Tax Type
Retail Sales and Use Tax
Description
Computer used in both manufacturing and administration
Topic
Exemptions
Property Subject to Tax
Date Issued
01-04-1994
January 1, 1994
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear *******
This will reply to your letters of July 6, 1993 and July 23, 1993 in which you seek correction of a sales and use tax assessment for **** (the "Taxpayer").
FACTS
The Taxpayer is in the business of manufacturing (sewing) garments. The Taxpayer purchased a computer system to assist in the production process. You contend that the computer system and the system software are used directly in the manufacturing process and qualify for the manufacturing exemption provided in Va.Code §58.1609.3(2) (formerly Va.Code §58.1-608(A)(3)(b)). The auditor determined that the computer system and software were not predominantly used in the manufacturing process and assessed use tax. Penalty was also assessed because of the Taxpayer's low use tax compliance ratio.
The issues you raise will be addressed separately.
DETERMINATION
Computer system: Va. Code §58.-609.3(2) 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 Va. Code §58.1-602 as "those activities which are an integral part of the manufacturing ... process, but not including ancillary activities such as general maintenance or administration."
Virginia Regulation (VR) 630-10-63 further defines the term "used directly," noting that "[i]tems of tangible personal property which are used directly in manufacturing ... are machinery, tools, and repair parts therefor, fuel, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process." However, this section continues, "items which are essential to the operation of a business but not an immediate part of the actual production are not used directly in manufacturing.
In this case, the Taxpayer uses the computer system for various functions, including use in production activities qualifying for the exemption. Under Va. Code §58.1-609.3(2), equipment is exempt if the preponderance of its use is used directly in manufacturing products for sale or resale. Therefore, the computer system in this case will be totally exempt if it is used directly in manufacturing more than 50% of the time. However, if used directly in manufacturing 50% or less of the time, the tax applies in full to the computer system.
Many of the functions which you believe are an immediate part of the production process and which may be necessary to the operation of the business as a whole do not touch directly on production as is necessary to gain exemption under the statute. For example, you note that "the computer controls the plant operation by analyzing vast amounts of product and production line data and optimizing plant production levels by directing the flow of work through the manufacturing process and relieving line supervision and operators of such process." This function appears to relate to production scheduling as it allows production personnel to plan production by telling them which machines and which operators are performing the best. Under VR 630-10-63 C.2., this function (monitoring the efficiency of production machinery) does not touch directly on the manufacturing process and is nonexempt in nature. Similarly, the "count down clock" feature which displays on an operator's terminal the amount of time available to perform a given job is a nonexempt monitoring function.
While it is recognized that some of the functions performed by the computer system are used directly in the manufacturing process, there is no evidence to prove that the computer is used directly in manufacturing more than 50% of the time. Because exemptions from the tax are construed strictly against the taxpayer, and the Taxpayer could not document that the preponderance of the computer system's use was directly in manufacturing products for sale or resale, the auditor properly held the purchase of the computer system to be taxable.
You cite P.D. 88-154 (6/23/88) to support your position that the computer system is used directly in manufacturing and, therefore, is tax exempt. However, in that case it was documented that the preponderance of the computer's use was in processing ongoing production line data and providing equipment operators with the information to enable them to make the constant equipment adjustments necessary to ensure correct and continuous production of the product. In the Taxpayer's situation, there is no documentation that the preponderance of the computer's use is directly in manufacturing.
Software: Based on the information provided and the analysis set forth above, the software appears to be used predominantly for administrative and managerial purposes. Therefore, it is subject to tax.
Penalty: The use tax compliance ratio of 35% is not deemed acceptable for a third generation audit. Moreover, the Taxpayer has not demonstrated any exceptional mitigating circumstances to warrant waiver of the penalty. Accordingly, the penalty was properly assessed in this case.
However, if you can provide documentation showing that, during the period in question, the preponderance of the computer system's and software's use was in exempt activities, then the audit will be adjusted accordingly. The information should be sent to the Office of Compliance, Audit Review Unit, P.O. Box 615, Richmond, Virginia 23205-0615, within 30 days. If the requested information is not timely submitted, the information on which the assessment was originally based will be presumed to be the best available and collection action will resume.
Sincerely,
W. H. Frost
Tax Commissioner
OTP/7225F
Rulings of the Tax Commissioner