Document Number
14-105
Tax Type
Retail Sales and Use Tax
Description
Assessment issued for untaxed sales and purchases
Topic
Exemptions
Manufacturing
Payment and Refund
Records/Returns/Payments
Date Issued
07-16-2014

July 16, 2014



Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *****:

This is in response to your letter in which you seek correction of a retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period April 2007 through March 2010. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a furniture manufacturer. As a result of the Department's audit, an assessment was issued for untaxed sales and purchases. The Taxpayer contests various items in the audit assessment. In addition, the Taxpayer requests waiver of the penalties, claiming that the majority of the contested issues relate to new issues.

DETERMINATION

Manufacturing

Virginia Code § 58.1-609.3 2 provides an exemption from the sales and use tax for tangible personal property used directly in manufacturing products for sale or resale. The term "used directly" is defined in Va. Code § 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."

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. In Webster Brick Company, Inc. v. Department of Taxation, 219 Va. 81, 245 S. E.2d 252 (1978), the Virginia Supreme Court stated that "essential items which are not an immediate part of actual production are not exempt." Therefore, the manufacturing exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 interprets the "used directly" requirement of the manufacturing exemption statute and states:
    • Items of tangible personal property which are used directly in manufacturing . . .are machinery, tools and repair parts therefor, fuel, 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. Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing . . . . [Emphasis added.]

Burden of Proof

Pursuant to Va. Code § 58.1-205 1, any assessment issued by the Department is deemed prima facie correct. This means that the burden of proving an error in the assessment is upon the Taxpayer. In regard to the issues raised in the appeal, the Taxpayer has the burden of proving an exemption from the tax regardless of whether the transaction is for the sale or purchase of tangible personal property.

Keeping the above in mind, I will address the contested issues as stated in the Taxpayer's appeal.

Sales - Certificates of Exemption

Virginia Code § 58.1-623 A states, "The burden of proving that a sale. . . of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt . . . ."

In regard to sales made to ***** (Customer A) and ***** (Customer B), the exemption certificates on file were denied by the auditor on the basis that these customers are trucking companies and the exemption for common carriers was repealed prior to the audit.

Customer A: In this instance, the Taxpayer accepted a resale exemption certificate from Customer A on the purchase of furniture for resale. A trucking company usually is not in the business of retail sales and does not qualify for the resale exemption. However, according to the Taxpayer, Customer A is charged for any furniture damaged during transportation and resells the damaged furniture to recoup its cost. Based on this explanation, it is reasonable that the items purchased were for resale as claimed on the exemption certificate. Further, I find that the exemption certificate provided by Customer A is complete on its face with a valid retail sales and use tax registration number. Accordingly, this line item will be removed from the audit. (Line items 1-8).

Customer B: Customer B is a common carrier and provided the Taxpayer an exemption certificate, Form ST-20. Customer B checked box one indicating property sold to a common carrier used directly in the rendition of its public service is exempt. The certificate of exemption was on file at the time of the audit.

Title 23 VAC 10-210-280 B provides that reasonable care and judgment must be exercised by all concerned to prevent the giving or receiving of false, fraudulent or bad faith exemption certificates. An exemption certificate cannot be used to make a tax free purchase of any item of tangible personal property not covered by the exact wording of the certificate.

In this instance, the transactions involve the sale of furniture to Customer B. The ST-20 certificate does not allow an exemption for property not used directly in the rendition of a common carrier's public service. Furniture is not property that would be used directly in the rendition of a common carrier's public service. Because the Taxpayer was responsible for ensuring that the purchases were consistent with the language of the exemption certificate, and because the contested items could not be purchased exempt of the tax, I find that the Taxpayer did not accept the exemption certificate in good faith. Consequently, the Taxpayer is liable for the tax that should have been collected.

Further, I note that the exemption for common carriers of property by motor vehicles was repealed effective on September 1, 2004. Because such exemption is no longer in effect, the exemption certificate is no longer valid. See Public Document (P.D.) 04-122 (8/30/04).

Assets

Spray Booth Equipment and Spray Booth Filters: The Taxpayer claims that the spray booth, steel, and filters are items that have been certified by the Department of Environmental Qualify (DEQ) as pollution control equipment and, therefore, are exempt from the tax.

