Tax Type
Retail Sales and Use Tax
Description
Maintenance vs. manufacturing; Use tax compliance ratio
Topic
Collection of Delinquent Tax
Date Issued
10-21-1998
October 21, 1998
Re: Sec. 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This is in reply to your letter of August 7, 1998, in which you seek correction of the department's sales and use tax assessment issued to ***** (the "Taxpayer'), for the period August 1994 through December 1997. Receipt is acknowledged of your payment of the tax and interest totaling *****. A balance of ***** which represents the penalty portion of the assessment, remains outstanding.
FACTS
The Taxpayer operates a water purification processing facility for industrial users requiring pure water for manufacturing purposes. The department's audit disclosed that the Taxpayer made certain sales and purchases of tangible personal property on which the retail sales and use tax was not paid.
Miscellaneous Sales: The Taxpayer takes exception to the taxation of a transaction in which the Taxpayer contracted with its customer to chemically regenerate resin beads for its customer's use in their manufacturing processes. The Taxpayer states that the function performed on its customer's property is no different from the process used in its own facilities to generate pure water. Accordingly, the Taxpayer contends that the taxation of the sale is in error and that the regeneration is an exempt manufacturing activity.
General Expense Purchases: The Taxpayer contests the taxation of chemicals and preservatives used to insure that equipment used in production processes perform to required specifications established in contracts with its customers. The Taxpayer considers these items to be used directly in the production process and, therefore, exempt.
Penalty: The Taxpayer requests waiver of the penalty on the basis that the compliance analysis does not take into consideration all taxes paid by the Taxpayer, and therefore inaccurately portrays the Taxpayer's true compliance.
Determination
Title 23 of the Virginia Administrative Code (VAC) 10-210-560 defines fabrication as:
Code of Virginia Sec. 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 ... manufacturing ... products for sale or resale.' The term "used directly' is defined in Code of Virginia Sec. 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.' (Emphasis added).
Miscellaneous Sale: The Taxpayer contracted with its customer to regenerate resin beads. This process entails the cleaning and recharging of resin beads by way of an ionic exchange, which is the chemical treatment of the beads, for the purpose of restoring a static charge to the beads. When water flows over the statically charged beads, impurities in the water adhere to the beads, leaving ultra pure water. The cleaning and recharging of the beads are completed at the Taxpayer's plant, and once recharged, the beads are returned to the customer.
In this instance, the Taxpayer is performing an operation which restores a used or worn item of tangible personal property. The fact that the Taxpayer is also a manufacturer or processor is of no consequence, as the customer's beads are not used directly in the Taxpayer's own processing of ultra pure water. Consequently, I find that the Taxpayer is fabricating tangible personal property for sale or resale. The Taxpayer did not receive a certificate of exemption from its customer to indicate the sale could be made exempt of the tax. Therefore, the tax is applicable to the total charge to the customer.
General Expense Purchases: These cleaners and preservatives are used to clean and preserve membranes, which are essentially filters, that are used in the processing function. The membranes are removed from the Taxpayer's processing equipment for cleaning and placement in preservatives until needed again for use in the processing of the water.
The foregoing functions serve purposes related to maintenance. While I am aware of the fact that the property is used in exempt manufacturing equipment, the chemicals and preservatives are not used directly in conjunction with the manufacturing equipment as an immediate part of the production process. An item may be essential to facilitate the manufacturing or processing operation and not be an immediate part of the actual production. See Public Documents (P.D.'s) 92-34 (04/23/92), and 97-134 (03/20/97), copies enclosed, which further address the department's position respecting this issue. Accordingly, I find that the auditor was proper in including these chemicals in the audit.
Penalty: 23 VAC 10-210-2032, copy enclosed, provides for the mandatory application of penalty to a second or subsequent audit based on the level of compliance exhibited by the taxpayer. Penalty is generally applied on a third audit unless the compliance ratio meets or exceeds 85% for use tax. I note that the current audit, which is the Taxpayer's third, reflects a 51% compliance ratio.
The tax paid to vendors at the time of purchase is regarded as "sales' tax, not "use' tax. The purpose of the "use' tax compliance ratio is to determine how well the taxpayer has complied with Virginia tax laws in accruing and remitting use tax on purchases where the tax has not been paid to vendors. The inclusion of sales tax paid to vendors in computing the use tax compliance ratio would inaccurately portray the taxpayer's compliance with the Virginia use tax laws. Accordingly, I do not find sufficient cause for waiver of the assessed penalty.
Please return your payment for the balance of penalty totaling ***** to the department's Office of Tax Policy, Post Office Box 1880, Richmond, Virginia 23218-1880, within 30 days. If payment is not received within that time, interest will accrue on the balance due. If you should have any questions regarding this matter, please contact ***** of the department's Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/17084Q
Re: Sec. 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This is in reply to your letter of August 7, 1998, in which you seek correction of the department's sales and use tax assessment issued to ***** (the "Taxpayer'), for the period August 1994 through December 1997. Receipt is acknowledged of your payment of the tax and interest totaling *****. A balance of ***** which represents the penalty portion of the assessment, remains outstanding.
