Tax Type
Retail Sales and Use Tax
Description
Penalties and Interest; Compliance ratio
Topic
Collection of Delinquent Tax
Date Issued
10-25-1996
October 25, 1996
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear*************
This is in response to your letter in which you seek correction of a sales and use tax assessment issued to***** (the Taxpayer) for the period October 1991 through September 1994. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a newspaper publisher. 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). In addition, the Taxpayer questions the assessment of (i) equipment used to treat hazardous waste, (ii) services in connection with uniform rentals, and (iii) sales of back copies of publications. The Taxpayer also protests the assessed penalty.
DETERMINATION
I will address each of the issues raised by the Taxpayer separately.
UPS Batteries
The batteries at issue are used solely to generate power to shut down production machinery and equipment in case of a power outage in order to protect the machinery from damage. The Taxpayer maintains that the batteries are used directly in manufacturing.
Fuel and energy are generally exempt in that they are a part of the operation which provides power to production equipment, a function which is specifically exempt under § 58.1-609.3(2). Items of tangible personal property which are used directly in manufacturing or processing are 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. While the batteries may be essential to the operation of the business in the case of a power outage, they are not directly used in the actual production of the tangible personal property. I find that the auditor correctly assessed the batteries in this case.
Editorial Workstations
The Taxpayer questions the application of the tax to the purchase of computers used by the editorial staff to write their stories. The computers are used to enter news and editorial data. The data is then electronically converted into another software system used by the copy desk editors for electronic pagination. The Taxpayer maintains that the contested computers are used directly in the production of the newspaper.
Code of Virginia § 58.1-609.3(2)(v) provides an exemption for equipment, printing or supplies when such items are used directly to produce publications described in Code of Virginia § 58.1-609.6(3). VR 630-10-63(B)(2) provides that "[i]tems of tangible personal property which are used directly in manufacturing... are...[those] which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Ancillary activities such as general maintenance or administration... or 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." Emphasis added.
While the computers are an essential part of the production and printing process, they are not an immediate part of the actual production of the newspaper. The computers in this case are deemed to be a part of pre-production activities, those activities which prepare materials for production. Accordingly, I find that the computers were properly held taxable in the assessment.
Packaging Materials
It is my understanding that the Taxpayer provides a delivery service for magazines, etc. In the instant case, the Taxpayer was hired to deliver class schedules.
The Taxpayer maintains that the purchase of labels and plastic bags used to deliver the schedules are exempt packaging materials under Code of Virginia § 58.1--609.3.
Based on the information provided, the packaging materials in question are used to package items for delivery in connection with the Taxpayer's delivery service. Since the Taxpayer is not the publisher of the items which it packages and delivers, the exemption under § 58.1-609.3 does not apply. Rather, VR 630-10-26 (copy enclosed) states that "persons who provide packaging services must pay the tax at the time of purchase on pallets, dunnage, etc. which are used in providing the service and are not resold to a customer." Accordingly, I find that the auditor correctly assessed the purchase of labels and plastic bags for use in connection with the Taxpayer's delivery service.
On the other hand, line item 372 is for the purchase of door hanger bags used to package and deliver a tabloid printed by the Taxpayer. The door hanger bags in this transaction qualify as exempt packaging materials under § 58.1-609.3. Accordingly, the audit will be adjusted to remove this item.
Press Cleaner
As indicated in your letter, the press cleaner is used after every press run to clean ink, grease and particles off of the press in order to improve the quality of the newspaper printed. The Taxpayer maintains that the cleaner is an essential part of the printing process based on a Ruling of the Tax Commissioner dated May 28, 1995.
VR 630-10-63(C) provides that "operating supplies which are actively and continually consumed in the operation of exempt machinery and equipment, are deemed used directly in manufacturing or processing and are not subject to the tax." The term "used directly" refers to 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....
It is my understanding the cleaner in this case is used once at the end of the production day to clean the parts that have been removed from the press. As can be seen from the above, in order for an item to enjoy the industrial manufacturing exemption, the item must be used directly in manufacturing a product for sale, or must be actively and continuously consumed in maintaining exempt production machinery.
You reference Public Document 85-107 (5/28/95), in which the department ruled that the purchase of certain cleaners used to clean printing equipment during a press run and between jobs qualified for exemption under VR 630-10-63(C) as they were actively and continually consumed in the operation of exempt machinery. While the cleaner in this case may be used to maintain the production equipment and is necessary to carry on production, it is not "actively and continuously" used in production machinery. Rather, the cleaner used to clean ink, grease, and particles off the press is used indirectly in the taxpayer's production process and subject to the tax. I have enclosed P.D. 87-176 (7/2/87) which upholds this position and which is analogous with the issue at hand.