The Taxpayer has provided the-Department a certification from DEQ for water curtain devices, filters and spray nozzles used for the control and abatement of air pollution at the Taxpayer's facility. The spray booth filters are exempt and will be removed from the audit. (Line item 34). However, the certification from DEQ does not cover the contested spray booths.

The Department has issued several public documents that specifically address paint booths. The most recent, P.D. 11-135 (7/26/11), addresses a paint booth used by a manufacturer of wood cabinets, tables and similar products to create a special environment for the controlled application of finishes. The Tax Commissioner ruled that while certain components of the taxpayer's paint spray booths may qualify for the manufacturing exemption, structural components of the spray booth are taxable because they do not play a direct role in and are not an immediate part of the production process. Based on the Department's longstanding policy regarding spray booths, I find no basis to remove these items from the audit. (Line items 5-6).

Transferred to Virginia: The Taxpayer claims that the sales tax was properly paid to ***** on the contested assets purchased for use at the Taxpayer's ***** facility. The Taxpayer states that these assets were later transferred to Virginia after the ***** facility closed.

According to the auditor, the contested purchases are listed on the Taxpayer's depreciation schedule at cost. The auditor further states that no tax was charged on the invoices for such items. The auditor requested from the Taxpayer but was not provided documentation to verify that tax was properly paid on such items. Without documentation that the tax was properly paid, I find no basis to remove these items from the audit. (Line items 1-4).

Purchases

Dust Handling Equipment: The Taxpayer maintains that the contested purchases are used to collect dust from the sanding and sawing operations at the fiberboard plant and reused in its manufacturing process or sold as boiler fuel. The Taxpayer claims that the equipment is used directly in manufacturing and exempt of the tax.

As noted in Title 23 VAC 10-210-920 B, the manufacturing exemption specifically excluded items which are essential to the operation of a business but not an immediate part of actual production, even though such items may be directly attached to exempt production equipment.

Accordingly, the fact that an item is essential to production is not sufficient grounds for exemption unless the item is an immediate part of the actual production of the product. In this instance, the dust handling equipment is used to collect sawdust from the sanding and sawing operations that are not an immediate part of the actual production of fiberboard used in the manufacturing of furniture.

While the dust handling equipment is not an immediate part of the production of furniture, the manufacturing exemption may apply to the dust handling equipment when used to gather sawdust for sale or resale, provided the production is industrial in nature. See Title 23 VAC 10-210-920 A. Because the equipment is used to collect sawdust for reuse in processing fiberboard and for sale or resale, the dust handling equipment is exempt only if the preponderance of its use is in an exempt production activity. See Title 23 VAC 10-210-920 D. Thus, for the exemption to apply to the Taxpayer's dust handling equipment, it must be used more than 50% of the time as a direct part of a process to produce sawdust for sale or resale.

The Taxpayer has provided no documentation that the preponderance of the dust handling equipment is used to collect sawdust for sale or resale. Therefore, the Taxpayer has not met the burden of proof pursuant to Va. Code § 58.1-205 1 to support the exemption claimed. Therefore, there is no basis to remove the contested dust handling equipment from the audit. (Line items 30-33).

Hydraulic Oil, Hydraulic Filter and Lubricants: The Taxpayer claims that these items are directly used in manufacturing and exempt of the tax.

Based on Webster Brick and Community Motor Bus Co., the manufacturing exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. According to the auditor, the lubricants are manually applied to the fiberboard press and other fiberboard equipment. The manner in which the contested items are used by the Taxpayer is to perform general maintenance to production equipment, which is a taxable general maintenance activity. Accordingly, the auditor properly assessed the tax on the lubricants, hydraulic oil and filter. (Line items 1-5, 15-19, 20, 25, 27-28 and 35).

Poly Strapping and Stretch Wrap: The Taxpayer claims that the poly strapping and stretch wrap are used to package fiberboard for sale. The Taxpayer maintains that the poly strapping and stretch wrap restrict movement of the product in more than one plane of direction and are exempt packaging materials.

Virginia Code § 58.1-609.3 2 iv provides an exemption from the sales and use tax for materials, containers, labels, sacks, cans, boxes, drums or bags for future use for packaging tangible personal property for shipment or sale. Title 23 VAC 10-210-400 further addresses the application of the tax to packaging materials and transportation devices. Subsection A of this regulation defines transportation devices as "items which are used to transport and protect products for sale and to restrain product movement in a single plane of direction." Such transportation devices include strapping used to brace or secure cargo for transport. Subsection B of this regulation provides that "[t]ransportation devices are not packaging materials and may not be purchased tax exempt unless purchased for resale."

