Tax Type
Retail Sales and Use Tax
Description
Mining; Coal testing facility
Topic
Taxability of Persons and Transactions
Date Issued
10-19-1994
October 19, 1994
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear****************
This will reply to your letter in which you seek correction of a sales and use tax assessment for *******( the "Taxpayer") for the period March 1986 through February 1992. 1 apologize for the delay in responding to your request.
FACTS
The Taxpayer operates a coal testing facility (the "Sampling Facility") in which coal is sampled and tested for various characteristics. The Sampling Facility is located at the point where coal is transferred from a rail car to a ship.
A railroad company (the "Licensor") transports the coal to the point at which testing occurs at dockside. The Licensor owns the Sampling Facility. The Licensor has contracted with the Taxpayer to operate the Sampling Facility (this contract is referred to herein as the "Agreement"). Pursuant to the terms of the Agreement, the Taxpayer is required to operate the Sampling Facility to provide coal purchasers with information concerning the coal being purchased. In exchange for allowing the Taxpayer to operate the Sampling Facility and providing the Taxpayer with a steady supply of coal, the Taxpayer pays the Licensor a fixed annual fee and a per ton charge based upon the amount of coal the Taxpayer actually samples (the "Payments").
The department audited the Taxpayer and issued an assessment of sales and use tax on the Payments claiming that they were rental payments for the Taxpayer's use of the equipment located at the Sampling Facility. You filed this protest claiming that the Agreement was not subject to taxation. You cite four specific reasons why the Agreement is not taxable. I shall address each point below.
DETERMINATION
Tangible Personal Property
You assert that the Sampling Facility is not subject to the tax since the Sampling Facility and the machinery and equipment contained within are incorporated into realty. The department has consistently held that the machinery and equipment contained in coal tipples and similar apparatuses (as opposed to the tipple or other structures themselves) are tangible personal property and not realty. This policy was upheld in Commonwealth of Virginia, Department of Taxation v. Wellmore Co., 228 Va. 149 ( 1 984).
The structure and character of the Sampling Facility is very similar to a coal tipple. Both consist of several items of machinery and equipment which are related to the coal mining industry. The Court in Wellmore held that a tipple was not a single machine, but rather a series of machines and equipment exempt from the tax since they were directly used in the mining process. This determination implicitly holds that such machinery and equipment are tangible personal property and not realty.
Like the machinery and equipment contained in a coal tipple, the machinery and equipment contained in the Sampling Facility is tangible personal property. However, a portion of the Payments are for the use of the structure and realty that support and house the machinery and equipment. If the taxpayer can provide financial data concerning the value of the real property as compared to the tangible personal property, the assessment can be adjusted in accordance herewith.
License Agreement
Second, you assert that since the Agreement is a license agreement that requires the Taxpayer to provide services, the transaction between the Taxpayer and the Licensor is not taxable. In asserting this argument you distinguish the Agreement from a typical lease agreement of tangible personal property which is taxable.
The department does not disagree with your characterization of the Agreement as a license agreement as opposed to a lease of tangible personal property. However, the key to the taxability of the Agreement depends on the substance of the license agreement.
Va. Code § 58.1-603 imposes the tax on the furnishing of tangible personal property to the user or consumer of such property. A license arrangement which includes the transfer of tangible personal property for the licensee's use or consumption in the performance of its contractual duties is taxable. See P.D. 87-97 in which the tax was imposed upon the transfer of a computer software program in tangible form and a license to use such program (copy enclosed). See also, P.D. 87-209 (copy enclosed). Like the software transferred in P.D. 87-97, the charge by the Licensor for furnishing the machinery and equipment to the Taxpayer is subject to the tax.
Additionally, the Sampling Facility contains machinery and equipment that is essential to the Taxpayer's performance of its contractual obligations. If the Licensor did not provide the Taxpayer with the machinery and equipment, but rather, the Taxpayer used machinery and equipment it had purchased itself, the purchase of the machinery and equipment would be taxed since the Taxpayer's use of the equipment is not otherwise exempt under the Code. The mere fact that the Licensor provides the machinery and equipment to the Taxpayer does not negate the fact that this property is taxable.
Common Carrier Exemption
Third, you assert that the Sampling Facility is used directly in the railroad's provision of common carrier services to the general public. The railway common carrier exemption is specifically reserved for those railway companies which hold themselves out to carry goods by rail for hire for anyone who would employ the railway. By contrast, the Taxpayer is not a railway carrier and thus not a common carrier. Therefore, it does not qualify for this exemption. Also, even if it was a common carrier, the sampling activity would not qualify for the exemption since it does not fall within those activities that are exempt pursuant to the common carrier exemption.
Virginia Regulation 630-10-24.4 exempts tangible personal property from the imposition of the tax if a common carrier directly uses such property in the rendition of its public service. An item of tangible personal property is not deemed to be directly used in the rendition of a public service within the meaning of the regulation unless it is indispensable to the transportation activity and is used immediately in such activity.
The fact that certain property is used in the rendition of transportation services, due to a statutory requirement or otherwise, does not in itself satisfy the requirement that such property is used directly in the public service.
The sampling of coal at the Sampling Facility does not appear to be a necessary or integral part of the transportation of coal. It is merely a function, although necessary, which makes the coal being shipped more marketable. The sampling of the coal is merely a test to identify the quality of the coal for the purchaser's use in marketing the product.
Furthermore, case law recognizes that common carriers are under a high obligation to maintain the integrity of items entrusted to their care. Again, however, the testing does not ensure the integrity of the product transported by the Licensor; rather, it is an "after the fact" procedure to enhance the marketability of the coal.
Manufacturing and Industrial Processing
Finally, you assert that the Sampling Facility is exempt from the tax pursuant to the manufacturing exemption. Specifically, you contend that the Sampling Facility is an exempt quality control operation.
Va. Code §58.1-609.3 exempts tangible personal property directly used in a manufacturing or processing operation . VR 630-1 0-63(C)(2) provides that equipment used for production line testing and quality control is exempt from taxation. Additionally, the quality control exemption only applies to testing or monitoring activities that occur during the manufacturing process. Such activities must be intended to maintain the integrity of the products being produced for the activity to be exempt from taxation. Testing, which occurs away from the production line, such as post-production testing to determine whether or not the product meets contract specifications or applicable safety standards or for some other reason, is not exempt from taxation.
The Taxpayer tests the coal immediately prior to the transfer of the coal from rail car to ship container. This occurs well after the termination of the production phase of the coal mining and processing operation. Therefore, the manufacturing and industrial processing exemption does not shield the Sampling Facility from the imposition of tax.
Additionally, VR 630-10-65.2 provides for the exemption of tangible personal property used in mining and mineral processing which includes product inspection and testing. However, the property used to test or inspect products are only exempt if the testing is conducted at the mine or processing site, which includes the processing conducted at the tipple. Wellmore at 159.
Again the Taxpayer tests the coal well after the completion of the mining and processing operations which is not an exempt activity. Therefore, the Sampling Facility is not exempt from the tax pursuant to the mining and mineral processing exemption.
Based upon the department's position stated herein, the assessment shall be modified as discussed above, and a partial refund will be issued if it is deemed appropriate. A representation of the *****District Office will contact you for this purpose. Please do not hesitate to contact*******if you have
any further questions.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/67640
Rulings of the Tax Commissioner