Tax Type
Retail Sales and Use Tax
Description
Engineering computers; Coveralls and shoe covers; Manufacturing
Topic
Taxability of Persons and Transactions
Date Issued
05-10-1988
May 10, 1988
Re: Ruling Request / Sales and Use Tax
Dear**************
This will reply to your letter of October 8, 1987 seeking a ruling as a result of a recently completed audit of *********** (taxpayer) for the period January, 1984 through December, 1986.
FACTS
In connection with its operation of a power transformer manufacturing plant, the taxpayer was recently audited and held liable for the tax on the untaxed portion of certain leases of computer equipment According to the taxpayer, the computer equipment in question should not have been held taxable in the audit since it is used over 90% of the time in its manufacturing process.
For example, the taxpayer states, unique information regarding the performance, dimensions, etc., of the transformers to be manufactured, (as specified by its customers) is fed into a mainframe computer. This data is then forwarded to the taxpayer's engineering department which reviews the customer's requirements, and through the use of another computer and a computerized design program, creates a manufacturing design. This design describes each part to be used in the manufacture of a transformer. This computer readable data is then transferred back to the mainframe computer where each component of the transformer to be produced is broken down into its raw material requirements, and the sequence of operations to be performed on the material. This information is then either fed directly into a computer which actually performs some of the instructions, or to plant personnel which perform specific operations. The taxpayer contests the application of the tax to its mainframe computer and to the computer used in performing computerized design.
The taxpayer also states that in a prior audit the department held computer equipment used by the taxpayer in a similar manner to be used 85% of the time in exempt manufacturing operations, and 15% in taxable administrative functions. Accordingly, the taxpayer seeks the application of this same percentage calculation for the current audit.
In addition, while not specifically raised as an issue in your letter, it is the department's understanding that at the time of the audit, the taxpayer also contested the application of the tax to its purchases of certain disposable coveralls and shoe covers.
RULING
Section 58.1-608(i) 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." (Emphasis added)
In addition, Virginia Regulation (VR) 630-10-63(C)(2) provides generally that, computers which are used to direct or control production line and/or quality control operations qualify for tax exemption. However, computers which are used to "produce production reports, make production information available to plant personnel, monitor the efficiency of production machinery, etc., ... are deemed to be taxable administrative items."
Based on the information provided and the regulation cited above, I cannot agree that either the taxpayer's mainframe or its engineering design computer qualify for tax exemption as being used directly in its manufacturing process. While this equipment may be essential to the smooth functioning of the taxpayer's manufacturing process, it is not such an immediate part of such process to qualify for tax exemption.
Instead, the computers are used primarily in pre-production activities, such as in providing engineering and production plant personnel with the information necessary to manufacture transformers to the taxpayer's customers specifications. Such functions are directly analogous to the taxable administrative functions listed in the regulation above. Therefore, the department's auditors correctly held such computers to be fully taxable in the present audit.
With regard to the taxpayer's purchases of disposable coveralls and shoe covers, it is my understanding that such items are provided to production line employees to prevent their clothes from being soiled while painting transformers. Subsection (C)(1) of VR 630-10-63 provides in pertinent part that "tangible personal property used in administrati[ve] [activities] ... are subject to the tax." Tangible items used in administrative activities include those used in "management, selling and marketing, employee comfort and convenience, and record keeping ... whether used on or off the assembly line. (Emphasis added) However, subsection (C)(2) of this regulation provides that, "[s]afety apparel furnished gratuitously by [a] manufacturer to production line employees, N qualifies for tax exemption.
While the disposable coveralls and shoe covers are provided for use by employees of the taxpayer on its production line, they are provided more for the comfort and convenience of such employees than for their safety. Therefore, the auditors properly held such items to be fully taxable in the audit.
A representative of the department's Tax Policy Division will contact you by telephone regarding payment of the tax for the computers contested herein.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner