Tax Type
Retail Sales and Use Tax
Description
Deficiency assessments, manufacturer of outdoor power equipment
Topic
Collection of Delinquent Tax
Date Issued
11-12-1999
November 12, 1999
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear***
This is in reply to your letter in which you request correction of the retail sales and use tax assessment issued to your client, ***** (the "Taxpayer'), for the period December 1994 through November 1997. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a Virginia manufacturer of outdoor power equipment. The Taxpayer's dealers and distributors are all located outside Virginia, and all of the Taxpayer's products are shipped outside Virginia for distribution. The Taxpayer was audited and assessed tax on (i) equipment used to test product emissions, (ii) equipment used to test component product parts from third parties, and (iii) warranty cards included in product packaging. The Taxpayer is taking exception to each of the above items, and also requests waiver of the assessed penalty.
DETERMINATION
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel power, energy, or supplies, used directly in processing, manufacturing,... products for sale or resale.' The term "used directly' is defined in § 58.1-602 as "those activities which are an integral part of the production of a product ... but not including ancillary activities such as general maintenance or administration.'
Further, in the case of Commonwealth of Virginia v. Community Motor Bus Co. 214 Va. 155, 198 S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly' in a statute was intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products.
Keeping the above in mind, I will address each contented issue in the order presented in the Facts section above.
Equipment Used to Test Products in Emissions Lab
The lab area for testing emissions is comprised of several separate rooms located at the factory site, but away from the production line. As understood by this office, this area is used to test the emissions of products which have completed the production process, or products shipped in from the Taxpayer's manufacturing facilities in other countries which do not have the facilities for testing emissions. It is unclear from the facts presented if the emissions tests are performed to meet a federal Environmental Protection Agency mandate, or to satisfy a quality standard set by the Taxpayer.
If the sample finished product does not meet mandated emissions levels, the entire lot included in the product batch is returned to the manufacturing process for reworking. If the sample product does meet the emissions test standards, the lot from which the sample product was withdrawn is finished and ready for sale. It should be noted that all products have been boxed in ready-for-sale condition prior to the emission testing step.
The Taxpayer believes the testing done in the emissions lab serves a quality control function, and the equipment used in the testing is exempt from the sales tax in accordance with VAC 10-210-920(C)(2).
The terms "manufacturing' and "processing' are defined in Code of Virginia ***** § 58.1-602 to 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 policy that the manufacturing exemption does not extend to equipment used in pre-production or post production quality control activities.
Based on the reading of the statute and regulations cited above, and the strict construction of the retail sales and use tax exemption as mandated by Virginia Supreme Court in Commonwealth of Virginia v. Community Motor Bus Co., I cannot agree that the equipment used to test product emissions is exempt from the tax. This position is supported by Public Document 98-125 (8/5/98) enclosed. Based on the information, while the product may not have been placed in final inventory prior to emissions testing, the product is completed for sale at this point, as the products have been packed in shipping boxes. Based on the above, I find no basis for removing the emissions testing equipment from the audit.
Equipment Used to Test Components Purchased from Third Parties
The Taxpayer purchases component parts which are incorporated into their final products. In order to ensure product quality, the Taxpayer will test the component parts prior to such parts entering into the manufacturing process. The Taxpayer believes the equipment used in this testing is quality control equipment and should be exempt from the tax.
VAC 10-210-920(C)(2) addresses which activities qualify as manufacturing and processing and provides that "production includes the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site.' Based on the information you have provided, the component parts purchased by the Taxpayer for incorporation into their final product qualify as raw materials. Due to the fact that the regulation defines production activities to include the handling and storage of raw materials at the plant site, I find that equipment used to test raw materials, i.e., component parts, qualify as the handling of raw materials and are exempt. The audit will be adjusted accordingly.
Warranty Cards Shipped with the Product
The Taxpayer purchases warranty/registration cards which are packaged with each product. The customer will send the warranty/registration card to a third-party service company which will compile product and marketing data for the Taxpayer and register the product for warranty purposes. The Taxpayer believes the warranty/registration cards are part of the product being sold and are exempt.
VAC 10-210-920(C) provides that manufacturing and processing is divided into three separate activities, those activities being "administration,' "production,' and "distribution.' Subsection 1 of this regulation section addresses administration and provides for the following:
The information provided indicates that the warranty/registration cards included with the product being sold provide consumer information to the Taxpayer and facilitate product registration. The cards themselves are not a component part of the product being sold and ultimately do not become the property of the customer. The cards serve an administrative purpose similar to product invoices shipped with the product, which the department has traditionally deemed to be a taxable administrative item. For this reason, I find that the warranty/registration cards were properly held taxable in the audit
Audit Penalty
The audit sample period included a charge for a one-time inter-company transfer of computer software from the parent corporation to the Taxpayer. The value of the computer software comprised 21.4% of the total tax measure. The removal of this from the compliance calculations would put the compliance ratio well above the required 85%. Due to the unique nature of this transaction, the Taxpayer is requesting waiver of audit penalty.
Based on the information you have provided, the transaction is a new issue for the Taxpayer, and has not been addressed in prior audits. Based on this fact, and in view of the audit adjustments noted above, I will agree to waive the audit penalty.
