Tax Type
Retail Sales and Use Tax
Description
Manufacturing, mining machinery
Topic
Taxability of Persons and Transactions
Date Issued
09-24-1993
September 24, 1993
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear**************
This will reply to your letter of January 25, 1993 in which you seek correction of a sales and use tax assessment issued to********** and its successor, **********(the Taxpayer).
FACTS
An audit for the period October 1986 through November 1990 produced an assessment for the Taxpayer's failure to pay the tax on certain purchases of tangible personal property. You contend that the bulk of these purchases is exempt from the tax pursuant to the industrial manufacturing exemption.
The Taxpayer's predominant activity at two plants within Virginia is the rebuilding of customer-owned mining machinery and the major components thereof. You maintain that this process frequently entails the complete remanufacture of large machinery such as continuous miners, shuttle cars and longwall shearers and that the rebuilding process incorporates state of the art technology into the remanufactured product.
The Taxpayer also rebuilds small components of the mining machinery noted above. You indicate that most of this work is performed under the "customer exchange program" in which a customer gives the Taxpayer a component, such as a motor or a gear case, and then purchases a replacement from the Taxpayer's inventory.
In addition to seeking the exemption available to industrial manufacturers, the Taxpayer raises questions regarding the validity of the assessment. The Taxpayer maintains that it was not properly notified in writing of the assessment, that a portion of the audit period is outside of the statute of limitations, and that the error ratio used to calculate the assessment is flawed. In addition, and irrespective of any determination concerning the applicability of the industrial manufacturing exemption, the Taxpayer requests that all penalty charges be abated.
DETERMINATION
Each of the issues raised by the Taxpayer will be addressed separately as follows:
Industrial manufacturing exemption
Va. Code §58.1-609.3(2), formerly Va. Code §58.1-608(A)(3)(b), exempts from the retail sales and use tax "machinery or tools or repair parts therefore or replacement parts thereof, fuel, power, energy, or supplies, used directly in processing [or] manufacturing ... products for sale or resale." Virginia Regulation (VR) 630-1063(B) defines industrial processors to be "engaged in the treatment of materials, substances, or other products in such a manner as to render such products more useful or marketable. Products need not undergo a change in state or form in order for an establishment to be classified as an industrial processor."
Further, Va. Code §58.1-602 indicates that the industrial manufacturing exemptions be applicable primarily to "those businesses classified in codes 10 through 14 and 20 through 39 published in the Standard Industrial Classification Manual .... "
A review of the SIC Manual shows that businesses engaged in the manufacture and rebuilding of heavy machinery and equipment used by the mining industries are classified in SIC Code 3532. Therefore, this activity is deemed to be industrial in nature, and equipment and other items used predominantly and directly in this activity qualify for the industrial manufacturing exemption.
The basis for the department's assessment was that the property being rebuilt or repaired was customer-owned and as such the products of the manufacturing process were not "for sale or resale" for purposes of the statute. However, this overlooks the fact that repair transactions generally are considered to involve the "sale" of tangible personal property (see VR 630-10-90). Similarly, the fabrication of customer-owned property is deemed a sale (see VR 630-10-37).
Accordingly, to the extent that the Taxpayer is predominantly using the contested items in its capacity as an industrial processor, the assessment will be revised.
Notification of the assessment
Va. Code §58.1-1820 provides that an assessment made by the department "shall be deemed to be made when a written notice of assessment is delivered to the taxpayer,...or mailed to the taxpayer at his last known address."
It is my understanding that assessments were mailed to the Taxpayer's corporate address in immediately after their issuance. Furthermore, I understand that the auditor also sent copies of the audit report and the assessments when the Taxpayer's new accounting manager indicated that the originals were misplaced.
Statute of limitations
Because of a merger during the audit period, multiple assessments were issued: For the pre-merger period of October 1986 through October 1988, and for the post-merger period of November 1988 through November 1990. The assessments for the pre-merger period were issued 7/20/90, within the period stipulated by the signed waiver of Time Limitation, and copies of the department's records showing that assessment date are enclosed. The assessment for the post-merger period is dated 3/22/91.
Validity of error ratio
In accordance with the Taxpayer's organization of fiscal records, the auditor sampled a one month period of payments at each location, those months being August 1989 and November 1988. The dates listed on the audit working papers are the dates of the vendors' invoices which coincide with those payments. In reviewing this sampling, I find that it was correctly performed and that the resulting error ratio properly calculated.
Penalty
VR 630-10-80 provides for the mandatory application of penalty to second and subsequent audits. Assessment of penalty on audits is determined by the level of compliance exhibited by taxpayers. Compliance on second generation audits, as in the instant case, must be at least 50 percent on purchases in order to avoid penalty charges, yet the auditor found no compliance whatsoever on purchases.
Moreover, your argument that the relatively low error ratio be considered as evidence of high compliance is not valid. As discussed in the attached Public Document 92-100 (6/15/92), the compliance factor is based upon a taxpayer properly accruing and remitting use tax on untaxed purchases. However, to the extent audit adjustments are made pursuant to this determination which result in a revised compliance ratio, the penalty will be adjusted accordingly.
Accordingly, the audit staff will review the results of the audit in light of this determination and revise the assessment as applicable. A revised audit report and bill reflecting these revisions will be issued to the Taxpayer as soon as practicable.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/6704I
Rulings of the Tax Commissioner