Tax Type
Retail Sales and Use Tax
Description
Manufacturing, Processing, Assembling, or Refining; Milk processing
Topic
Taxability of Persons and Transactions
Date Issued
03-20-1997
March 20, 1997
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear*************
This will reply to your letter in which you seek correction of a sales and use tax assessment issued to ********* (the Taxpayer) for the period April 1992 through March 1995.
FACTS
The Taxpayer operates a milk processing plant. Milk is shipped by tanker trucks to the Taxpayer's plant for processing into dairy products for sale to distributors and retail stores. The Taxpayer takes exception to purchases of certain chemicals held taxable in the audit and contends that all the items are exempt under the manufacturing exemption and a previous ruling of the department on an identical issue. The Taxpayer maintains that the chemicals are regulatory and are used to prevent contamination of the milk products being processed. I will address each of the issues raised by the Taxpayer separately.
DETERMINATION
Code of Virginia § 58.1-609.3(2) provides an exemption from the sales and use tax for machinery used directly in manufacturing products for sale or resale. The term "used directly" is defined in Code of Virginia § 58.1-602 as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing...process, but not including ancillary activities such as general maintenance or administration."
Virginia Regulation (VR) 630-10-63(B)(2) further defines the term "used directly," noting that "items of tangible personal property which are used directly in manufacturing...are machinery, tools, and repair parts therefor, fuel, 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." This section continues, "integrated manufacturing includes the production line of a plant...starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished...and conveyed to a warehouse at the plant site...." Subsection C.2 of this regulation provides that equipment used for production line testing and quality control is exempt from taxation. The department has interpreted this regulation to only include that equipment which is "used directly" in the quality control function on the production line of the plant site during the manufacturing process.
Kee-Phos and AC-30: The Kee-Phos and AC-30 are alkaline and acid base cleaners that are used to remove or loosen milkstone buildup in the processing equipment. Milkstone is a calcium buildup that over a period of time becomes hard in texture and must be removed to facilitate the free flow of milk to the holding tanks and packaging machines. The cleaning process is performed after each production run.
The chemicals in this case compare to those discussed in Public Document P.D. 85-208 (10/31/85), wherein a distinction is made between water treatment chemicals used in general maintenance and those that relate directly to protecting the integrity of the product. It was concluded in that ruling that anti-corrosive chemicals mixed with the water used in the product itself were deemed to be an integral part of the manufacturing process; however, water treatment chemicals used to maintain machinery were not. The department has previously determined that such chemicals are not an immediate part of the production process and are therefore not used directly in manufacturing. See the attached P.D.'s 88-129 (6/13/88) and 92-34 (4/23/92) which further address the department's policy regarding this issue.
Based on the facts presented, it is my conclusion that the Kee-Phos and the AC-30 serve to maintain the normal operation of the production equipment. The chemicals do not mix with, become a part of or even touch upon any component of the manufactured product. They are essential to the production only in a maintenance capacity and are only used to remove calcium buildup to ensure the free flow of product through the holding tanks and packaging machinery. These chemicals are thus subject to the tax.
XY-12. Mikroklene DF. and Enforce: The XY-12 chemical is used in the sanitation process after the equipment has been cleaned. In the final cleaning process, XY-12 is added to cold water and run through all the piping, tanks, silos and packaging machines. The sanitation process is to prevent the contamination of the product. The frequency of the sanitation is dependent upon the completion of each batch in production.
The chemical Mikroklene DF is a sanitizing chemical sprayed on the outside product package that comes in contact with the finished product. The chemical is applied on an hourly basis to prevent bacterial contamination of the product during the packaging process.
Enforce is a chemical used daily to sanitize the packaging machinery after the cleaning process. The sanitizing process is to prevent bacterial contamination of the product during the packaging process in the same manner as the XY-12 is used to sanitize production machinery.
The chemicals used to sanitize the production equipment in this case are analogous to the sanitization chemicals addressed in P.D. 92-65 (5/11/92). In that case, sanitizing chemicals used in a food facility were an indispensable part of the quality control of the manufacturing process and not subject to sales tax. In this case, the chemicals are used to prevent the formation of bacteria on the production machinery.
In this case, because inadequate sanitary conditions would result in the contamination of the product, the chemicals are an indispensable part of the quality control process. Accordingly, the assessment will be revised to remove these chemicals used in the sanitization of production machinery. I note that any chemicals used to sanitize tanker trucks being used to transport raw materials to the plant site are taxable.
Pensan NR: This chemical is an acid sanitizer used as a soaking agent in the milk filler bowls. The sanitizer is not used on a daily basis but only on the weekend when the production line is not operating. The Taxpayer indicates that 50% of the chemical is resold to customers for use on their equipment.
The department views the use of such chemical agents to be one-step removed from the actual production process. The department's position in this area is set forth in P.D. 96-337 (11/19/96), copy enclosed. In that document, the department determined that the chemicals used to clean Teflon roll covers following several days of production did not qualify as being used directly in manufacturing. Further, the cleaning process of the roll covers was not so specialized and closely related to the processing function that production must be interrupted throughout the day to clean the production equipment.
Based on the fact that this chemical is clearly not in active use on the production line, and only used on weekends when the production line is not in operation, it is not being used directly in the actual manufacturing process within the limitations set forth in the above statutes and regulation. The industrial exemption applies only to materials used directly in the production process and does not extend to ancillary activities such as general maintenance. Because the chemical is essential to production only in a maintenance capacity, it is subject to the tax.
The Taxpayer maintains that 50% of this chemical is resold to customers for their own use. It is my understanding that the a majority of the chemicals are sold to restaurants for use in cleaning ice cream equipment. The sale of chemicals to restaurants for their own use is taxable to the purchaser. The department will remove any purchases from the audit if the Taxpayer provides evidence that the chemicals were, in fact, sold to customers for resale.
Penalty: In order for penalty to be waived on third and subsequent audits, sales and use tax compliance ratios must be a minimum of 85%. Based on the above, and the fact that the Taxpayer's sales tax compliance is 74% and its use tax compliance is 0% on this third generation audit, the department is unable to waive the penalty. Subsequent to any audit revisions necessary, the use tax compliance ratio will be recomputed. Once a new compliance ratio has been established, the penalty will apply in accordance with the above tolerances.
Summary: The audit will be returned to the******District Office for revisions in accordance with this determination. The auditor will contact the Taxpayer to resolve the issue of chemical sales. The Taxpayer will receive a revised bill, with updated interest. This bill should be paid within 30 days to avoid the accrual of additional interest.
If you have any questions, please contact ********in the Office of Tax Policy at ********.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/11591T
Rulings of the Tax Commissioner