Tax Type
Retail Sales and Use Tax
Description
Printing; Applicability of manufacturing exemption
Topic
Taxability of Persons and Transactions
Date Issued
07-10-1996
July 10, 1996
Re: § 58.1-1821 Determination: Retail Sales and Use Tax
Dear***************
This replies to letters dated February 24, 1995, and June 30, 1995, from , formerly of your firm. ******(the "Taxpayer") seeks the correction of separate retail sales and use tax assessments issued for the audit periods of May 1990 through April 1993 and May 1990 through December 1993. apologize for the delay in responding to your letters.
Gross Purchases Used in Sample
The Taxpayer states that the purchase amounts used by the department's auditors to extrapolate the audit sample were not correct. It furnished a schedule of purchase figures to the auditors but the department's auditors used amounts in the sample extrapolation that were originally agreed to by the Taxpayer. In addition, the Taxpayer changed its chart of accounts during the audit period, but could not provide the department with documentation showing the relationship between accounts coded under the old and new charts of accounts. In an effort to reconcile the amounts used by the department with the amounts supplied by the Taxpayer, the auditors offered to meet with the Taxpayer to resolve the problem, but this never occurred.
Sampling is an audit technique that is widely used in both the public and private sectors. When sampling techniques are properly applied, the final result should be within a narrow margin of the actual liability which would have resulted from a detailed audit. Code of Virginia § 58.1-205 (copy enclosed) provides that tax assessments issued by the department are deemed prima facie correct. The burden of proving that an assessment is erroneous is on the taxpayer. If the Taxpayer can provide documentation showing that the purchase balances used by the department were incorrect, the audit will be adjusted accordingly. Otherwise, the assessment will be considered correct.
Donations of Research Equipment
The Taxpayer, after being acquired by *******disposed of much of its research equipment during the audit period. Many items were donated to various universities. The items in question were purchased by the Taxpayer exempt of the tax under the research and development exemption found in Code of Virginia § 58.1-609.3(5). The Taxpayer maintains that the tax would not apply to its donation of the equipment because the equipment continued to be used in an exempt manner after its donation to the universities.
Code of Virginia § 58.1-609.3(5) provides an exemption from the sales and use tax for "[t]angible personal property purchased for use or consumption directly and exclusively in basic research or research and development in the experimental or laboratory sense." Virginia Regulation (VR) 630-10-92 (copy enclosed) interprets this code section and provides in pertinent part:
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- Tangible personal property must be purchased or leased by the person, firm, corporation, or other entity that actually will perform research activities in order to qualify for the tax exemption for items used directly and exclusively in research. If the research equipment is purchased or leased by a person and is subsequently donated or loaned to another person to perform research for either party, the equipment is taxable to the person making the purchase, even if the other party is a nonprofit organization, governmental entity, oris otherwise exempt from the sales and use tax. (Emphasis added).
Based on the above, the Taxpayer's donations of the equipment in question is taxable. Code of Virginia § 58.1-609.8(5) also provides an exemption from the tax for "[t]angible personal property withdrawn from inventory and donated to (i) an organization exempt from taxation under § 501(c)(3) of the Internal Revenue Code (I.R.C.) or (ii) the Commonwealth, any political subdivisions of the Commonwealth, or any school, agency or instrumentality thereof." This exemption would not apply to these transactions as the items were not withdrawn from the Taxpayer's inventory.
Sales of Personal Property Prior to Audit Period
The department listed audit exceptions for sales of tangible personal property made in connection with the sale of a house and real estate owned by the Taxpayer. The sales were recorded in the Taxpayer's general ledger in June 1990. The Taxpayer states the transaction occurred in January 1990, which places the sales outside of the current audit period. The Taxpayer also maintains individual values were not assigned to the personal property in the sales contract.
Based on the Taxpayer's accounting records reviewed by the department's auditors, the sales price was allocated between real property and tangible personal property. Each item of tangible personal property sold was listed in the audit based on separate journal entries obtained from the Taxpayer's records. The Taxpayer's entries were recorded as June 1990 transactions. Unless the Taxpayer can provide documentation establishing that the sales took place in January 1990, its burden of proving the transactions occurred outside the statute of limitations has not been met.
Exempt Sales of Fixed Assets
The department's auditors also included sales of fixed assets to various parties in the audit assessment. The Taxpayer suggests that these sales were exempt but it was unable to obtain exemption certificates before the audit assessment was made. According to the department's auditors, the Taxpayer was given approximately six months to obtain exemption certificates.
Code of Virginia § 58.1-623(A) states that "All sales or leases are subject to the tax until the contrary is established. The burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter." Paragraph B of this same section provides that the acceptance of a certificate as provided for in paragraph A relieves the seller from any liability for the payment or collection of the tax.
