.1-608(1) of the Virginia Code 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 §58.1-602(22) of the Code as "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 general maintenance or administration." The term "manufacturing" is defined in §58.1-602(9) of the Code 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 addition, Virginia Regulation 630-10-63(C)(2), copy enclosed, provides in pertinent part that "computer hardware and software used...to monitor production operations..., to produce production reports, make production information available to plant personnel, [or] to monitor the efficiency of production machinery,...are deemed to be taxable administrative items." Such nonexempt activities are directly analogous to those for which the taxpayer's computers are used.
Subsection D of VR 630-10-63 provides that "[w]hen a single item of tangible personal property is put to use in two different activities, one of which is an immediate part of the industrial production process (exempt) and the other of which is not (taxable), the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in non-exempt activities. Likewise, the item will be totally exempt from tax if the preponderance of its use is in exempt production activities." (Emphasis added)
It is the department's understanding that the computer equipment held taxable in this case was not being used in the same manner as the computers which were prorated as 70% exempt in prior audits. Based on this and other information provided by the taxpayer, I cannot conclude that the taxpayer's computer equipment was used more than 50% of the time in exempt production activities.
However, since the audit period in this case extended several months prior to the July 1, 1984 effective date of the preponderance of use test, proration will be allowed for those computer equipment purchases made by the taxpayer prior to July 1, 1984. For periods on and after this date, the preponderance of use test was properly applied. Accordingly, the taxpayer should review the criteria for determining exempt versus taxable computer equipment usage set forth in the enclosed regulation, and apply these criteria to its computer equipment purchases made prior to July 1, 1984. The taxpayer should then revise its percentage calculation of exempt computer usage for pre-July 1, 1984 computer purchases, and remit such revised breakdown to the department's Technical Services Section, Office Services Division, P.O. Box 6-L, Richmond, Virginia 23282, within 30 days of the date of this letter.
Penalties
While the working papers indicate that the compliance ratios were computed correctly by the department's auditor, based upon the authority granted in §58.1-105 of the Virginia Code and the facts and circumstances of this case, I find basis for the waiver of all penalties assessed in this case. Therefore, after receipt of the information requested above, the audit assessments will be adjusted in a manner consistent with this determination, and revised assessments will be issued to the taxpayer under separate cover.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner