October 13, 2016
Re: § 58.1-1821 Appeal: Retail Sales and Use Tax
Dear *****:
This will reply to your letter submitted on behalf of your client, ***** (the “Taxpayer”), seeking correction of the retail sales and use tax assessment issued for the period of January 2010 through April 2015. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is an industrial manufacturer of aircraft pistons and claims the retail sales and use tax exemption for industrial manufacturers. In the course of a retail sales and use tax audit, the Taxpayer was assessed tax on a ***** (hereinafter “Cabinet”). The Cabinet is a workstation/tool chest that is used by the Taxpayer to facilitate the cleaning, deburring (removal of sharp edges), and inspection of products manufactured by the Taxpayer. The Taxpayer contends the Cabinet is an integral part of the Taxpayer's manufacturing process and should be exempt from the retail sales and use tax under the industrial manufacturing exemption.
DETERMINATION
Virginia Code § 58.1-609.3 2 provides an exemption from the retail sales and use tax for machinery, tools, fuel, power, energy or supplies used directly and predominantly 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 interpreting this exemption statute, subsection B 2 of Title 23 of the Virginia Administrative Code (VAC) 10-210-920 provides that the exemption applies to “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.” (Emphasis added). Items that are essential to the operation of a business but not an immediate part of actual production are not used directly in manufacturing. This same regulation also provides that convenient or facilitative items are not used directly even though they may be attached to exempt production equipment.
Subsection C 2 of Title 23 VAC 10-210-920 provides that equipment used for production line testing and quality control is exempt from taxation. The Department has interpreted this regulation to only include equipment that is used directly in the quality control function on the production line of the plant site during the manufacturing process. See Public Document (P.D.) 98-81 (4/29/98).
In accordance with the authorities cited above, for an item to qualify for the industrial manufacturing exemption, it must be used directly in the production process and it must also be indispensable and an immediate part of the production process. As set out in P.D. 98-10 (1/20/98), the fact that an item is essential to production is not sufficient grounds for exemption based on the Virginia Supreme Court's holding that “essential items which are not an immediate part of actual production are not exempt." Webster Brick Company, Inc. v. Department of Taxation, 219 Va. 81, 245 S.E.2d 252 (1978). Also, when there is any doubt as to whether an exemption applies, the Department must adhere to the rule of strict construction of the statutory exemptions as established by the Virginia courts and deny the exemption.
Based on the information provided, the Cabinet is not an immediate part of the actual production process, nor is it indispensible to the production process. While the Cabinet may serve an essential function for the Taxpayer, the Cabinet is not used directly in the Taxpayer's production process. The Cabinet serves as a convenient or facilitative item with respect to product inspection. It is not used directly in the production process.
With regard to the quality control function of the Cabinet, in order to be exempt for quality control purposes, the quality control function must take place directly on the production line during the production process, neither of which is applicable to the Cabinet. Based on all of the above, I find that the Cabinet was correctly held taxable in the audit.
CONCLUSION
Based on this determination, the two contested assessments are correct. Updated bills, with interest accrued to date, will be sent to the Taxpayer. The outstanding balances should be paid within 30 days of the bill date to avoid additional interest charges.
The Code of Virginia section, regulation, and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section for the Department's website. If you should have any questions concerning this determination, please contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-6119056788.R
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