Tax Type
Retail Sales and Use Tax
Description
Deficiency assessments, manufacturer of semiconductor wafers
Topic
Collection of Delinquent Tax
Date Issued
05-18-1999
May 18, 1999
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear***
This will reply to your letter in which you seek correction of a retail sales and use tax assessment on behalf of ***** (the "Taxpayer') for the period February 1996 through December 1997. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a manufacturer of semiconductor wafers. An audit by the department resulted in the assessment of tax on various untaxed purchases. You contest the tax assessed on: (1) the *****, an integrated manufacturing system (hereinafter, the "Integrated System'); (2) partially processed wafers used in calibrating production tools; and (3) steel cylinders used to store specialty gases used in the production of wafers.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the sales and use tax for machinery, tools, fuel, power, energy or supplies "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.'
Title 23 of the Virginia Administrative Code (VAC) 10-210-920 states that the exemption applies to "machinery, tools, and repair parts therefor, 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.' Items which are essential to the operation of a business but not an immediate part of actual production are not used directly in manufacturing.
In addition, Code of Virginia § 58.1-602 includes equipment and supplies used directly in production line quality control within the scope of the manufacturing exemption.
In view of this background, I will address each of the contested issues noted above.
Integrated System
The Integrated System, consisting of both hardware and software, directs and controls the semiconductor production line (an exempt function). It also has the capability to perform non-manufacturing (taxable) functions, such as inventory tracking, prioritization of work, and operator authorization.
I understand that, following the audit, members of the department's Tax Policy and audit staffs toured the Taxpayer's facility and reviewed the functions of the Integrated System. Based on information provided during that meeting, it has been determined that the preponderance of the Integrated System's use is in exempt manufacturing activities. Accordingly, the portion of the assessment related to the Integrated System will be abated.
Partially Process Wafers
Partially processed wafers are used by the Taxpayer to calibrate production line tools used in the manufacturing of semiconductor wafers. Prior to the production of wafers for sale or resale, the partially processed wafers were introduced to the tools where they underwent production processing. Upon completion of the process by a tool, the partially processed wafers were tested to determine the extent to which they conformed to predetermined production standards. If they did not meet the standards, the tools were adjusted to correct any deficiencies. The partially processed wafers were not sold by the Taxpayer.
The auditor determined that the partially processed wafers were used in pre-production activities (performing acceptance tests and configuring the tools). The wafers were not used directly in the manufacturing process; therefore, the manufacturing exemption did not apply to the purchase of partially processed wafers. The Taxpayer believes that the wafers perform a quality control function within the scope of the manufacturing exemption. Specifically, the Taxpayer maintains that the partially processed wafers were used in ensuring the proper calibration of the Taxpayer's production tools, which in turn ensured the high quality and salability of the finished product.
The terms "manufacturing' and "processing' as defined by Code of Virginia § 58.1-602 include "equipment and supplies used for production line testing and quality control.' (Emphasis added). As the exemption is limited to production line testing, it has been the department's consistent treatment that the manufacturing exemption does not extend to equipment used in pre-production or post-production quality control activities. See, for example, Public Document (P.D.) 95-218 (8/22/98), copy enclosed, which specifies that the quality control exemption only applies to testing or monitoring activities that occur during the production process. Testing which occurs prior to the production process does not qualify for the exemption.
In the instant case, the partially processed wafers are used to calibrate tools prior to actual production. While the proper calibration of manufacturing machinery and tools may be necessary for efficient production to occur, the partially processed wafers do not serve a quality control function during the actual production process. Instead, the facts presented indicate that the wafers are used in a pre-production activity, specifically, testing the machinery for operational efficiency prior to their use in actual production of wafers for sale or resale.
Under 23 VAC 10-210-920(C)(2), testing for the purpose of improving administrative efficiency or any other testing not relating to quality control is taxable. The testing in which the wafers are used is not considered quality control for purposes of the manufacturing exemption, as the equipment is not yet part of the production process. Accordingly, the auditor was correct in holding the partially processed wafers taxable.
The Taxpayer cites two public documents to support its position that the partially processed wafers are used in an exempt quality control function. However, in the public documents cited, the supplies at issue interacted with machinery which had been used directly in the production process. The supplies were applied to the production machinery to prevent contamination of the final product. The department determined that the supplies served a production line quality control function. By contrast, the partially processed wafers do not prevent contamination of the final product (semiconductor wafers). The wafers are used to test and calibrate production tools to ensure they are operating efficiently. Furthermore, the partially processed wafers test the tools prior to their being placed in actual production. For these reasons, I find that the public documents cited are not directly applicable to the Taxpayer's situation.
