January 8, 2015
Re: Appeal of Final Local Determination
Taxpayer: *****
Locality Assessing Tax: ****
Machinery and Tools Tax
Dear *****:
This final state determination is issued upon the application for correction filed by you on behalf of your client, ***** (the "Taxpayer"), with the Department of Taxation. You appear the assessment of certain equipment for purposes of machinery and tools tax issued by the ***** (the "County") for the 2009 and 2012 tax years.
The machinery and tools tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 authorizes the Department to issue determinations on taxpayer appeals of machinery and tools tax assessments. On appeal, the machinery and tools tax assessment is deemed prima facie correct, i.e., the local assessment will stand unless the taxpayer proves it is incorrect.
The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections and public documents cited are available on-line in the Laws, Rules and Decisions section of the Department's web site, located at www.tax.virginia.gov.
FACTS
The Taxpayer was a manufacturer of glass beverage bottles that was located in the County. The Taxpayer either placed the bottles on pallets or cartons prior to shipment in accordance with the customer's preference.
The Taxpayer filed amended machinery and tools (M&T) tax returns for the tax years at issue. It requested the removal of certain equipment included on the original returns as machinery and tools. In its initial final determination, the County removed some of the contested equipment from the Taxpayer's machinery and tools. However, it determined that equipment used to package the beverage bottles was used in the manufacturing process and subject to the M&T tax. The County also concluded that certain equipment deemed by the Taxpayer as ghost assets and idle machinery was machinery and tools.
The Taxpayer appeals the County's final determination, contending the manufacturing process ends once its products are packaged for resale and any additional packaging was not a part of the manufacturing process. It also contends that it produced sufficient evidence to demonstrate that certain machinery and tools were idle and ghost assets. Subsequent to the filing of the appeal with the Department, the County issued a revised determination removing some of the contested equipment from the Taxpayer's machinery and tools. However, the County declined to remove the cartoning equipment and the equipment the Taxpayer asserted was ghost assets and idle machinery. The Taxpayer reaffirmed its appeal, asserting that the cartoning equipment was not used in the manufacturing process and the equipment it deemed ghost assets and idle machinery were not subject to the M&T tax.
ANALYSIS
Taxation of Machinery and Tools
All tangible personal property, unless declared intangible under the provisions of Va. Code § 58.1-1100 et seq., is reserved for local taxation by Article X § 4 of the Constitution of Virginia. Included in the category of tangible property that is declared intangible and subject to state taxation only is "[c]apital which is personal property, tangible in fact, used in manufacturing (including, but not limited to, furniture, fixtures, office equipment and computer equipment used in corporate headquarters) ...." See Va. Code § 58.1-1101 A2.
The machinery and tools, motor vehicles and delivery equipment of a manufacturing business are not defined as intangible personal property. Such property is to be taxed locally as tangible personal property. Virginia has elected to create a separate classification of tangible personal property for machinery and tools used in manufacturing. Virginia Code § 58.1-3507 A also provides:
Machinery and tools . . . used in a manufacturing . . . business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only.
Used in Manufacturing
In City of Winchester v. American Woodmark, 250 Va. 451, 458, 464 S.E.2d 148, 152 (1995), the Virginia Supreme Court (the "Court") stated, "Since 1950, the Tax Commissioner has opined that the phrase 'machinery and tools' contained in Va. Code § 58.1-1101 A 2 and its precursors, means machinery used in the actual process of manufacturing." The Court also cited previous opinions of the Attorney General in deriving the meaning of "used in manufacturing."
In The Daily Press, Inc. v. County of Newport News, 265 Va. 304, 576 S.E.2d 430 (2003), the Court amplified the principles set forth in American Woodmark:
The principle gleaned from American Woodmark can be simply stated: personal property that may be essential to the overall operations of a manufacturing business is not 'machinery and tools' subject to local taxation unless the property is actually and directly used in the manufacturing process where new materials are transformed into a substantially different product or the property is connected with the operation of machinery actually and directly used in the manufacturing process. 265 Va. 304, 311.
The Attorney General has consistently opined that "machinery and tools" used in a particular manufacturing business are the machinery and tools that are necessary in the particular manufacturing business and which are used in connection with the operation of machinery that is actually and directly used in the manufacturing process. Id., citing 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317; see also 1987-1988 Att'y. Gen. Ann. Rep. 590. Id.
