Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Processed poultry
Topic
Taxability of Persons and Transactions
Date Issued
11-02-1994
November 2, 1994
Re: §58.1-1821 Application: Sales and Use Tax
Dear**************
This will reply to your letter of December 30, 1992 addressed to our ****** District Office in which you are appealing under Code of Virginia §58.1-1821 the sales and use tax audit for the period of January, 1988 through December, 1990.
FACTS
*********(the "Taxpayer) is a vertically integrated producer of processed chickens. The Taxpayer contracts with growers to house and feed Taxpayer owned chickens. The Taxpayer provides the feed, vaccination, veterinary assistance, as well as financial assistance, to the growers. The Taxpayer owns its own feed mill and hatchery to support its growing operation and provides delivery of both feed and chick in company owned trucks. In addition, the Taxpayer operates an over the road live haul operation to transport mature chickens from the farms to the processing plants, of which the Taxpayer owns three. Due to major expansion, new product development, and substantial changes in top level management, the results of the current audit are significantly larger than expected and have resulted and a number of contested areas as set forth below.
1. New Quality Control (QC) Laboratory: The QC Lab was constructed at a separate site away from the processing plant. The Taxpayer contention is based on the premise that the quality control work being carried on at the new QC Lab involves the same exempt production line quality control function conducted at the plant site, thus tangible personal property at the QC Lab should also enjoy the exemption.
2. Insulated Mechanical Doors: The Taxpayer has purchased and installed specially designed insulated doors at their shipping docks and processing plant in order to maintain a temperature controlled environment. The Taxpayer feels such doors are directly involved in production and therefore exempt.
3. Live Haul Poultry Containers: The Taxpayer uses large (4%' x 4' x 9') steel containers to haul live poultry from the farms to the processing plant across public roadway systems. Such containers are stacked 20 to a standard flat bed trailer. Once the containers have been emptied at the processing plant, they are washed and returned to the farms for another load of live poultry. Based on previous correspondence of the department which exempted live haul poultry cages, the Taxpayer feels the containers serve the same purpose and are therefore exempt.
4. Tub Wash Machine: The Taxpayer ships ice packed products in returnable plastic tubs to customers. Upon return to the plant, the tubs are washed and re-used. The Taxpayer feels the fabricated machine used to wash the exempt plastic tubs is also exempt.
. Floor Plate for Ice Plant: The Taxpayer's ice plant produces ice used directly in the production process. The Taxpayer has installed floor plates in the ice plants to protect the ice from contamination. The Taxpayer takes the position the floor plates are used directly in the manufacture of ice and are therefore exempt.
6. Live Receiving Shed: The Taxpayer maintains a Live Receiving Shed which temporarily houses loaded trailers of live poultry at the processing plant site prior to the live poultry entering the production process. The purpose of the shed is to keep the birds cool and prevent their untimely death until they can be unloaded at the receiving docks. The Taxpayer updated the Live Receiving Shed with fans, fan blades and other electrical materials in order to keep the birds cool. The Taxpayer feels the fans, fan blades and electrical materials are part of the handling and storage of raw materials at the plant site and are therefore exempt.
7. Rain Pants, Coats and Boots: The Taxpayer gratuitously furnishes rain pants, coats, and boots to the production line equipment cleaning crews. Production line equipment is cleaned once a day after the third shift. The Taxpayer considers this to be gratuitously furnished safety apparel and exempt from the tax.
8. Weight Information System (Bar Code Label System): This system consists of four main components; scales, label printer, computers, and label readers. Once a boxed product is complete, the scales weigh the box and transmits the weight and type of product to the computer. The computer instructs the label printer to produce a label which contains the following information; manufacture date, plant number, USDA seal, weigh, description of product, and name of manufacturer. It is the Taxpayer's contention that the label provides their customers with an inventory control mechanism and the product is not ready for sale until the label is applied, thus rendering the Bar Code Label System tax exempt. It is the auditor's position that the label is used for the Taxpayer's inventory control, production reports, and shipping reports, thus rendering the Bar Code Label System administrative in nature and therefore taxable.
DETERMINATION
The Code of Virginia §58.1-609.3(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 the Code of Virginia § 58.1-602 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".
Virginia Regulation (VR) 630-10-63 (copy enclosed) the term "used directly", noting that "items 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".
Keeping the above in mind, I will address each of the issues raised by the Taxpayer separately as follows.
New Quality Control (QC) Laboratory
VR 630-10-63(C)(2) provides that equipment used for production line testing and quality control is exempt from taxation. The department has interpreted this regulation to only include that equipment which is "used directly" in the quality control function on the production line of the plant site during the manufacturing process. Due to the fact the facility in question is located away from the plant site, the exemption would not apply.
Insulated Mechanical Door
VR 630-10-63(B)(2) provides the definition of "used directly" and states, in part, "convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt machinery". Subsection C.2 of this regulation in its discussion of what qualifies as "production", provides that "ancillary activities such as plant construction are not a part of production and are taxable". This section goes on to say "construction materials such as concrete, structural steel, and roofing which becomes permanently incorporated into the production plant... are taxable".