In Webster Brick Company, Inc. v. Department of Taxation, 219 Va. 81, 86, 245 S.E. 2d 252 (1978), the Virginia Supreme Court defined the term "packaging" for purposes of the above exemption as "placing in a package or container." In this case, strapping used to wrap fiberboard products for shipment or sale does not constitute placing the product in a package or container for shipment. Based on the definition provided by the court, the strapping does not qualify for the packaging exemption noted above. Accordingly, the auditor properly assessed the tax on the strapping materials. Stretch wrap is not listed in the audit exceptions and, therefore, is not an issue. (Line items 6-9, 21-23, 26 and 29)

Shipped Directly to *****: The Taxpayer provides documentation that the contested items were shipped by the vendor directly to the Taxpayer's Upholstery Division in *****. Accordingly, these items will be removed from the audit. (Line items 10, 12-14).

Subscription: The Taxpayer claims that the purchase of a regulation rulebook held in the audit is a subscription sent out on a periodic basis and is exempt of the tax. In this instance, the Taxpayer has provided no evidence that the regulation rulebook is a subscription that qualifies for exemption under Va. Code § 58.1-609.6 3. Accordingly, I find no basis to remove this item from the audit. (Line item 24).

Use Tax Payments: During the audit, the Taxpayer made lump sum use tax payments on its returns to account for any use tax liability it may incur during the audit period. As a result of the audit, an assessment was issued for the use tax audit liability. The auditor applied credit for the use tax payments to both the contested and non-contested portions of the audit liability. The Taxpayer contends that the total use tax credit should have been applied to the non-contested portion of the audit. This would result in a refund to the Taxpayer.

Any assessment of a tax by the Department is deemed prima facie correct and the burden of proving that the assessment is erroneous is upon the Taxpayer. For this reason, the auditor applied the remaining credit for use tax payments to the contested portion of the audit. If any refund is due after the auditor completes the revisions to the audit in accordance with the determination in this letter, it will be issued to the Taxpayer. I apologize for any inconvenience this may have caused the Taxpayer; however, I find that the auditor properly applied the credit for use tax payments to the contested portion of the audit.

Sample

The Taxpayer claims that it was agreed upon by both the Taxpayer and the auditor that all advertising purchases would be treated as a separate issue and not included in the sample. The Taxpayer argues four purchases included in the sample are advertising and should be removed from the sample and taxed separately.

According to the auditor, no invoices were available for these purchases. These purchases were charged to administration, office supplies and training expenses that do not constitute advertising. The Taxpayer has provided no evidence that such purchases are for advertising. Therefore, I find no basis to remove these purchases from the sample. (Line items 38-41).

Advertising

The Department has issued prior determinations to the Taxpayer regarding its advertising activities. In P.D. 88-250 (9/6/88), the Tax Commissioner ruled that the Taxpayer's purchase of photographs and catalog prints qualified for the catalog and other printed material exemption when stored in Virginia for less than twelve months and for distribution outside the state. Further, in P.D. 10-159 (8/3/10), the Tax Commissioner concluded that the Taxpayer is an in-house advertising agency and was subject to the tax on purchases in accordance with Title 23 VAC 10-210-43.

The Taxpayer disagrees with the prior determination in P.D. 10-159 and maintains that it is not an in-house advertising agency nor does it create media advertising. The Taxpayer contends that the contested purchases qualify for the printed materials exemption in Title 23 VAC 10-210-3010 or as exempt purchases of media advertising as defined in Title 23 VAC 10-210-40.

Virginia Code § 58.1-609.6 5 provides that the retail sales and use tax shall not apply to "[a]dvertising as defined in Va. Code § 58.1-602." Virginia Code § 58.1-602 defines advertising as:
    • The planning, creating, or placing of advertising in newspapers, magazines, billboards, broadcasting and other media, including, without limitation, the providing of concept, writing, graphic design, mechanical art, photography and production supervision. Any person providing advertising as defined herein shall be deemed to be the user or consumer of all tangible personal property purchased for use in such advertising.