The Taxpayer has not met the requirements set forth in the Code of Virginia to warrant removing the sales of fixed assets from the audit. I will allow the Taxpayer sixty days to furnish the department with valid exemption certificates. The audit will be adjusted to reflect the acceptance of any valid certificates the Taxpayer can provide.
Purchases of Plates and Advertising Materials
The Taxpayer purchased plates used by printers to imprint products and product cartons that are marketed with its products. A separate charge was made by the printers for the plates. The plates are not used by the Taxpayer to manufacture packaging and I understand that in most cases the plates listed as audit exceptions were duplicates of the plates actually used by the printer. The Taxpayer maintains that the plates are directly related to the production process and should be exempt. The Taxpayer also states that similar charges to produce advertising should be exempt under the advertising exemption.
The application of the manufacturing exemption found in Code of Virginia § 58.1-609.3 is addressed in Virginia Regulation (VR) 630-10-63 (copy enclosed). The regulation states that the exemption applies to those items "used directly" in the manufacturing process. VR 630-10-63(B)(2) defines "used directly" as"those activities that are an integral part of the production of a product, including all steps of an integrated manufacturing process, but not including incidental activities such as general maintenance, management, and administration." VR 630-10-86, § 6 (copy enclosed) also addresses the application of the manufacturing exemption to printing and states "Materials, such as photographs and plates, that are furnished by customers, but do not become a part of the printer's finished product, are taxable." (Emphasis added).
Based on the above, I do not find the Taxpayer's purchase of plates to qualify for the manufacturing exemption. The Taxpayer does not actually use the plates to produce printed materials. The plates are not an integral part of its manufacturing process and therefore, the plates are not "used directly" as required by the statute. The printing regulation cited above clearly states that the purchase of printing plates by printers are exempt of the tax because they are "used directly" in production, but the exemption does not extend to purchasers who do not actually use the plates themselves.
It is not clear from the Taxpayer's letter if it has made purchases of advertising services that are exempt under VR 630-10-3 (copy enclosed). You should note, however, that purchases of tangible personal property for use in "in-house" advertising are subject to the tax as provided in VR 630-10-3, § 4. "In-house" advertising is advertising produced by an entity for promoting, displaying, or advertising its own products or services. The department will review any questionable invoices provided by the Taxpayer to determine if they were properly held in the audit.
Penalty
The Taxpayer was assessed compliance penalty in both audits. In the audit of the location responsible for producing samples and promotional materials, the Taxpayer seeks waiver of the penalty based on improvements in compliance since its last audit. The Taxpayer's compliance ratio was 55%; the required ratio was 85%. In the last audit, compliance was 46%.
The Taxpayer was also assessed a use tax compliance penalty in an audit of its general expense purchases and fixed asset purchases. Its compliance ratio was 31% while the required ratio is 85%. In the last audit, compliance was 25%. The Taxpayer also cites its improved compliance since the last audit cycle as the basis for waiving the penalty.
VR 630-10-80 (copy enclosed) requires the application of compliance penalty to audit deficiencies based on the percentage of compliance exhibited by taxpayers, which is determined by computing a compliance ratio. In third and subsequent generation audits, taxpayers are required to have at least an 85% compliance ratio to avoid the penalty. This was at least the third audit of each location and the compliance ratios were 55% and 31%.
While the Taxpayer has exhibited some improvement in compliance levels since the last audit cycle, its compliance levels are far below those required for third and subsequent generation audits. I understand that the Taxpayer made late use tax accruals in response to a previous determination received from the department. Although these accruals were made after the end of the original audit period, the auditors agreed to extend the audit period to allow credits for the accruals and to include them in the compliance calculation. The inclusion of the late accruals in the compliance calculation only raised compliance to 55%. In addition, the department agreed to waive compliance penalties in the Taxpayer's previous audits due to personnel turnover and staffing problems associated with the Taxpayer's bankruptcy proceedings. For these reasons, and the lack of exceptional mitigating circumstances as required by VR 630-10-80, I do not find basis to waive the compliance penalties.
Due to the length of time taken to respond to you, I will agree to waive the accrual of any additional interest if the current balances of ********* and**********are paid within sixty days. If the Taxpayer has additional documentation for review, please contact our*************District Office at to make an appointment within sixty days from the date of this letter. If you have any questions concerning this determination, please contact**** in the Office of Tax Policy at****** . You may mail your payment to****at P. O. Box 1880, Richmond, Virginia 23218-1880.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/9928S
Rulings of the Tax Commissioner