Silver Filtration System
The filtration system at issue pumps the waste chemicals through a series of canisters that reduce the silver levels from waste photographic chemistry. You indicate that the filtration system is exempt pollution control equipment and have applied for certification from the Department of Environmental Quality (DEQ).
It is my understanding that the Taxpayer has not obtained proper certification at this time from DEQ for the filtration system. Absent documentation that will exempt such equipment, the auditor properly held these purchases taxable. If the Taxpayer obtains proper certification from DEQ for the equipment, the department will refund the tax paid (provided that the certification is within the statute of limitations).
You further indicate that the tax was accrued and remitted to the department on a particular item relating to the filtration system. You request that this item be treated as a credit towards the audit liability.
As discussed above, the Taxpayer must first obtain proper certification from DEQ for the filtration equipment. If the Taxpayer obtains such certification, the department will refund the tax paid on this equipment, provided that the certification is within the statute of limitations.
Waste Water Treatment Laundry Service
The Taxpayer entered into an agreement with a textile company for the rental of employee uniforms. In connection with the rental, the textile company also launders the uniforms in an environmentally safe manner. The Taxpayer is billed for the uniform rental and a separate charge for energy and environmental cost. The tax is charged on the rental portion of the invoice. At issue is the untaxed environmental charge separately stated on the rental invoice.
The Taxpayer maintains that the textile company is providing a service when it launders employee uniforms; therefore, the environmental charge in connection with this service is exempt under VR 630-10-54.
The Taxpayer also maintains that since the environmental charge is separate from the rental charge, it should not be included in the taxable gross rental receipts as provided under VR 630-10-58.
The "true object" test, as discussed in VR 630-10-97.1 (copy enclosed) is used to determine whether a transaction involving both the provision of a service and tangible personal property constitutes an exempt service or a taxable retail sale. This section further provides that a charge for any services included in or in connection with the sale of tangible personal property is taxable. "Gross proceeds" is defined in Code of Virginia § 58.1-602 as "the charges made or voluntary contributions received for the lease or rental of tangible personal property or for furnishing services, computed with the same deductions, where applicable, as for sales price...." VR 630-10-95 defines "sales price" as including "any services in connection with such sale."
An analogous issue was addressed in P.D. 95-270 (10/24/95) which involved both a service and the provision of tangible personal property. In that case, the department applied the "true object" test to determine whether the taxpayer was providing a laundering service or the rental of tangible personal property. The department determined that the true object of the transaction was the furnishing of linens to the taxpayer's customer, as the provision of the laundering service without the linens would serve no purpose to the customer. The entire charge for the rental of the linens was subject to the tax.
Further, in P.D. 94-241 (8/10/94) the department addressed the application of the tax to waste disposal fees in connection with the sale of tangible personal property. The department determined that the waste disposal fee was a service provided in connection with the sale of tangible personal property and was subject to the tax.
Based upon the information provided, and consistent with the department's determination in P.D. 95-270, the "true object" in the instant case is the furnishing of uniforms. The provision of the laundering service without the uniforms would serve no purpose to the Taxpayer. The entire charge, including the environmental charge which is a service provided in connection with the uniform rental, is taxable.
Counter Sales
The Taxpayer provides newsstand sales of books, promotional items, back copies of publications, etc. At issue is untaxed sales of back copies of publications by the Taxpayer. The Taxpayer is aware of the amendment to the law effective July 1, 1995 that provides an exemption for sales of back copies by publishers. The Taxpayer requests that this exemption be applied retroactively to its counter sales prior to July 1, 1995.
Code of Virginia § 58.1-609.6(3) was amended effective July 1, 1995 to provide an exemption from the sales and use tax for the sale of back copies of publications by publishers. As provided in the enclosed P.D. 94-248 (10/12/94), the sale of back copies of publications prior to July 1,1995 is taxable. Because the Taxpayer's sale of back copies of publications occurred prior to the law change, the department is unable to apply the exemption in this case. Accordingly, I find that the auditor properly held these items taxable in the audit.
Penalty
The Taxpayer was assessed the penalty based on its use tax compliance ratio of 79%. During the audit period, VR 630-10-80 was revised and the required use tax compliance ratio for third and subsequent audits was increased from 75% to 85%, effective July 1, 1993. A review of the audit indicates twenty-one months of the thirty--six month audit period were prior to the effective date and subject to the 75% ratio, which the Taxpayer met and exceeded. Under the authority granted the Tax Commissioner by Code of Virginia § 58.1-105 to accept offers in compromise, and based on the circumstances in this case, I find sufficient justification to waive the penalty assessed.
Summary
In accordance with the determination in this case, the Taxpayer will receive an updated bill with interest accrued through the date of the letter of protest. If you have questions regarding this letter, please contact **********at***********.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10743T
Rulings of the Tax Commissioner