Title 23 VAC 10-210-40 defines the term "media" to include "newspapers, magazines, billboards, direct mail, radio, television, and other modes of communication." Furthermore, Title 23 VAC 10-210-41 B provides, in pertinent part:
    • Advertising businesses are engaged in providing professional services and are the users and consumers of all tangible personal property purchased for use in such businesses. Therefore, the tax applies to all purchases by an advertising business including . . . printing, including direct mail items, non-customized or stock mailing lists, handbills, brochures, flyers, bumper stickers, posters and similar printed materials whether or not for use in the development of a specific advertising campaign, and whether or not any of such materials are intended for distribution out of state . . . .

Title 23 VAC 10-210-43 provides that "[m]aterials and supplies and other tangible personal property used in 'in-house' advertising, that is, advertising produced by any entity to advertise, promote or display its own products or services, are subject to the tax at the time of purchase." (Emphasis added).

In this instance, the auditor assessed the tax on various purchases of advertising. The auditor relied on Title 23 VAC 10-210-43 and the Tax Commissioner's determination in P.D. 10-159 as the basis for the assessment. The auditor concluded that P.D. 88-250 is no longer applicable to the Taxpayer because the regulation for catalog and other printed materials in Title 23 VAC 10-210-260 was repealed effective July 1, 1990. Although Title 23 VAC 10-210-260 was repealed, the Department's policy on catalog and other printed materials as set out in that regulation remains applicable today in the provisions of Va. Code § 58.1-609.6 4. Therefore, the policy set out in P.D. 88-250 regarding the application of the tax to printed materials remains in effect and is applicable to the current audit.

In regard to P.D 10-159, it appears that the conclusion that the Taxpayer is an in-house advertiser may not be applicable to all purchases during this audit period because the Taxpayer purchased finished printed materials that qualify for exemption pursuant to Va. Code § 58.1-609.6 4.

Purchases from Advertising Agencies: In order for the Taxpayer's purchases to qualify for the advertising exemption, the object of the transaction must be for one of the media advertising services set out above. For example, if the Taxpayer hires an advertising agency to create, design and furnish catalog prints or brochures, the application of the tax to the charge by the ad agency will depend upon whether the catalog prints or brochures will be used by the Taxpayer for an exempt media advertising purpose or for a taxable non-media advertising purpose. The tax applies to an ad agency's charges when catalog prints or brochures containing promotional information are used only in the Taxpayer's stores as this use is considered a non-media advertising purpose. When an advertising agency creates designs and produces catalog prints or brochures for a mass distribution by direct mail to potential customers of the Taxpayer, the object of the transaction is for media advertising services, and the charge is not subject to taxation.

In this instance, the contested items held in the audit consist of finished printed materials such as catalog pages, brochures, photographs, tear sheets, posters, displays, sold tags, sales cards, envelopes, in-store signage and other printed materials for use in non-media advertising of the Taxpayer's own products. The purchase of printed materials is exempt pursuant to Va. Code § 58.1-609.6 4 when they are stored in Virginia for twelve months or less and distributed for use outside of Virginia for non-media advertising purposes. Accordingly, the audit will be adjusted to remove printed materials that qualify for exemption in accordance with Va. Code § 58.1-609.6 4. (various line items).

Videos: These items represent purchases of in-house training videos and DVDs for prospective sales representatives. The auditor assessed the tax on the videos shipped to the Taxpayer's Virginia location.

In this instance, the training videos and DVD's are not for use in media advertising but rather used for a non-media purpose and are subject to the tax. Accordingly, I find that the tax assessed on the Taxpayer's purchase of training videos and DVD's is correct and consistent with the policy set out in P.D. 90-60 (4/12/90). Also see Tax Bulletin 95-5 (6/23/95), which explains that the tax applies to sales of in-house training films. (Line items 307-309)

DVD's and Video Duplication: The auditor relied on Title 23 VAC 10-210-43 as a basis for the assessment. These items represent the purchase of five looped DVD's and video duplicates. The Taxpayer claims that the vendor directly shipped the items to the Taxpayer's various store locations.

P.D. 07-125 (8/17/07) addresses a furniture manufacturer's purchase of a video for one of its furniture collections for use in its showroom and dealer locations as a point-of-purchase advertising tool. The Tax Commissioner ruled that the video shown at the taxpayer's showroom and at its dealer locations is intended to convey promotional information to the public generally and qualifies as exempt media advertising pursuant to Va. Code § 58.1-609.6 5. Further, any duplicates of an advertising video purchased by a taxpayer from the video production studio simultaneously with the master advertising video will also qualify for exemption. See P.D. 88-245 (8/26/88). Based on P.D. 07-125 and 88-245, I find basis to revisit this issue to determine if the contested videos are media advertising. (Line items 480, 483, 125-135 and 451-455).