The audit will be returned to the ***** District Office for the appropriate adjustments. Once the adjustments have been made, a revised audit assessment will be issued. If you should have any questions, please contact ******************* Office of Tax Policy, at *************
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/16829K
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear***
This is in reply to your letter in which you request correction of the retail sales and use tax assessment issued to your client, ***** (the "Taxpayer'), for the period December 1994 through November 1997. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is a Virginia manufacturer of outdoor power equipment. The Taxpayer's dealers and distributors are all located outside Virginia, and all of the Taxpayer's products are shipped outside Virginia for distribution. The Taxpayer was audited and assessed tax on (i) equipment used to test product emissions, (ii) equipment used to test component product parts from third parties, and (iii) warranty cards included in product packaging. The Taxpayer is taking exception to each of the above items, and also requests waiver of the assessed penalty.
DETERMINATION
Code of Virginia § 58.1-609.3(2) provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel power, energy, or supplies, used directly in processing, manufacturing,... products for sale or resale.' The term "used directly' is defined in § 58.1-602 as "those activities which are an integral part of the production of a product ... but not including ancillary activities such as general maintenance or administration.'
Further, in the case of Commonwealth of Virginia v. Community Motor Bus Co. 214 Va. 155, 198 S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly' in a statute was intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products.
Keeping the above in mind, I will address each contented issue in the order presented in the Facts section above.
Equipment Used to Test Products in Emissions Lab
The lab area for testing emissions is comprised of several separate rooms located at the factory site, but away from the production line. As understood by this office, this area is used to test the emissions of products which have completed the production process, or products shipped in from the Taxpayer's manufacturing facilities in other countries which do not have the facilities for testing emissions. It is unclear from the facts presented if the emissions tests are performed to meet a federal Environmental Protection Agency mandate, or to satisfy a quality standard set by the Taxpayer.
If the sample finished product does not meet mandated emissions levels, the entire lot included in the product batch is returned to the manufacturing process for reworking. If the sample product does meet the emissions test standards, the lot from which the sample product was withdrawn is finished and ready for sale. It should be noted that all products have been boxed in ready-for-sale condition prior to the emission testing step.
The Taxpayer believes the testing done in the emissions lab serves a quality control function, and the equipment used in the testing is exempt from the sales tax in accordance with VAC 10-210-920(C)(2).
The terms "manufacturing' and "processing' are defined in Code of Virginia ***** § 58.1-602 to 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 policy that the manufacturing exemption does not extend to equipment used in pre-production or post production quality control activities.
Based on the reading of the statute and regulations cited above, and the strict construction of the retail sales and use tax exemption as mandated by Virginia Supreme Court in Commonwealth of Virginia v. Community Motor Bus Co., I cannot agree that the equipment used to test product emissions is exempt from the tax. This position is supported by Public Document 98-125 (8/5/98) enclosed. Based on the information, while the product may not have been placed in final inventory prior to emissions testing, the product is completed for sale at this point, as the products have been packed in shipping boxes. Based on the above, I find no basis for removing the emissions testing equipment from the audit.
Equipment Used to Test Components Purchased from Third Parties
The Taxpayer purchases component parts which are incorporated into their final products. In order to ensure product quality, the Taxpayer will test the component parts prior to such parts entering into the manufacturing process. The Taxpayer believes the equipment used in this testing is quality control equipment and should be exempt from the tax.
VAC 10-210-920(C)(2) addresses which activities qualify as manufacturing and processing and provides that "production includes the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site.' Based on the information you have provided, the component parts purchased by the Taxpayer for incorporation into their final product qualify as raw materials. Due to the fact that the regulation defines production activities to include the handling and storage of raw materials at the plant site, I find that equipment used to test raw materials, i.e., component parts, qualify as the handling of raw materials and are exempt. The audit will be adjusted accordingly.
Warranty Cards Shipped with the Product
The Taxpayer purchases warranty/registration cards which are packaged with each product. The customer will send the warranty/registration card to a third-party service company which will compile product and marketing data for the Taxpayer and register the product for warranty purposes. The Taxpayer believes the warranty/registration cards are part of the product being sold and are exempt.
VAC 10-210-920(C) provides that manufacturing and processing is divided into three separate activities, those activities being "administration,' "production,' and "distribution.' Subsection 1 of this regulation section addresses administration and provides for the following:
-
- "Administration' is the managerial, sales, and nonoperation aspects of manufacturing and processing operations and includes management, selling and marketing, employee comfort and convenience, and record keeping. Tangible personal property used in administration is subject to the tax.
The information provided indicates that the warranty/registration cards included with the product being sold provide consumer information to the Taxpayer and facilitate product registration. The cards themselves are not a component part of the product being sold and ultimately do not become the property of the customer. The cards serve an administrative purpose similar to product invoices shipped with the product, which the department has traditionally deemed to be a taxable administrative item. For this reason, I find that the warranty/registration cards were properly held taxable in the audit
Audit Penalty
The audit sample period included a charge for a one-time inter-company transfer of computer software from the parent corporation to the Taxpayer. The value of the computer software comprised 21.4% of the total tax measure. The removal of this from the compliance calculations would put the compliance ratio well above the required 85%. Due to the unique nature of this transaction, the Taxpayer is requesting waiver of audit penalty.
Based on the information you have provided, the transaction is a new issue for the Taxpayer, and has not been addressed in prior audits. Based on this fact, and in view of the audit adjustments noted above, I will agree to waive the audit penalty.
The audit will be returned to the ***** District Office for the appropriate adjustments. Once the adjustments have been made, a revised audit assessment will be issued. If you should have any questions, please contact ******************* Office of Tax Policy, at *************
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/16829K
Rulings of the Tax Commissioner