Tax Type
Retail Sales and Use Tax
Description
Government contractor specializing in development and manufacture of rocket motors
Topic
Exemptions
Date Issued
08-24-2004
August 24, 2004
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to correspondence requesting correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") as a result of an audit. I apologize for the delay in the Department's response.
FACTS
The Taxpayer is a federal government contractor specializing in the development and manufacture of rocket motors. An audit for the period July 1995 through June 1998 resulted in an assessment of retail sales and use tax on various purchases of tangible personal property. The Taxpayer has paid the assessment in full.
The Taxpayer contests the tax assessed on testing equipment and maintains that it is used in exempt production line testing and quality control. The Department's audit staff maintains that the contested testing equipment is taxable because it is used to determine whether products meet customers' specifications.
You indicate, however, that the tested products are not "finished or completed for sale" because they have not yet been packaged for sale and conveyed to storage. In this regard, the Taxpayer's production line "for the manufacture of these products is not just at one facility on its campus, but rather occurs at several different facilities on its campus until the products are completed and conveyed to the on-site warehouse."
You also indicate that federal government regulations require this testing to be performed at a specified distance from workers and the surrounding community. In this regard, you indicate that "[d]ue to the externally-mandated separation of the testing from close proximity to the rest of the assembly line (and the stockpile of explosive raw materials), the 'production line' quality control must be physically separated from the rest of the production line, although it is still on the campus of the plant."
In regard to the prior audit for the period January 1992 through October 1994, you contend that the "auditors did not take exception to the production line testing and quality control process, but instead, permitted the tangible personal property and consumables used therein to be exempt from the tax pursuant to the manufacturing exemption." For all of these reasons, you maintain that the testing equipment is exempt pursuant to the industrial manufacturing exemption at Va. Code § 58.1-609.3(2).
DETERMINATION
Virginia Code § 58.1-609.3(2)(iii) 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 ... manufacturing ... products for sale or resale ...." Va. Code § 58.1-602 defines the term "manufacturing" to encompass "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, and also includes equipment and supplies used for production line testing and quality control."
This definition of "manufacturing" indicates that many activities are exempt even though they are not part of the actual production of a product. For example, conveying a finished product to the warehouse is an exempt activity. Testing and quality control, however, are subject to a stricter test in order to qualify for the exemption: To be exempt, testing and quality control activities must be performed on the "production line."
In Public Document (P.D.) 93-135 (6/4/93), the Department recognized the stricter standard applicable to testing and quality control activities and indicated that:
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- The quality control exemption only applies to the testing or monitoring activities that occur during the manufacturing process. Such activities must be intended to maintain the integrity of the products being produced for the activity to be exempt from taxation. Testing which occurs away from the production line, such as post-production testing to determine whether or not the product meets contract specifications or applicable safety standards or for some other reason, is not exempt from taxation. [Emphasis added.]
Similarly, P.D. 01-204 (12/7/01) sets out that "equipment used in the quality control function must be used directly to influence or control the quality of the product being produce[d]." Thus, for the industrial manufacturing exemption to apply, the testing equipment must ensure the integrity of the product while being produced.
In the instant case, the facts establish that the rocket motor testing occurs away from the production line and that the testing is conducted on a completed rocket. According to the Taxpayer's Engineering Department Specifications, the contested testing "shall be conducted on each lot of motors manufactured for delivery ...." Clearly, this testing occurs after the product is off the production line.
In regard to the prior audit, I can find no conclusive evidence that the contested activity was deemed to be exempt. Pursuant to Va. Code § 58.1-205, the Taxpayer has the burden of proving that the assessment is erroneous. The Taxpayer has not met that burden of proof.
Based on the facts presented and the doctrine of strict construction established by the courts in interpreting sales tax exemptions, the contested items do not qualify for the industrial manufacturing exemption. Accordingly, the assessment is correct.
The Code of Virginia sections and public documents cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have any questions about this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
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AR/39452R
Rulings of the Tax Commissioner