Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Aluminum and plastics
Topic
Taxability of Persons and Transactions
Date Issued
06-19-1996
June 19, 1996
Dear *****
This will reply to your letter of July 10, 1995 in which you seek correction of sales and use tax assessments issued to *** (the "Taxpayer') for the period April 1990 through August 1994. The major concern in this case involves the statute of limitations issue which has been addressed through a number of meetings and which has been resolved. Further, most of the remaining issues, which were predominantly part of the out-of-statute assessment, have little fiscal impact on the assessment itself. These issues, however, may affect the front-end agreement which the Taxpayer and the department have entered into.
FACTS
The Taxpayer is a manufacturer of aluminum and plastic products. An audit of the Taxpayer resulted in an assessment primarily for untaxed purchases of tangible personal property used in its production process. The Taxpayer maintains these purchases are exempt under the manufacturing exemption set out in Code of Virginia § 58.1-609.3(2).
DETERMINATION
Each of the issues raised by the Taxpayer will be addressed separately as follows:
-
- Fire Suppression Systems: These systems include sensors mounted within machinery to detect the presence of heat and flame. If activated, the systems (1) shut down the machine by cutting off the electricity and (2) set off carbon dioxide to extinguish fires. Each system is mounted directly on exempt manufacturing equipment but is purchased separately from the equipment.
- Fire Suppression Systems: These systems include sensors mounted within machinery to detect the presence of heat and flame. If activated, the systems (1) shut down the machine by cutting off the electricity and (2) set off carbon dioxide to extinguish fires. Each system is mounted directly on exempt manufacturing equipment but is purchased separately from the equipment.
-
- 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 production machinery.
- 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 production machinery.
Nor can I agree that the fire suppression systems are analogous to circuit breakers which shut down machinery in the event of electrical overloads. The circuit breakers are generally exempt in that they are part of the operation which provides power to production equipment, a function which is specifically exempt under § 58.1-609.3(2).
Based on the concept of direct use, and as set out in established tax policy, the fire suppression systems are properly assessed. I understand that in the future the Taxpayer's manufacturing machinery may possibly be purchased with such systems installed as built-in components. In this eventuality, the fire suppression systems, when purchased as part of exempt manufacturing machinery, would be exempt.
Lubricants: The lubricants at issue are manually applied to exempt machinery and equipment. In this regard, the statutory definition of "manufacturing' in Code of Virginia § 58.1-602 specifically excludes "ancillary activities such as general maintenance or administration.' Further, VR 630-10-63(C)(2) indicates that the exemption does not extend to "tangible personal property used in the repair, servicing, and maintenance of production machinery. . . .'
The Taxpayer questions the assessment given that lubricants which are automatically applied (through reservoir and pump systems) are generally exempt. The Taxpayer maintains the contested lubricants are functionally identical to lubricants which are automatically dispensed and that the exemption should apply to both.
Automatic lubrication systems were addressed in Public Document 87-167 (6/24/87). The exemption was extended to these systems because they were an active part of production and played a more direct role in production than manually applied lubricants. Also, the automated system acted continuously during production. Manual lubrication is intermittent and is clearly not as immediate as the automated systems. The contested lubricants used by the Taxpayer are therefore found to be taxable maintenance items.
Roll Grinding Subsystem: The Taxpayer uses mill rolls to manufacture various types of aluminum foil products. Each mill roll must conform to specific tolerances with respect to diameter, crown, and surface qualities.
The mill roll subsystem is used to (1) grind new rolls (or blanks) to required specifications; (2) change the existing specifications of used rolls; and (3) re-establish the surface and shape of used rolls. You indicate that the usage of the roll grinding machinery for these three processes is 5%, 25%, and 70%, respectively.
The grinding process takes place at the plant, but away from the production line. Accordingly, the mill roll must be removed from other machinery and then transported to the roll-grinding section where the grinders are located. I understand that the tangible personal property used in this process includes a roll grinder and surface finish measuring equipment.
VR 630-10-63(B)(2) indicates that the concept of the integrated manufacturing process includes within the scope of the exemption "subprocessing activities which produce tangible personal property used directly in the main manufacturing or processing activity.' The mill rolls are clearly used directly in the Taxpayer's industrial manufacturing. Further, I find that the extensive nature of the roll grinding process goes beyond taxable general maintenance and is rather the reprocessing of equipment which is used directly in manufacturing. Also, and as you indicate, the roll grinding process, including the regrinding of used mill rolls, is itself classified as a manufacturing activity in the Standard Industrial Classification Manual.
Accordingly, tangible personal property used predominantly and directly in grinding the mill rolls is deemed exempt from the tax.