Steel Cylinders Used to Store Specialty Gases
The Taxpayer purchased several steel cylinders during the audit period. The cylinders are custom made and store specialty gases used in the actual production of semiconductor wafers. The auditor assessed tax on the purchase price of the gas cylinders on the basis that they were not used directly in manufacturing. The Taxpayer disagrees and contends that the gas cylinders are used to convey raw materials from storage to the production line, which falls within the scope of the manufacturing exemption.
Specialty gases which are used directly in the production process but which do not become a component part of the final product are not considered raw materials. While the gas contained in the cylinders may qualify for the manufacturing exemption, the department's longstanding policy is that the cylinder is merely used to store or contain the gas and is not used directly in manufacturing. Consequently, the gas cylinder is taxable. This policy applies to cylinders which are leased or purchased.
On the other hand, if specialty gases become a component part of the semiconductor wafer (and do not merely treat the semiconductor by removing some of the etching chemicals added to the wafer), then the specialty gases qualify as raw materials. Cylinders used to store the gases at the plant site and to convey the gases from one area of production to another at the same plant site would qualify as exempt raw materials storage tanks.
The Taxpayer has not provided enough information to determine exactly how the gases are used in the production process. Therefore, I cannot determine at this time if the steel cylinders qualify for the manufacturing exemption as raw material storage tanks. I will refer this matter to the auditor, who will meet with the Taxpayer at a mutually convenient time.
Summary
The audit assessment will be adjusted to remove the tax and interest associated with the Integrated System. The portion of the assessment relating to the partially processed wafers is correct as issued. The auditor will contact the Taxpayer within the next few weeks and arrange a meeting to gather additional information regarding the use of the specialty gases to determine if the steel cylinders qualify as raw material storage tanks exempt from the sales tax under the manufacturing exemption. Furthermore, due to the length of time it has taken to resolve this appeal, I will agree to limit the accrual of interest on the outstanding assessment to July 7, 1998, the date the department received the Taxpayer's final letter explaining its position.
If you have any questions regarding the audit revisions, please contact ***** at *****. Questions regarding this letter should be directed to ***** in the department's Office of Tax Policy at *****
Sincerely,
Danny M. Payne
Tax Commissioner
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear***
This will reply to your letter in which you seek correction of a retail sales and use tax assessment on behalf of ***** (the "Taxpayer') for the period February 1996 through December 1997. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a manufacturer of semiconductor wafers. An audit by the department resulted in the assessment of tax on various untaxed purchases. You contest the tax assessed on: (1) the *****, an integrated manufacturing system (hereinafter, the "Integrated System'); (2) partially processed wafers used in calibrating production tools; and (3) steel cylinders used to store specialty gases used in the production of wafers.
DETERMINATION
Generally
Code of Virginia § 58.1-609.3(2) provides an exemption from the sales and use tax for machinery, tools, fuel, power, energy or supplies "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.'
Title 23 of the Virginia Administrative Code (VAC) 10-210-920 states that the exemption applies to "machinery, tools, and repair parts therefor, 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.' Items which are essential to the operation of a business but not an immediate part of actual production are not used directly in manufacturing.
In addition, Code of Virginia § 58.1-602 includes equipment and supplies used directly in production line quality control within the scope of the manufacturing exemption.
In view of this background, I will address each of the contested issues noted above.
Integrated System
The Integrated System, consisting of both hardware and software, directs and controls the semiconductor production line (an exempt function). It also has the capability to perform non-manufacturing (taxable) functions, such as inventory tracking, prioritization of work, and operator authorization.
-
Title 23 VAC 10-210-920(D) provides that:
[w]hen a single item of tangible personal property is put to use in two different activities, one of which is an immediate part of the industrial production process (exempt) and the other of which is not (taxable), the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in non-exempt activities. Likewise, the item will be totally exempt from tax if the preponderance of its use is in exempt production activities.
I understand that, following the audit, members of the department's Tax Policy and audit staffs toured the Taxpayer's facility and reviewed the functions of the Integrated System. Based on information provided during that meeting, it has been determined that the preponderance of the Integrated System's use is in exempt manufacturing activities. Accordingly, the portion of the assessment related to the Integrated System will be abated.
Partially Process Wafers
Partially processed wafers are used by the Taxpayer to calibrate production line tools used in the manufacturing of semiconductor wafers. Prior to the production of wafers for sale or resale, the partially processed wafers were introduced to the tools where they underwent production processing. Upon completion of the process by a tool, the partially processed wafers were tested to determine the extent to which they conformed to predetermined production standards. If they did not meet the standards, the tools were adjusted to correct any deficiencies. The partially processed wafers were not sold by the Taxpayer.
