Tax Type
Retail Sales and Use Tax
Description
Deficiency assessments, industrial manufacturing exemption
Topic
Collection of Delinquent Tax
Date Issued
05-28-1999
May 28, 1999
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear****************
This is in response to your letter requesting correction of the sales and use tax audit assessment issued to ************** (the Taxpayer).
FACTS
The Taxpayer is a manufacturer. An audit for the period July 1994 through June 1997 resulted in an assessment of use tax on various untaxed purchases of equipment, supplies and other tangible personal property which were determined to be used for non-exempt purposes in its business.
The Taxpayer takes exception to the use tax assessed on mezzanines, safety rails, hand rails, platforms, steps, splash shields, splash guards, grating, cat walks, walkways, drip pans, covers, trays, troughs, and a lab crane. The Taxpayer maintains that these items qualify for the industrial manufacturing exemption. The Taxpayer also takes exception to the use tax assessed on certain metering equipment, claiming that such items qualify for the certified pollution control equipment exemption. The Taxpayer takes exception to the use tax assessed on purchases of competitors' products and maintains that these items qualify for the research and development exemption. The Taxpayer also requests waiver of the penalty assessed in this case.
DETERMINATION
Mezzanines, platforms, guards, rails, etc.
Code of Virginia § 58.1-609.3 provides an exemption from the retail sales and use tax for "machinery or tools ... used directly in ... manufacturing or processing products for sale or resale.' (Emphasis added.) Title 23 of the Virginia Administrative Code (VAC) 10-210-920(B)(2) indicates that in order for property to be used directly, it must be indispensable to the actual production of products for sale and it must be an immediate part of the production process. Convenient or facilitative items such as equipment supports are not used directly even though they may be attached to exempt production machinery.
It is the longstanding policy of the department that structural steel, special flooring, catwalks, walkways, metal platforms, and similar structural materials do not meet the direct usage test. This issue was addressed by the Virginia Supreme Court in Webster Brick v. Commonwealth, 219 Va. 81, 145 S.E.2d 252 (1978); copy enclosed. In Webster Brick, the manufacturing exemption was denied for structural materials placed in the floor of a manufacturing plant for use as a trackage system. The court found the trackage system to be indispensable to the production of brick, but used only indirectly in production.
In the present case, the mezzanines, safety rails, hand rails, platforms, steps, splash shields, splash guards, grating, cat walks, walkways, drip pans, covers, trays, and troughs help expedite production but do not play an immediate role in the production processes. Rails, shields and guards appear to serve a safety function. Mezzanines, platforms, steps, grating, cat walks, walkways appear to provide access to machinery. Drip pans, trays and troughs appear to be used as receptacles. Although these items may support exempt production machinery or facilitate its support, they clearly serve an indirect role in the production of the product.
As you point out, 23 VAC 10-210-920(C)(2) provides that "[s]teel or similar supports which are a component part of exempt production machinery and which do not become permanently affixed to realty are not subject to the tax.' (Emphasis added.) You also cite Public Document (P.D.) 91-183 (8/26/91) which determined that supporting structures must be used solely to support exempt machinery to be considered a "component part' of such machinery. Because these items serve other functions in addition to their use as supports, they are not considered a component part of the machinery and are therefore taxable. A similar result is found P.D. 95-43 (3/17/95); copy enclosed.
Engineering lab crane
The Taxpayer indicates that this crane is used in the packaging of advance production or prototype models produced by the Taxpayer for shipment and sale to customers, generally other manufacturers who decide whether to make a bulk purchase of the Taxpayer's product by evaluating the model. Based on the exempt listing shown in 23 VAC 10-210-920(C)(2), the Taxpayer claims that the exemption for "packaging equipment ... used at the plant site in packaging products for sale' applies to this crane.
Whether the crane is primarily used in packaging these models has not been established by the facts presented. Due to the location of the crane, it is possible that it is subject to other uses, e.g., lifting, unloading, and examining competitors' products; lifting or holding Taxpayer's product to perform maintenance or repairs and make improvements; etc. However, if the Taxpayer can show that this crane is primarily used in packaging prototype models for sale, the crane may be removed from the audit.
