July 20, 2015
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of a retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period January 2007 through December 2009. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer operates several manufacturing facilities in Virginia. The Department audited and assessed the Taxpayer use tax on untaxed expense purchases and fixed asset purchases made during the audit period. The audit was conducted without complete records and without sufficient information about the Taxpayer's manufacturing operation for the auditor to determine if various transactions qualified for sales and use tax exemption. The Taxpayer appealed the assessment on the basis that the audit liability was overstated and that documentation was available for the Department to accurately determine the liability. The Taxpayer's case was referred to the Department's audit staff to review the available records and to tour the manufacturing plant to obtain information about the use of various contested items included in the audit. The audit and the assessment were revised based on the tour and the information provided by the Taxpayer.
The Taxpayer appeals various transactions that remained in the audit assessment after the audit revision. The Taxpayer maintains that the revised assessment is erroneous because it includes transactions that qualify for the manufacturing exemption. In addition, the Taxpayer states that some transactions in the audit are exempt real property services provided by contractors and that other transactions in the audit are charges for exempt services. The Taxpayer also requests waiver of the compliance penalty assessed in the audit.
DETERMINATION
Manufacturing Exemption
Virginia Code § 58.1-609.3 2 (iii) provides an exemption from 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, refining, mining or converting 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 the statute was intended to narrow the scope of the exemption. 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. This standard established by the Court is also reflected in the Department's manufacturing regulation. 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 and processing are machinery, tools and repair parts therefor, fuel, power, 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 which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt production machinery. Furthermore, the fact that the use of a particular item, such as firefighting and safety equipment, may be required by federal, state or local law is not, by itself, dispositive of direct usage in manufacturing or processing. [Emphasis added.]
Based on the information provided by the Taxpayer and the plant tour taken by members of my staff, it has been confirmed that various items in the audit are used directly in the Taxpayer's manufacturing process and qualify for the manufacturing exemption. Some contested items remain in the audit because sufficient information has not been provided to determine if the items meet the "used directly" criteria of the manufacturing exemption.
I understand that a member of my staff has requested additional information for these contested items. Virginia Code § 58.1-205 1 states that a tax assessment issued by the Department is deemed to be prima facie correct. The burden is on taxpayers to prove that an assessment issued by the Department is incorrect. The Taxpayer must provide sufficient information to prove that the contested items that make up the audit assessment qualify for exemption. Otherwise, the assessment of the tax on those items is considered correct.
The fixed asset exceptions that qualify for the manufacturing exemption and will be removed from the audit are line item #s 13, 20, 23 and 24. Line item #s 9, 22 and 25 require more information and evaluation to determine if the manufacturing exemption applies. These line items are included in the information request referenced above. The Taxpayer has been unable to provide backup documentation for line item # 27. Without such information, this audit exception will remain in the audit. Based on the Department's review, fixed asset line item #s 16, 26 and 29 are taxable and will remain in the audit.
The expense purchase transactions that qualify for the manufacturing exemption are line item #s 4, 14, 16, 28, 33 - 35, 37, 38, 41, 51, 52, 55, 56, 68, 69, 90 - 94, 96 - 98, 103, 106, 109, 130, 131 and 133. The audit and the liability will be revised to reflect the removal of these items. Line item #s 7, 18, 19, 21, 22, 24, 25, 27, 32, 45, 46, 54, 60, 61, 74, 86, 87, 95 and 99 are included in the request for additional information referenced above. The audit will be revised based on the review of documentation provided for these items by the Taxpayer. If no information is provided or the information is not sufficient to prove that the property is exempt, these items will remain in the audit.
Real Property Transactions
Various capital projects were performed at the Taxpayer's manufacturing plant during the audit period. Contractors were used to perform the work for many of these projects. The Taxpayer states that some of the jobs are real property construction projects and the contractors that performed the work are liable for the tax on purchases of tangible personal property used for the jobs.
Virginia Code § 58.1-610 A provides, in part, that "[a]ny person who contracts orally, in writing, or by purchase order, to perform construction, reconstruction, installation, repair, or any other services with respect to real estate or fixtures thereon, and in connection therewith to furnish tangible personal property, shall be deemed to have purchased such tangible personal property for use or consumption."
Virginia Code § 58.1-610 E and Title 23 VAC 10-210-410 A provide that contractors may purchase exempt from the sales and use tax equipment, machinery and other tangible personal property that qualifies for the industrial manufacturing and processing exemption under Va. Code § 58.1-609.3 2. Title 23 VAC 10-210-280 E requires contractors to apply in writing to the Department for the issuance of an exemption certificate, Form ST-11A. A copy of Form ST-11A is provided to vendors by the contractor to make exempt purchases of qualifying machinery and equipment to be furnished under contracts with manufacturing businesses. Based on these authorities, a contractor furnishing and installing tangible personal property that qualifies for the industrial manufacturing and processing exemption may purchase such property exempt of the tax. This is true whether or not the property furnished and installed by the contractor becomes real property after installation.
Contractors that furnish and install tangible personal property that does not qualify for the manufacturing exemption and becomes real property when installed are liable for payment of the applicable sales and use taxes on the purchase of the property, materials and any other tangible items that are installed under the contract. The contractor does not charge sales or use tax on the charges for the work billed to the manufacturer but includes any sales and use taxes paid in the total charge for the work performed.
