Tax Type
Consumer Use Tax
Retail Sales and Use Tax
Description
Wholesale distributer of computer cables and related parts.
Topic
Tangible Personal Property
Date Issued
08-02-2013
August 2, 2013
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter in which you request correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") as a result of an audit
for the period February 2009 through December 2011.
FACTS
The Taxpayer is a wholesale distributer of computer cables and related parts. An audit resulted in the assessment of consumer use tax on tangible personal property used in the Taxpayer's business.
The Taxpayer buys manufacturing machinery that it depreciates for federal income tax purposes and pays personal property taxes on such equipment. This machinery is not used by the Taxpayer in an exempt production process. Rather, the Taxpayer's sister corporation uses such equipment to produce specialized items for sale only to the Taxpayer who resells them. The Taxpayer hired several employees that are dedicated to operating the machinery used to manufacture the specialized items on behalf of the sister corporation. The sister corporation has no employees or payroll and owns no capital equipment but pays a management fee to the Taxpayer for the use of such production employees.
The Taxpayer contends that the contested equipment qualifies for the industrial manufacturing exemption set out in Va. Code § 58.1-609.3 2 on the basis that the Taxpayer is the alter ego of its sister corporation. The Taxpayer maintains that the sister corporation is a manufacturer eligible for the industrial manufacturing exemption. The Taxpayer also maintains that it purchased the contested machinery for exempt use in the production process of its sister corporation.
DETERMINATION
Virginia Code § 58.1-609.3 2 sets out the exemptions from the retail sales and use tax for certain purchases made by industrial manufacturers, including an exemption for "machinery or tools . . . used directly in . . . manufacturing . . . products for sale or resale." Interpreting this exemption, subsection A of Title 23 of the Virginia Administrative Code 10-210-920 lists the exemptions available to industrial manufacturers and then provides the following:
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- Unless otherwise specified, only the types of tangible personal property listed above may be purchased exclusive of the tax by an industrial manufacturer or processor for direct use in producing products for sale or resale. Other production items and items of tangible personal property used indirectly in production activities are deemed subject to the tax.
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- Based upon the foregoing, for a business to obtain the exemption, it first must be manufacturing or processing products for sale or resale and secondly, such production must be industrial in nature. The determination of whether an operation is industrial in nature shall be made without regard to plant, size, finished product inventory size, degree of mechanization, amount of capital investment, number of employees or other factors relating principally to size. Third, the types of tangible personal property which may be purchased exclusive of the tax by an industrial producer are machinery and tools, raw materials or one of the other types specifically set forth above, and fourth, such types of tangible personal property must be used directly in the manufacturing or processing operation. In addition, the statutory definitions of “manufacturing" and "processing" under the Retail Sales and Use Tax Act limit the industrial exemption to activities conducted at a single plant site (see also subdivision B2 of this section). [Emphasis added.]
- Based upon the foregoing, for a business to obtain the exemption, it first must be manufacturing or processing products for sale or resale and secondly, such production must be industrial in nature. The determination of whether an operation is industrial in nature shall be made without regard to plant, size, finished product inventory size, degree of mechanization, amount of capital investment, number of employees or other factors relating principally to size. Third, the types of tangible personal property which may be purchased exclusive of the tax by an industrial producer are machinery and tools, raw materials or one of the other types specifically set forth above, and fourth, such types of tangible personal property must be used directly in the manufacturing or processing operation. In addition, the statutory definitions of “manufacturing" and "processing" under the Retail Sales and Use Tax Act limit the industrial exemption to activities conducted at a single plant site (see also subdivision B2 of this section). [Emphasis added.]
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- In this case, the Taxpayer is not the one actually using the contested equipment in an exempt manufacturing process. Rather, it is another legal entity that actually uses the equipment in an exempt manufacturing process. Under these circumstances, the industrial manufacturing exemption does not apply to the Taxpayer's purchases of contested equipment because it is not the one making an exempt use of the equipment.
Based on the Department's consistent policy noted above, the industrial manufacturing or processing exemption is only available to those purchasers who are industrial manufacturers or industrial processors. While the Taxpayer purchased the contested machinery and contends that it should be recognized as a manufacturing operation, there is no indication that it manufactures or processes products for sale or that it used such machinery in its own industrial production process during the audit period. Because the Taxpayer was not engaged as an industrial manufacturer or industrial processor during the audit period, it is not eligible for any of the industrial exemptions set out in Va. Code § 58.1-609.3 2.
The Taxpayer claims that it employs more than 50% of its employees as a direct result of the manufacturing of its sister corporation's branded product. The Taxpayer indicates that it employs 17 full-time and 2 part-time employees in Virginia. The Taxpayer further indicates in its appeal that it has employed seven full-time employees and several part-time employees as dedicated manufacturing assembly technicians. Even if the majority of the Taxpayer's employees are dedicated to manufacturing activities, I must point out that such employees are not dedicated to manufacturing directly performed by the Taxpayer. On the contrary, the Taxpayer has indicated that it performs no manufacturing. The purpose for presenting these labor criteria appears to establish the Taxpayer as engaged primarily or substantially in industrial manufacturing in order to gain entitlement to the industrial manufacturing exemption. However, the Taxpayer is not so engaged and is not entitled to such exemption.
The Taxpayer also claims that it was denied the application of the manufacturing exemption because the audit findings were based upon the business classification code used by the Taxpayer in filing its income tax returns. Although such coding may have been a factor that was considered, it is not the sole or decisive factor used in determining that the Taxpayer is not entitled to the industrial manufacturing exemption. In this regard, Va. Code § 58.1-602 establishes that an industrial manufacturer includes those establishments that are substantially similar to those businesses classified in codes 20 through 39 of the Standard Industrial Classification (SIC) Manual for 1987 [or codes 30 to 33 of the North American Industry Classification System (NAICS) of 2002 that replaces the SIC Manual]. Based on a review of these classification systems, the Taxpayer's business activities appear to be substantially similar to those businesses classified under wholesale code 5063 of the SIC Manual and under wholesale code 423610 of the NAICS.1 Because the Taxpayer conducts no manufacturing, the Taxpayer's classification is appropriately classified in the wholesale trade as a wholesale distributor of cable assemblies.
Of further importance is the tax consequence of creating a new legal entity in which to perform the manufacturing activities. Because the manufacturing activities were completely incorporated into a separate legal entity, they must be treated as separate activities apart from the Taxpayer's business, regardless of the fact that the ownership and thus the control of both businesses may be governed by the same person. Thus, I find no basis for accepting the Taxpayer's alter ego argument.
Finally, there is no indication that the Taxpayer resold, leased or rented the contested machinery to its sister corporation or another entity. While the Taxpayer loans the machinery to its sister corporation apparently for no consideration, the sister corporation cannot be considered the purchaser, lessee or renter of the machinery. Accordingly, the resale exemption is not available for the contested purchases.
CONCLUSION
Based on this determination, the assessment is correct. Because the contested assessment is paid in full, no further action is required.
The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this determination, please contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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Craig M. Burns
Tax Commissioner
AR/1-5370155856.R
1. The Taxpayer sells fiber optic cables, connectors, patch panels, and other durable goods. Although there is no classification code directly on point, the SIC code 5063 includes establishments primarily engaged in wholesale distribution of electrical power equipment, including cable conduit, insulated wire, wire rope or cable, and wiring supplies. The NAICS Industry code 423610 includes establishments primarily engaged in the merchant wholesale distribution of wiring supplies or insulated wire.
Rulings of the Tax Commissioner