Metering devices and flow monitoring equipment
The Taxpayer maintains that the metering devices and flow monitoring equipment purchased in 1996 are covered under the pollution control equipment certification issued by the Department of Environmental Quality (DEQ) in 1994. Based on documentation furnished the department by DEQ, this certification was for a pretreatment wastewater system which included two flow meters purchased by the Taxpayer in 1993 or 1994 for the system's expansion and four flow meters purchased in 1988 for the original system. These six flow meters are an integral part of the pretreatment system as they are used to accurately measure flows to determine chemical feed rates and maintain adequate records of effluent discharge.
It is my understanding, however, that the metering devices and flow monitoring equipment at issue in this audit were not replacements for any of the items certified by DEQ in 1994. It is also my understanding that they are not used as part of the certified pretreatment system nor have they been certified by DEQ as pollution control equipment. In addition, it is my understanding that the Taxpayer's decision to install these new flow meters and devices was to ensure that it was not overcharged by the municipality on treated wastewater discharged into the municipality's system. As such, this equipment appears to be installed only for administrative purposes rather than to serve the purpose of pollution abatement or prevention. Based on all of the foregoing, I find no basis to remove this equipment from the audit.
Competitors' products
Competitors' products are purchased by the Taxpayer's engineering lab. The Taxpayer maintains that these items are used directly and exclusively in research and development activities and therefore qualify for the research and development exemption granted by Code of Virginia § 58.1-609.3(5). These products are run through a series of tests under various conditions in the lab. The Taxpayer indicates that the purposes of the tests are to: (1) evaluate the operating performance of competitors' products under a variety of controlled conditions in the lab, and (2) develop enhancements or product improvements for the Taxpayer's product based on features observed in the competitor's models.
In 23 VAC 10-210-3070, "basic research' is defined as "a systematic study or search in a scientific or technical field of endeavor with the ultimate goal of advancing knowledge or technology in that field.' (Emphasis added.) This regulation also defines "research and development' as "a systematic study or search directed toward new knowledge or new understanding of a particular scientific or technical subject and the gradual transformation of this new knowledge or new understanding into a usable product or process.' (Emphasis added.)
It is the department's longstanding policy that the research and development exemption generally is unavailable for activities that merely entail the testing or analysis of existing products as these activities do not actually seek to advance scientific knowledge or technology. The same is true in this case as the nature of the Taxpayer's testing focused on the analysis of existing products and not on advancing scientific knowledge or technology. Accordingly, the exemption is unavailable for purchases of competitors' products used in the Taxpayer's testing operation.
Penalty
In reference to its request for waiver of penalty charges, the Taxpayer points out that it paid the tax directly to its vendors on many of its purchases of tangible personal property.
The purpose of the use tax compliance ratio is to determine how well the Taxpayer has complied with Virginia laws in accruing and remitting the use tax on untaxed purchases. To include the sales tax paid to vendors in computing the use tax compliance ratio would not accurately show compliance with the Virginia use tax laws. This issue was previously addressed by the department. See P.D. 92-100 (6/15/92); copy enclosed.
On second audits, penalty will generally apply to use tax deficiencies unless a taxpayer's compliance ratio meets or exceeds 60% for use tax. The use tax compliance ratio in this case was 45%.
When a satisfactory level of compliance is not achieved, the penalty may be waived only when there is evidence of exceptional mitigating circumstances. In this audit, the Taxpayer has not demonstrated any exceptional mitigating circumstances to justify waiver of the assessed penalty. Accordingly, penalty has been properly applied in this case.
Conclusion
If the Taxpayer can establish that the engineering lab crane is primarily used in packaging prototype models manufactured by the Taxpayer for sale, such information should be furnished to ***** Audit Supervisor of the department's************** District Office, within 60 days of the date of this letter. ***** will determine whether such evidence is satisfactory to justify removal of the crane from the audit.
If the evidence is satisfactory, the audit will be revised accordingly and the Taxpayer will receive a revised bill for the outstanding liabilities. However, if the requested information is not received by the department within the time allotted, we will assume that it is not forthcoming, and no adjustment will be made to the audit. In such an event, the Taxpayer will receive an updated bill for the outstanding liabilities.
In its letter, the Taxpayer requested a conference in the event the determination was adverse to the Taxpayer. As the issues raised in this case involve established policies, I do not find it necessary to hold a conference on these issues.
If you have any questions about this response, please contact ***** of my tax policy staff at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/18280R
Rulings of the Tax Commissioner