Tax Type
Retail Sales and Use Tax
Description
Penalties and Interest; Waiver not justified
Topic
Collection of Delinquent Tax
Date Issued
08-11-1995
August 9, 1995
Re: §58.1-1821 Application: Sales and Use Tax
Dear**************:
This will reply to your letter of August 25, 1994 in which you, on behalf of your client****************(the "Taxpayer"), seek correction of the sales and use tax audit for the period of February, 1991 through April, 1994.
FACTS
The Taxpayer is a multi-faceted business specializing in fabrication, ship repair, and service oriented functions. The Taxpayer has been operating in accordance with the department's response to a ruling request dated April 4, 1988, copy enclosed. The department's ruling advised the Taxpayer that their operation qualified as fabrication and that the Taxpayer enjoyed the sales and use tax manufacturing exemption set forth in Code of Virginia §58.1-609.3.2 (formerly 58.1-608.3.b). Upon completion of the current sales and use tax audit, the Taxpayer requested from the auditor a letter setting forth the sales and use tax application to their current business operations. In addition to fabrication, the auditor also advised the Taxpayer that they were engaged in ship repair and service work. By way of the auditor's letter dated May 26, 1994, the auditor advised the Taxpayer of the sales and use tax application to each facet of their operation.
The Taxpayer has operated solely in accordance with the April 4, 1988 letter and has applied the exemption set forth Code of Virginia §58.1-609.3.2 to all facets of its operation. The Taxpayer is taking exception to the sales tax application to consumables used indirectly in their operation. Such items include, but are not limited to, light bulbs, oil absorbent, trash bags, extension cords, and equipment rental. The Taxpayer takes the position, based on the exemption set forth in § 58.1-609.3.2, that the consumable items listed above and charged to certain jobs are used directly in the performance of job contracts and are therefore exempt.
The Taxpayer also takes exception to the application of penalty to the use tax portion of the audit. The Taxpayer feels they have operated their business to the best of their ability based on the April 4, 1988 letter and based on the reading of Virginia Regulation (VR) 630-10-80, the imposition of audit penalty is totally unmerited.
DETERMINATION
Code of Virginia §58.1-609.3.2(iii) provides a sales and use tax exemption for "machinery or tools or repair parts therefor or replacement thereof, fuel, power, energy or supplies, used directly in processing, manufacturing, refining, mining or converting products for sale or resale". (Emphasis added). Code of Virginia §58.1-602 defines "used directly" as it relates to manufacturing and processing as "those activities which are an integral part of the production of a product,... but not including ancillary activities such as general maintenance or administration".
In accordance with the foregoing, Virginia Regulation (VR) 630-1 0-63(B) provides that the exemption applies to "machinery, tools and repair parts therefor, fuel, power, 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 regulation continues, "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...".
Based on the above, and after a careful review of the audit workpapers by a member of my staff, none of the items which the Taxpayer is taking exception to could be classified as "directly used" in the manufacturing process. While items such as light bulbs, oil absorbent, trash bags, extension cords, etc., may be necessary to the actual fabrication process, they are not considered "directly used". It should also be pointed out that the April 4, 1988 ruling on which the Taxpayer relied, specifically set forth that items used indirectly may not be purchased tax exempt. Therefore, this audit was conducted in strict accordance with April 4, 1988 letter on which the Taxpayer relied.
Finally, the Taxpayer feels that due to the fact they relied in good faith upon the April 4, 1988 ruling letter and complied with the rules and regulation of the department the audit penalty applicable to the use tax portion of the audit should be waived.
The purpose of the use tax compliance ratio in audit cases is to determine how well the taxpayer has complied with Virginia tax laws in accruing and remitting use tax on untaxed purchases. Although I am sympathetic, the use tax compliance ratio in this case was 0% meaning that no use tax was paid to the department during the audit period. In order for use tax penalty to be waived on second audits, the compliance ratio must be 60% or better; on third and subsequent audits, a compliance ratio of 85% or better is expected (see VR 630-10-80 enclosed). Additionally, the Taxpayer had the benefit of a ruling and VR 630-10-63 in explaining that manufacturers do not enjoy a blanket exemption from the tax. Therefore, use tax penalty was properly applied in this case.
Based on all of the above, the department finds no basis for revising the audit. If you should have any further questions, please contact*****at*******.
Sincerely
Danny M. Payne
Tax Commissioner
OTP/8450K
Rulings of the Tax Commissioner