FACTS
The Taxpayer operates a water purification processing facility for industrial users requiring pure water for manufacturing purposes. The department's audit disclosed that the Taxpayer made certain sales and purchases of tangible personal property on which the retail sales and use tax was not paid.
Miscellaneous Sales: The Taxpayer takes exception to the taxation of a transaction in which the Taxpayer contracted with its customer to chemically regenerate resin beads for its customer's use in their manufacturing processes. The Taxpayer states that the function performed on its customer's property is no different from the process used in its own facilities to generate pure water. Accordingly, the Taxpayer contends that the taxation of the sale is in error and that the regeneration is an exempt manufacturing activity.
General Expense Purchases: The Taxpayer contests the taxation of chemicals and preservatives used to insure that equipment used in production processes perform to required specifications established in contracts with its customers. The Taxpayer considers these items to be used directly in the production process and, therefore, exempt.
Penalty: The Taxpayer requests waiver of the penalty on the basis that the compliance analysis does not take into consideration all taxes paid by the Taxpayer, and therefore inaccurately portrays the Taxpayer's true compliance.
Determination
Title 23 of the Virginia Administrative Code (VAC) 10-210-560 defines fabrication as:
-
- [a]n operation which changes the form or state of tangible personal property ... Fabrication ... is an operation that restores a used or worn piece of tangible personal property ... A person regularly engaged in the fabrication of tangible personal property for sale at retail must collect and pay the tax on the sales price of the property.
Code of Virginia Sec. 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 ... manufacturing ... products for sale or resale.' The term "used directly' is defined in Code of Virginia Sec. 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.' (Emphasis added).
-
- In interpreting the above statute, VAC 10-210-920(B)(2) provides:
-
- 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. Convenient or facilitative items ... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing .... (Emphasis added).
- 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. Convenient or facilitative items ... or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing .... (Emphasis added).
Miscellaneous Sale: The Taxpayer contracted with its customer to regenerate resin beads. This process entails the cleaning and recharging of resin beads by way of an ionic exchange, which is the chemical treatment of the beads, for the purpose of restoring a static charge to the beads. When water flows over the statically charged beads, impurities in the water adhere to the beads, leaving ultra pure water. The cleaning and recharging of the beads are completed at the Taxpayer's plant, and once recharged, the beads are returned to the customer.
In this instance, the Taxpayer is performing an operation which restores a used or worn item of tangible personal property. The fact that the Taxpayer is also a manufacturer or processor is of no consequence, as the customer's beads are not used directly in the Taxpayer's own processing of ultra pure water. Consequently, I find that the Taxpayer is fabricating tangible personal property for sale or resale. The Taxpayer did not receive a certificate of exemption from its customer to indicate the sale could be made exempt of the tax. Therefore, the tax is applicable to the total charge to the customer.
General Expense Purchases: These cleaners and preservatives are used to clean and preserve membranes, which are essentially filters, that are used in the processing function. The membranes are removed from the Taxpayer's processing equipment for cleaning and placement in preservatives until needed again for use in the processing of the water.
The foregoing functions serve purposes related to maintenance. While I am aware of the fact that the property is used in exempt manufacturing equipment, the chemicals and preservatives are not used directly in conjunction with the manufacturing equipment as an immediate part of the production process. An item may be essential to facilitate the manufacturing or processing operation and not be an immediate part of the actual production. See Public Documents (P.D.'s) 92-34 (04/23/92), and 97-134 (03/20/97), copies enclosed, which further address the department's position respecting this issue. Accordingly, I find that the auditor was proper in including these chemicals in the audit.
Penalty: 23 VAC 10-210-2032, copy enclosed, provides for the mandatory application of penalty to a second or subsequent audit based on the level of compliance exhibited by the taxpayer. Penalty is generally applied on a third audit unless the compliance ratio meets or exceeds 85% for use tax. I note that the current audit, which is the Taxpayer's third, reflects a 51% compliance ratio.
The tax paid to vendors at the time of purchase is regarded as "sales' tax, not "use' tax. The purpose of the "use' tax compliance ratio is to determine how well the taxpayer has complied with Virginia tax laws in accruing and remitting use tax on purchases where the tax has not been paid to vendors. The inclusion of sales tax paid to vendors in computing the use tax compliance ratio would inaccurately portray the taxpayer's compliance with the Virginia use tax laws. Accordingly, I do not find sufficient cause for waiver of the assessed penalty.
Please return your payment for the balance of penalty totaling ***** to the department's Office of Tax Policy, Post Office Box 1880, Richmond, Virginia 23218-1880, within 30 days. If payment is not received within that time, interest will accrue on the balance due. If you should have any questions regarding this matter, please contact ***** of the department's Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/17084Q
Rulings of the Tax Commissioner