This language does not imply that each piece of machinery or each tool used directly in the manufacturing process must be directly connected to the complete transformation of a material into something substantially different in character. In Public Document (P.D.) 04-39 (8/2/2004), the Department found equipment and tools that did not directly transform or even touch the product being produced could be used directly in the manufacturing process. The question, therefore, is not whether a particular piece of machinery transforms a product, but whether such machinery or tool is used directly in a manufacturing process.
Packaging Equipment
Generally, the Department considers machinery used for packaging a product for shipping purposes as not directly used in the manufacturing process and, therefore, not subject to the machinery and tools tax. See P.D. 04-39. In P.D. 08-30 (4/2/2008), the Tax Commissioner recognized that many food products are not marketable without additional packaging. Therefore, the Department must consider whether some packaging "is an integral part of the making of a substantially different product." In considering this issue, the Department identified three main factors that contribute to how food is packaged. These include government regulations, industry practices, and market or consumer demands. Thus, to the extent that packaging has to meet performance (industry standards), sanitation (government regulations), or product quality (consumer demands) standards, equipment used for such packaging is considered to be used directly in the manufacturing process.
The Taxpayer loads bottles into cartons for some of its customers. Some cartons are filled with bottles without any separators. Other cartons are filled with bottles with separators. Whether or not separators are included in the carton is in accordance with the Taxpayer's customer demands. The tops of the cartons are not sealed. Upon receipt, customers must unload the bottles and sanitize them prior to filling.
Evidence must be provided that demonstrates that a packaging function is performed to meet performance (industry standards), sanitation (government regulations), or product quality (consumer demands) standards. See P.D. 12-181 (11/13/2012). In its initial final determination, the County determined that the cartoning process met each of the three standards to be considered part of the manufacturing process. The Taxpayer contends that the County's statements regarding its cartoning process did not meet any of the three standards because each was factually incorrect.
In its revised determination, the County states that only one of the three standards must be met in order for equipment to be used in manufacturing test. It concluded that the Taxpayer's efforts to meet customer demands via cartoning satisfied the product quality standard. The Taxpayer contends that the cartoning process was only used for shipping and, therefore, not part of the manufacturing process. In P.D. 13-63 (5/10/2013), the Department determined that machinery used to package beverages ultimately sold to consumers in that same packaging would be considered to meet product quality standards and included in the manufacturing process. In this case, however, the cartons would not become part of the final product sold to consumers. In addition, the Department finds it doubtful that the cartons are necessary for Taxpayer's customers in order to get the bottles into subsequent processing.
Idle Machinery
The Taxpayer contends that the County included "ghost assets" (i.e., assets in the accounting records, but do not actually exist) for the 2009 through 2010 tax years and idle equipment for the 2009 through 2012 tax years as machinery and tools. It admits that its accounting records were insufficient, but it can provide employee testimony that the assets were removed from service or otherwise disposed. The County asserts that the Taxpayer's employee's testimony did not meet its burden of proof to show the existence of the idle machinery and ghost assets.
Virginia Code § 58.1-3109 6 grants local assessing officers the authority to require records and other information necessary to make an accurate assessment of a taxpayer's tangible personal property. In addition, pursuant to Va. Code § 58.1-3983.1 B 3, a local assessing officer may require the submission of additional information or documentation in order to make a proper and equitable determination of an application for correction.
As such, a local taxing officer is within his or her authority to request and examine a taxpayer's records. Further, issues regarding the idling and disposal of property are a matter of fact to be determined by the locality. An examination of a facility by a locality can indicate if machinery or tools are idle or no longer on the premises, but a taxpayer must provide sufficient documentation to a locality to show when it disposed of the property in question. See P.D. 13-129 (7/3/2013) and P.D. 10-26 (3/31/2010).
DETERMINATION
Based on the evidence presented, the machinery and tools used in the cartoning process were part of the shipping process and, therefore, exempt from the M&T tax. Further, I find no reason to overturn the County's determination regarding the disposals and idle machinery
The Taxpayer also indicated that there is an error in the County's reconciliation for the 2011 and 2012 years. As such, I am remanding this case to the County in order to make adjustments to its assessments in accordance with this determination and review its return reconciliations in order to verify their accuracy.
If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5803069260.B