Shipped Directly Outside Virginia: These items consist of posters, brochures, tear sheets, event and thank you cards, labels, sales cards and envelopes, sign stands, in-house signage, price lists and other printed materials. The Taxpayer claims that the vendor ships the printed materials directly to the Taxpayer's stores located in other states and no use is made in Virginia. To support its claim, the Taxpayer provides a letter from the vendor stating that it manufacturers and ships advertising materials for the Taxpayer directly to the Taxpayer's various store locations.

In this instance, the auditor relied on Title 23 VAC 10-210-43 as a basis for the assessment. In addition, the invoices reviewed by the auditor indicate that the items were delivered to the Taxpayer in Virginia. The vendor's letter indicating that it ships items directly to the Taxpayer's store locations outside Virginia is not sufficient documentation to warrant the removal of the contested purchases from the exceptions. The Taxpayer would need to provide delivery receipts or shipping logs to establish that the delivery address on the invoice for such items is not accurate. Notwithstanding the "ship to" issue, because the contested items consist of finished printed materials, I find basis to revisit this issue to determine whether the contested items qualify for the printed material exemption in Va. Code § 58.1-609.6 4.

Compliance Penalty

The Taxpayer requests a refund of the penalty paid on the non-contested portion of the audit on the basis that the Taxpayer's use tax compliance ratio for the non-contested purchases is within the specified compliance ratios. This was the Taxpayer's fourth audit.

On third or subsequent audits, penalty is generally applied unless the taxpayer's compliance ratios meet or exceed 85% for sales tax and 85% for use tax, as computed by the auditor or under the alternative method for computing audit penalty. See subsection B 5 of Title 23 VAC 10-210-2032.

The use tax compliance penalty is calculated on the total audit liability, contested and non-contested purchases. In this fourth audit of the Taxpayer, the Taxpayer's level of use tax compliance is 71%. In this instance, the penalty applies to the total use tax audit liability because an acceptable level of compliance was not achieved. Based on a review of the audit, the Taxpayer was properly assessed a 30% compliance penalty on purchases.

For purchases occurring prior to June 1, 2009, a 20% post-amnesty penalty was applied in addition to the 30% compliance penalty. At the conclusion of amnesty, any tax liability that was eligible for amnesty, but remained unpaid, became subject to a 20% post-amnesty penalty. See subsection F. 1 of Va. Code § 58.1-1840.1 and P.D. 09-140 (9/28/09).

The Taxpayer's claim that the Department erroneously assessed over 95% penalties on the uncontested audit liability is not founded. Based on the above authorities, the Taxpayer was properly assessed the 30% compliance penalty on purchases and the 20% amnesty penalty on months that were amnesty eligible. The penalty assessment may appear to be overstated because the use tax credit was applied to the tax liability prior to the assessment being issued.

A review of the use compliance calculations, however, shows that use tax payments made during the audit period were excluded prior to calculating the assessed penalty on purchases. Accordingly, I find sufficient cause to recalculate the penalty to take into consideration the monthly lump sum payments made on the returns against the use tax deficiency in the audit.

CONCLUSION

The audit will be returned to the appropriate field audit staff to revisit the advertising issue and to make the adjustments set out in this determination. With regard to the contested issues requiring additional documentation, the Taxpayer is given 45 days from the date of this letter to submit the necessary documentation to the auditor. If this documentation is not received within the allotted time, no additional adjustments will be made to the audit report. Because the non-contested bill has been paid in full, any refund as a result of the recalculation of the penalty will be applied to any remaining outstanding balance on the contested assessment.

A revised bill with interest accrued to date will be mailed to the Taxpayer and should be paid within 30 days of the bill date to avoid the accrual of additional interest. The Taxpayer should remit payment to: Virginia Department of Taxation, 600 E. Main Street, 15th Floor, Richmond, Virginia 23219, Attention: *****.

The Code of Virginia sections, regulations and public documents cited are available on-line in the Laws, Rules and Decisions section of the Department's website located at www.tax.virginia.gov. If you have any questions regarding this matter, please contact ***** of the Office of Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,



Craig M. Burns
Tax Commissioner



AR/1-5095537400.T

Rulings of the Tax Commissioner

Last Updated 09/22/2014 13:46