Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling or refining
Topic
Taxability of Persons and Transactions
Date Issued
09-27-1996
September 27, 1996
Re: § 58.1-1821 Application: Retail Sales & Use Tax
Dear***************
This will reply to your letter of March 23, 1995 in which you seek correction of the department's sales and use tax assessment issued to your client, ****** (The "Taxpayer"), for the period December 1990 through November 1993. I apologize for the length of time taken to respond to your concerns.
FACTS
The Taxpayer provides emergency and supplemental water treatment services through mobile processing units (trailers). Additionally, the Taxpayer also provides permanent water treatment installations. The Taxpayer protests the assessment of tax on: (1) the purchase of tools, parts and supplies which the Taxpayer states are used directly in processing/manufacturing; (2) the purchase of electronic components which the Taxpayer states are also used directly in processing; and (3) the sale of ultra-pure water to contractors.
The Taxpayer requests a review of the department's assessment and removal of the discussed purchases and sales. Additionally, the Taxpayer requests a waiver of all penalties due to the illness and death of the employee responsible for self assessing the sales and use tax for the Taxpayer.
DETERMINATION
Code of Virginia § 58.1-609.3.2 provides an exemption from the sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy or supplies, used directly in processing, manufacturing ... products for sale or resale." The term "used directly" is defined in § 58.1-602 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."
Virginia Regulation (VR) 630-10-63(B)(2) interprets these statutes by stating that:
-
- Items of tangible personal property which are used directly in manufacturing and processing are machinery, tools and repair parts therefor ... 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. Convenient or facilitative items ... 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.... Furthermore, the fact that the use of a particular item ... may be required by federal, state or local law is not, by itself, dispositive of direct usage in manufacturing or processing.
Further, in the case of Commonwealth of Virginia v. Community Motor Bus Co.
214 Va. 155, 198, S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in a statute was intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products.
With the foregoing in mind, I will address each of the issues as follows:
A. Non-Taxed Purchases: These purchases include tools, parts and supplies used to hook up and maintain processing trailers to customer water lines. The Taxpayer lists several areas of concern.
Parts, Tools and Supplies: Of the extrapolated contested purchase measure totaling******** is regarded by the Taxpayer as being exempt based on the manufacturing exemption. I note that this amount represents a portable hot water heater and an extension cord. These items were classified as "installation tools" used on job sites to hook up the mobile equipment. As such items were not used directly, and were not "indispensable" to the actual production or processing functions, I do not find cause to adjust the department's audit for this area
1. Fabrication of Computerized controls: The Taxpayer states that computerized controls totaling*********were fabricated for use in water processing equipment installed at various sites. The Taxpayer states that these controls were equipment used directly in the production process.
2 3 & 4 Tools. Parts & Supplies: The Taxpayer protests the inclusion of these purchases used in the fabrication of manufacturing equipment at locations in the United States and Great Britain. The Taxpayer states that the equipment is used directly in the manufacture of water purification equipment and is therefore exempt of the tax.
The department's auditors did not attempt to impose the tax on any production equipment during the audit process. I would advise that if the items listed in this category are installation tools and supplies, and are not indispensable to the actual production of the product, then the tax was properly included in the department's audit. I will allow the Taxpayer an additional 60 days to present documentation to support its contention that these items are used directly in the production process. Absent such documentation, the property will remain subject to the tax.
B. Non-Taxed Assets: The Taxpayer provides that these purchases consist of various electronic components which, while used in administrative capacities, are used in an exempt manner as quality control activities.
Computer Equipment and Electronic Controls: The electronic computer equipment and supporting controls sense changes in the water quality. This information is relayed to an in-line central processing unit, and is also displayed on a monitor which initiates audible and visual alarms. The Taxpayer's dispatch center is alerted to the variances in the specifications, and the Taxpayer's field service representative and customer's personnel are notified, who, in turn adjust the equipment to bring the customer's operations back into proper specifications. The Taxpayer states that this equipment is used in a quality control function more than 50% of the time and is accordingly exempt from the tax.
VR 630-10-63 explains that computers used to direct or control production lines and/or quality control operations "are generally considered to be exempt production equipment." Such computers, however, are distinguished from computers used merely to monitor production operations. Based on the information presented, the computers and electronic controls, while facilitative of the customer's production process, do not actually direct or control any aspect of that process.
The Taxpayer cites previous rulings, P.D.'s 88-154 (06/23/88), 93-135 (06/04/93), and 93--220 (11/16/93) to support its position. Those rulings are distinguishable in that the exempted equipment, while monitoring the production process, either relayed the corrective action required to correct the production malfunction, or were actually used in directly testing the products. In the Taxpayer's situation, the computers and electronic controls merely monitor the production of the product as was determined in the ruling of the Commissioner, P.D. 88-50 (04/04/88), copy enclosed. Accordingly, I find that the auditors were proper in their inclusion of the property in the audit computations.
Non-Taxed Sales: The Taxpayer provides that the sales at issue are sales to contractors for use in the initial filling of steam boilers used in power generators for the production and selling of electricity. The Taxpayer notes that if the sales had been made to the utility, no tax would have been due on the transaction. The Taxpayer requests that the sales in question be removed from the audit calculations
Code of Virginia § 58.1-610.E provides that "Nothing in this section shall be construed to (I) affect or limit the resale exclusion provided for in this chapter, or the industrial materials and other industrial exclusions set out in § 58.1-609.3 ...." Code of Virginia § 58.1-609.3.2.(iii) provides an exemption from the tax for "machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in processing, manufacturing ... products for sale or resale ...." (Emphasis added).
Since the power generator companies would have been eligible to purchase the water as an exempt supply to be used in the production of electricity and steam for sale to exempt public utilities, the Taxpayer, upon receipt of a properly completed certificate of exemption, could have sold the water supply to the contractor exempt of the tax. In light of the fact that the contractor did not present the Taxpayer with a Certificate of Exemption Form ST-11A, I find that the tax was properly applied in the auditor's calculations. I will, however, in this instance, allow for an adjustment of the audit by removing the sale of the water to the contractor. Please note that in the future, the taxpayer will be required to maintain certificates of exemption on file with regard to such sales.
Based on the foregoing, the department's assessment will be adjusted to remove the tax and interest totaling ****** inclusive of accrued interest, on sales to the contractor. Any additional adjustments will depend upon the provision of documentation as previously stated. Such information may be returned to the department's Office of Tax Policy, at P.O. Box 1880, Richmond, Virginia 23218-1880. If, at the end of the 60 day period, the requested information has not been returned to the department, it will be presumed that the foregoing adjustment is all that is required, and an updated assessment for the balance of penalties and interest will be issued.
If you have any questions regarding this matter, please contact ***** of the department's Office of Tax Policy at************.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/9554Q
Rulings of the Tax Commissioner