April 11, 2016
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 appeal the assessment of certain equipment for purposes of machinery and tools tax issued by the ***** (the "County") for the 2015 tax year.
The machinery and tools (M&T) 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 M&T 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 owns and operates a manufacturing plant in the County. The Taxpayer filed an application for review and an amended 2015 M&T tax return with the County asserting that the majority of its equipment used in the manufacturing process it classified as machinery and tools should be reclassified as real property.
In its final determination, the County concluded that the equipment was properly classified as machinery and tools because it was actually and directly used in the manufacturing process. The Taxpayer appeals the County's final determination, contending that the equipment is real property because it is a permanent and integral part of the plant and will remain in place for its normal life.
ANALYSIS
Real property and all tangible personal property except the rolling stock of public service corporations and that which is 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. The method of taxation of real property is provided under Va. Code § 58.1-3200 et seq., whereas the taxation of tangible personal property is provided under Va. Code § 58.1-3500 et seq.
The County contends that any machinery and tools used in the manufacturing process are machinery and tools for purposes of tangible personal property taxation. As such, it considers all of the Taxpayer's machinery used in the manufacturing process to be machinery and tools. The Taxpayer asserts most of the machinery it originally classified as machinery and tools was in fact real property because it was attached to the building for its normal life subject to replacement, maintenance and repair.
In Danville Holding Corp. v. Clement, 178 Va. 223, 16 S.E.2d 345 (1941), the Virginia Supreme Court (the "Court") set forth three general rules to be used in determining whether an article of tangible personal property is a fixture, and thus considered a part of the real estate for purposes of taxation, or remains personal property subject to taxation as business tangible personal property. The three tests are: (1) the annexation of the chattel (property) to the realty, actual or constructive; (2) its adaptation to the use or purpose to which that part of the realty to which it is connected is appropriated; and (3) the intention of the parties, i.e., the intention of the owner of the chattel to make it a permanent addition to the freehold. See Id. at 232.
In order for the rules to apply, it is presumed that the property is annexed to the realty in some form. In its decision, the Court noted that the "intention of the party making the annexation is the paramount and controlling consideration." Id at 232.
Annexation
Annexation of chattel must be actual or constructive. In Danville Holding at 232, the Court concluded "the method or extent of the annexation carries little weight, except insofar as they relate to the nature of the article, the use to which it is applied and other attending circumstances as indicating the intention of the party making the annexation." In other words, so long as chattel is attached to a building to carry out the purpose for which such building was erected and to increase its value for occupation or use, such chattel may become part of the realty even if it may be removed without injury to itself or the building.
Adaptation
If attached property is essential to the purposes for which the building (or realty) is used or occupied, it would generally be considered a fixture even if its annexation to such building is such that it may be severed without injury to either the chattel or the building.
Intention
The Court has emphasized the intention of the party making the annexation is the chief test to be considered in determining whether the chattel has been converted into a fixture. Although the intention does not need to be expressed in words, it should be able to be inferred from the nature of the property annexed, the purpose for which it was annexed, the relationship of the party making the annexation, and the structure and mode of annexation.
Under this test, an owner of real property usually places permanent improvements upon such property in order to enhance its usefulness and market value. Thus, when an owner of realty annexes chattels to such realty, a doubt as to his intention to annex them permanently will in most cases be resolved in favor of such intent.
The County argues that Danville Holding does not apply to the machinery and tools tax because it addressed the classification of machinery as collateral for a deed of trust. While Danville Holding addressed whether certain equipment was properly classified for purposes of a deed of trust's secured interest, the Court subsequently applied the Danville Holding test when classifying equipment as tangible personal property or real property for purposes of local taxation. See Transcontinental Gas P.L. Corp. v. Prince William Co., 210 Va. 550, 172 S.E.2d 757 (1970). The Department has also followed Danville Holding as authority when distinguishing machinery and tools from real property. See Public Document (P.D.) 06-106 (10/5/2006).
The County has presented the case of Newport News Shipbuilding and Dry Dock Company v. City of Newport News, Case No. CL15940-RW (11/30/1993) in order to support its position. In this case, the two parties entered into a consent agreement as to which equipment at issue was machinery and tools or real property. In the consent judgment, the judge stated ". . . assets which are machinery and tools are to be taxed as such pursuant to Va. Code § 58.1-3507, regardless of whether they are affixed to the realty." Id. at 4. Based on this statement, the County argues that the equipment at issue should be classified as machinery and tools even though it is attached to the Taxpayer's building.
The Department, however, does not find the judgment to be inconsistent with the three part test. The Court acknowledged in Danville Holding that it is "difficult, if not impossible," to develop precise rules for determining whether a particular item of property should be considered real or tangible. Id. at 231. By adopting the three part test, the Court has acknowledged that mere attachment does not make machinery a part of real property.
Further, in Transcontinental Gas, the Court opined that the three part test is to be applied when classifying equipment as tangible personal property or realty for local taxation purposes. When a court of last resort has established a precedent, after full deliberation upon the issue by the court, the precedent will not be treated lightly or ignored, in the absences of flagrant error or mistake. See Selected Risks Ins. Co. v. Dean, 233 Va. 260, 355 S.E.2d 579 (1987). Accordingly, the three part test established in Danville Holding is the standard for determining whether an item of machinery is realty or tangible property.
Under Va. Code § 58.1-3103, a commissioner of revenue is required to "ascertain and assess, at fair market value, all subjects of taxation . ." In order for a commissioner of revenue to make the proper assessment of tangible property tax, he or she must apply the proper standard. In this case, the commissioner of revenue needed to determine which of the Taxpayer's equipment qualified as machinery and tools in accordance with Danville Holding. The Commissioner of Revenue did not apply the three part test in Danville Holding in determining if any of the Taxpayer's equipment at issue should be properly classified as real property.
DETERMINATION
Based on the evidence provided, I am remanding this case back to the County with instructions to consider whether the equipment at issue was machinery and tools or real property using the three part test established in Danville Holding. If additional documentation is required, the Taxpayer must be allowed adequate time to provide such documentation. Once its review is complete, the County should issue a new final determination and adjust the Taxpayer's M&T tax liability for the 2015 tax year as appropriate.
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/1-6128806054.B