The question of direct use in production activities with respect to similar structural components was addressed and answered in both Webster Brick v. Commonwealth, 219 Va. 81, 145 S.E.2d 252 (1978) and Commonwealth v. Wellmore Coal, 228 Va.149 (1984). In Webster, exemption was denied for the structural materials used in the floor of a manufacturing plant. The floor in question constituted a trackage system, which the court found to be indispensable to the production of brick but used only indirectly in such production. In Wellmore, the court found taxable the material used to construct a coal tipple structure. In its opinion, the court specifically noted that "[the] structure contains, inter alia, a foundation, windows, floors, walls, work areas for employees, and a roof," 228 Va. at 154.
The insulated doors in the present case are analogous to Webster and Wellmore in that the doors may facilitate a climate controlled environment in order to enhance production, however, they do not appear to play an active role in the production or quality control process. For example, compare the use of the doors here to the articles used in the live poultry shed, which are found below to be exempt as they play an active role in maintaining the integrity of products on the production line.
Live Haul Poultry Containers
VR 630-10-26 (copy enclosed) addresses "containers and equipment" and provides that containers which are used as packaging materials and which ownership thereof transfers to the customer at the time of sale, may be purchased tax exempt as a purchase for resale. This regulation goes on to address "equipment" used in the shipping function and states, "the tax applies to the purchase of equipment for use in the operation of a business even though such equipment may be used in connection with the shipment or sale of tangible personal property. Examples of property which is subject to the tax are truck bodies and trailers,... containerized cargo,... and similar articles which are not resold and do not become the property of the purchaser".
VR 630-10-26 makes a definite and clear distinction between exempt packaging materials and taxable equipment used in connection with the shipment of tangible personal property. Packaging materials must be marketed with the property sold and become the property of the purchaser in order to be exempt. It is the department's position that the "live haul poultry containers" would not be classified as packaging material, however, they would be classified as equipment used in the operation of a business which does not become the property of the purchaser, and are therefore taxable. The determination is further supported by VR 630-10-63(C)(2), which provides that tangible personal property "used to transport raw materials to a plant site" is taxable.
The September 17,1985 letter to another producer, referenced in the Taxpayer's letter, was issued in error and that situation will be rectified. However, as similar items have been held taxable in prior audits of the Taxpayer, it is not appropriate to offer relief on the basis of the 1985 letter, the existence of which the Taxpayer learned after the conclusion of this audit.
Tub Wash Machine
While the tubs themselves are utilized as exempt packaging material, the maintenance of the tubs clearly would not fall under the "direct use" exemption provided under Code of Virginia §58.1-609.3.2. As provided in Code of Virginia §58.1-609.3.2(iii) in order for machinery or tools to enjoy the industrial processing exemption, such items must be used directly in the production process. Code of Virginia §58.1-602 defines "used directly" to include all steps of an integrated manufacturing... process, but not including ancillary activities such as general maintenance or administration. The tub wash machine is clearly used in general maintenance and not directly in the production process.
Floor Plate for Ice Plant
The floor plate for the ice plant serve purely as a facilitative item prevention of contaminating ice used directly in the production process. It has been the department's consistent position that flooring and platforms used for facilitative purposes are subject to the tax. VR 630-10-63.B.2 specifically provides that, "convenient or facilitative items, such as... platforms, structural steel,... special flooring, etc., or items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing...".
Live Poultry Shed
VR 630-10-63.C.1 defines production to "include the production line of the plant starting with the handling and storage of raw materials at the plant site...". Based on the information provided in your letter, I find the fans, fan blades, and electrical equipment incorporated at the Live Poultry Shed to maintain the integrity of the raw materials at the plant site to be exempt. The audit will be revised and a refund of tax and interest submitted on these items will be issued.
Rain Pants. Coats and Boots
VR 630-10-63.C specifically exempts from the sales and use tax, "safety apparel furnished gratuitously by manufacturer to Production line employees; however, safety apparel furnished to non-production line employees is taxable as are sales of such items to employees". The items in dispute are used by cleaning crews to perform routine maintenance activities, not by production line employees, therefore, are taxable.
Weigh Information System (Bar Code Label System)
VR 630-10-63.C.1 provides that the managerial, sales, and non-operational aspects of manufacturing and processing, which includes selling, marketing and record keeping, are indirect to the actual production of a product and are therefore taxable. Based on the information furnished to this office by the auditor, all equipment associated with the Bar Code Label System held taxable in the audit was solely for use in internal inventory control, production and shipping reports, thus rendering the system taxable. The auditor position is further substantiated by systems manuals and capital funds requests furnished to the auditor during the audit.
Based on the above, the audit will be adjusted and a refund, with updated interest, will be issued. If you should have any questions, please feel free to contact the department.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7405K
Rulings of the Tax Commissioner