The Taxpayer contends that certain transactions in the audit are for exempt real property services performed by contractors. Other transactions are contract charges to furnish, install or repair manufacturing equipment and machinery that qualifies for exemption. Based on the plant tour and a review of the documentation for these transactions, fixed asset line item #s 3 - 5, 17, 32 and 33 will be removed from the audit. Fixed asset line item #s 6, 8, 9 and 21 require more information and evaluation to determine if the transactions represent real property services or if the manufacturing exemption applies. These line items are included in the information request referenced above. Line item #s 7, 9, 14, 15 and 16 from the fixed asset transactions list were properly held taxable in the audit.
The contested expense purchases in the audit include line item #s 72 and 73, which are charges for the maintenance of the Taxpayer's heating, ventilation and air conditioning system. These charges are for real property services and will be removed from the audit. Line item # 30 cannot be addressed without additional information about this transaction. This item was included in the information request referenced above.
Miscellaneous Transactions
Office Equipment: The Taxpayer purchased office equipment from an office supply business. The vendor issued the Taxpayer two purchase invoices and each is missing the page that lists a breakdown of the total sales price of the property purchased and the applicable sales tax charged on the sales. The Taxpayer has been unable to locate copies of the missing pages. The Taxpayer asserts that the office supply vendor typically charges sales tax and that the purchases should be removed from the audit.
Title 23 VAC 10-210-470 requires taxpayers to maintain adequate and complete records necessary to determine the amount of tax liability. In this case, it cannot be determined if the Taxpayer paid the sales tax on the purchase of the office equipment. Without some form of documentation to verify the Taxpayer was charged and paid the sales tax, line item #s 107 and 108 will remain in the audit.
Hauling Services: The Taxpayer states that several purchase transactions in the audit are charges for transportation and hauling services. Based on the information provided, the amounts billed are for exempt hauling and transportation services. Line item #s 64, 65, 70 and 71 in the purchase exceptions list will be removed from the audit.
Monitoring Service: Line item # 29 is a charge billed by a third party service that tracks and monitors forklift repairs. The Taxpayer states that the bill is not related to actual repairs to the forklifts and is an exempt service. However, the Taxpayer has not provided an invoice or a contract with detailed information to allow the Department to confirm that the contract is for services only. I will allow the Taxpayer 30 days to provide such information. Otherwise, this transaction will remain in the audit.
Data Collector Rental: Line item #s 75 and 76 are charges for vibration testing services and the rental of a data collector. The charges for testing services and the data collector rental are separately stated on the invoice. However, it is not clear if the data collector is used by the vendor to provide vibration testing services or if the data collector is used by the Taxpayer in some manner. A contract or other documentation to clarify the use of the data collector is needed to resolve this issue. Additional information for this issue has also been included in the request referenced above.
Purchase Credit: The Taxpayer states that line item # 77 is a purchase credit issued by a vendor for the return of a tool. Based on the information provided, this line item will be removed from the audit.
Compliance Penalty
The Taxpayer seeks waiver of the compliance penalty assessed in the audit. This was the Taxpayer's second audit. Virginia Code § 58.1-635 mandates the application of penalty to tax deficiencies. Title 23 VAC 10-210-2032 A states that "[t]he application of penalty to audit deficiencies is mandatory and its application is generally based on the percentage of compliance determined by computing the dealer's compliance ratio." Subsection A 2 of this regulation states that, for second audits, a compliance penalty will be assessed unless a taxpayer's compliance ratio meets or exceeds 85% for sales tax and 60% for use tax.
As there was no use tax paid on untaxed purchases made during the audit period, the Taxpayer's use tax compliance ratio for this audit is 0%. Title 23 VAC 10-210-2032 A 6 also states that the application of penalty to audit deficiencies will not be waived on second and subsequent audits for "other than exceptional mitigating circumstances." The Taxpayer has not presented evidence of exceptional mitigating circumstances that warrant waiver of the penalty. While there is no basis to waive the compliance penalty, the penalty will be recalculated based on the reduction of the tax liability that results from the revision of the Taxpayer's audit.
CONCLUSION
The appropriate audit line items will be adjusted and the audit liability will be revised in accordance with this appeal determination. The Taxpayer has 30 days to provide the Department with the information requested for the review and finalization of the appeal for this location. The information provided must establish that the contested item qualifies for exemption. If so, the audit exception will be removed and the audit liability adjusted accordingly. If no information is provided or the information provided is not sufficient to establish that the audit item is exempt, the assessment with respect to that item will be considered correct.
The Taxpayer has also filed administrative appeals for the audit assessments issued to its ***** and ***** plant locations. As with this case, additional information, which possibly includes a plant tour, is needed to evaluate and resolve the appeals for these locations. I understand that the Taxpayer no longer has operations at the ***** facility. ***** of my staff will coordinate with the Taxpayer and the Department's audit staff to facilitate the review and resolution of the appeals for these locations.
The Code of Virginia sections and regulations cited, along with other reference documents, 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 concerning this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5333533350.S