Safety Equipment and Supplies: The Taxpayer questions the assessment on gas monitoring equipment, eyewash stations, fire blankets and electrolyte liquids (provided to production workers who are subject to excessive heat). The Taxpayer maintains that these safety items are exempt under the Virginia Supreme Court's decision in Department of Taxation v. Wellmore Coal Corporation, 228 Va. 149, 320 S.E.2d 509 (1984). In that case, the Court held that methanometers and first aid equipment were exempt protective materials used directly in mining. The Taxpayer points out that the exemptions available to manufacturing and mining activities are set out in the same statute. The Taxpayer therefore maintains that the exemption available to mining activities for safety equipment should also extend to manufacturing.
The Court's decision in Wellmore regarding protective materials was based on the language of the existing Sales Tax Regulation § 1-63. At that time, the regulation addressed both manufacturing and mining. In 1985, however, the department issued separate regulations for these two activities: VR 630-10-63 for manufacturing and VR 630-10-65.2 for mining and mineral processing. The latter regulation (mining) exempts protective apparel (including goggles, lamps, and methanometers) furnished to production personnel and first aid equipment and supplies. The former regulation (which governs the Taxpayer's manufacturing activities) limits the exemption to "safety apparel furnished gratuitously to production line employees. . . .'
The contested safety equipment in this case is clearly not "safety apparel.' Accordingly, the exemption is not applicable.
Self-Manufacturing: At its fabrication and machinery plants, the Taxpayer manufactures aluminum cans, can-making machinery and machine parts. These products are manufactured predominantly for resale but also for the Taxpayer's own use. The Taxpayer was assessed a certain percentage of expense items (supplies) used in the fabrication of machine parts for its own use. You contest this portion of the assessment on the grounds that the self-manufacture of machinery and equipment used by the Taxpayer directly in manufacturing is exempt.
As discussed above under the "Roll Grinding Subsystem,' the integrated manufacturing process extends the exemption to tangible personal property used directly to manufacture exempt production machinery. Accordingly, consumable supplies used directly to fabricate the Taxpayer's repair parts and other exempt manufacturing equipment will be removed from the assessment.
Storeroom and Maintenance Accounts: It was determined in previous audits that purchases charged to various storeroom and maintenance accounts were fully taxable, fully exempt, or partially taxable. Accordingly, items purchased for the storeroom were made exempt of the tax, and the Taxpayer accrued the tax at a rate based on the account to which the item was charged when items were withdrawn from the storeroom.
It was found during the current audit that the percentages used by the Taxpayer to accrue the tax, and which may have been accurate during prior periods, understated the tax due. The auditors therefore issued an assessment based on an increased percentage for taxable accounts. The Taxpayer disagrees with this assessment and maintains that the prior percentages be accepted.
I have reviewed the auditors' procedures used in examining storeroom accounts for the current audit period and can find no inconsistencies in those procedures. While percentages may have been accurate in the past, discrepancies were found in the current audit which resulted in an assessment. I can find no indication that the assessment of these accounts is erroneous.
Security Entrance System: In 1990, a contractor installed a security door system at the Taxpayer's headquarters. This system operates via a control box which reads magnetic cards which are issued to employees. When activated by a card, the system releases a lock which is built into the entry door. The system was assessed as a purchase of tangible personal property. The Taxpayer maintains that the system constitutes an improvement to realty. Further, I understand that the contractor paid the tax when purchasing the equipment. The assessment, therefore, is for the difference between the contractor's cost price and the sales price.
Code of Virginia § 58.1-610 was amended effective July 1, 1992 to provide that:
-
- Any person engaged in the business of furnishing and installing locks and locking devices shall be deemed a retailer of such items and not a using or consuming contractor with respect to them. Pursuant to this amendment, the sale of a security entrance system as described above would be a retail sale and not an improvement to realty. In the instant case, however, the security entrance system was sold and installed prior to the effective date of this amendment. Because it entails operation of locks and doors (which are real property), and because it was sold and installed prior to the effective date of the amendment to § 58.1-610, the security entrance system is found to be an improvement to realty as the Taxpayer contends.
- Any person engaged in the business of furnishing and installing locks and locking devices shall be deemed a retailer of such items and not a using or consuming contractor with respect to them. Pursuant to this amendment, the sale of a security entrance system as described above would be a retail sale and not an improvement to realty. In the instant case, however, the security entrance system was sold and installed prior to the effective date of this amendment. Because it entails operation of locks and doors (which are real property), and because it was sold and installed prior to the effective date of the amendment to § 58.1-610, the security entrance system is found to be an improvement to realty as the Taxpayer contends.
I trust that this information addresses your concerns regarding these issues. Please contact *** in my Office of Tax Policy at ***, if you have additional questions.
Rulings of the Tax Commissioner