The auditor determined that the partially processed wafers were used in pre-production activities (performing acceptance tests and configuring the tools). The wafers were not used directly in the manufacturing process; therefore, the manufacturing exemption did not apply to the purchase of partially processed wafers. The Taxpayer believes that the wafers perform a quality control function within the scope of the manufacturing exemption. Specifically, the Taxpayer maintains that the partially processed wafers were used in ensuring the proper calibration of the Taxpayer's production tools, which in turn ensured the high quality and salability of the finished product.
The terms "manufacturing' and "processing' as defined by Code of Virginia § 58.1-602 include "equipment and supplies used for production line testing and quality control.' (Emphasis added). As the exemption is limited to production line testing, it has been the department's consistent treatment that the manufacturing exemption does not extend to equipment used in pre-production or post-production quality control activities. See, for example, Public Document (P.D.) 95-218 (8/22/98), copy enclosed, which specifies that the quality control exemption only applies to testing or monitoring activities that occur during the production process. Testing which occurs prior to the production process does not qualify for the exemption.
In the instant case, the partially processed wafers are used to calibrate tools prior to actual production. While the proper calibration of manufacturing machinery and tools may be necessary for efficient production to occur, the partially processed wafers do not serve a quality control function during the actual production process. Instead, the facts presented indicate that the wafers are used in a pre-production activity, specifically, testing the machinery for operational efficiency prior to their use in actual production of wafers for sale or resale.
Under 23 VAC 10-210-920(C)(2), testing for the purpose of improving administrative efficiency or any other testing not relating to quality control is taxable. The testing in which the wafers are used is not considered quality control for purposes of the manufacturing exemption, as the equipment is not yet part of the production process. Accordingly, the auditor was correct in holding the partially processed wafers taxable.
The Taxpayer cites two public documents to support its position that the partially processed wafers are used in an exempt quality control function. However, in the public documents cited, the supplies at issue interacted with machinery which had been used directly in the production process. The supplies were applied to the production machinery to prevent contamination of the final product. The department determined that the supplies served a production line quality control function. By contrast, the partially processed wafers do not prevent contamination of the final product (semiconductor wafers). The wafers are used to test and calibrate production tools to ensure they are operating efficiently. Furthermore, the partially processed wafers test the tools prior to their being placed in actual production. For these reasons, I find that the public documents cited are not directly applicable to the Taxpayer's situation.
Steel Cylinders Used to Store Specialty Gases
The Taxpayer purchased several steel cylinders during the audit period. The cylinders are custom made and store specialty gases used in the actual production of semiconductor wafers. The auditor assessed tax on the purchase price of the gas cylinders on the basis that they were not used directly in manufacturing. The Taxpayer disagrees and contends that the gas cylinders are used to convey raw materials from storage to the production line, which falls within the scope of the manufacturing exemption.
Specialty gases which are used directly in the production process but which do not become a component part of the final product are not considered raw materials. While the gas contained in the cylinders may qualify for the manufacturing exemption, the department's longstanding policy is that the cylinder is merely used to store or contain the gas and is not used directly in manufacturing. Consequently, the gas cylinder is taxable. This policy applies to cylinders which are leased or purchased.
On the other hand, if specialty gases become a component part of the semiconductor wafer (and do not merely treat the semiconductor by removing some of the etching chemicals added to the wafer), then the specialty gases qualify as raw materials. Cylinders used to store the gases at the plant site and to convey the gases from one area of production to another at the same plant site would qualify as exempt raw materials storage tanks.
The Taxpayer has not provided enough information to determine exactly how the gases are used in the production process. Therefore, I cannot determine at this time if the steel cylinders qualify for the manufacturing exemption as raw material storage tanks. I will refer this matter to the auditor, who will meet with the Taxpayer at a mutually convenient time.
Summary
The audit assessment will be adjusted to remove the tax and interest associated with the Integrated System. The portion of the assessment relating to the partially processed wafers is correct as issued. The auditor will contact the Taxpayer within the next few weeks and arrange a meeting to gather additional information regarding the use of the specialty gases to determine if the steel cylinders qualify as raw material storage tanks exempt from the sales tax under the manufacturing exemption. Furthermore, due to the length of time it has taken to resolve this appeal, I will agree to limit the accrual of interest on the outstanding assessment to July 7, 1998, the date the department received the Taxpayer's final letter explaining its position.
If you have any questions regarding the audit revisions, please contact ***** at *****. Questions regarding this letter should be directed to ***** in the department's Office of Tax Policy at *****
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner