May 19, 2016
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letters in which you request correction of the retail sales and use tax assessment issued to ***** (the “Taxpayer”) as a result of an audit for the period August 2011 through July 2014. I apologize for the delay in responding to your request.
FACTS
The Taxpayer manufactures and sells wood flooring to wholesalers. An audit resulted in the assessment of sales tax on untaxed sales of tangible personal property and the assessment of consumer use tax on untaxed purchases of tangible personal property used in the Taxpayer's administrative and manufacturing operations.
The Taxpayer contends that the assessments are incorrect. The Taxpayer maintains that the industrial manufacturing exemption applies to purchases of strapping materials and a strapping machine (and related parts) that is attached to the end of the production line. The Taxpayer also contends that the strapping materials are purchased for resale and are thus not subject to the tax.
The Taxpayer disagrees with the sample size used to develop the sales audit liability. The Taxpayer maintains that it was never told that this sampling method would be used and feels that the sample results are not accurate. The Taxpayer also contends that four sales made to one customer are exempted from the retail sales and use tax based on a resale exemption certificate.
DETERMINATION
Strapping Materials, Machinery and Parts
The Taxpayer contends that a strapping issue came up in the prior audit. The Taxpayer has presented a copy of a 2007 letter from the audit supervisor. Although the Taxpayer contends that the correspondence indicates that the strapping materials were purchased for the purpose of sale or resale and are not subject to the tax, I can find no mention of it in the correspondence. The attachment to the letter includes information from the manufacturing regulation. Although such regulation references the packaging exemption, such information provides no conclusive evidence to support the Taxpayer's claim. Furthermore, while a review of the prior audit report indicates that strapping was not included in the audit, this fact alone does not establish that strapping was untaxed. Rather, it could mean that the strapping was taxed and therefore not included in the audit. For these reasons, I find no basis in the correspondence that convincingly supports this contention.
Notwithstanding, the Taxpayer further contends that the strapping and ancillary equipment as used by the Taxpayer clearly relate to the sale and resale of the product and are exempt under Title 23 of the Virginia Administrative Code (VAC) 10-210-920. In this regard, the Taxpayer sells both unfinished and prefinished flooring. The unfinished flooring is sold in standard lots. Once the appropriate square footage is assembled, the bundle is strapped and ready for sale. All unfinished flooring is sold by the bundle. Prefinished flooring is placed in boxes and strapped once full. This strapping generally remains in place until the goods are resold to consumers. Flooring is shipped on flat bed trailers and the trucking company provides tarps and straps to keep the load in place until delivery.
Virginia Code § 58.1-609.3 (2) (iii) provides an exemption from the retail sales and use tax for “machinery or tools or repair parts therefor or replacements thereof . . . or supplies, used directly in . . . manufacturing . . . converting products for sale or resale.” [Emphasis added.] Pursuant to Va. Code § 58.1-602, manufacturing and processing include “the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site, and also includes equipment and supplies used for production line testing and quality control.” [Emphasis added.]
In addition, subsection C 2 of Title 23 VAC 10-210-920 clarifies that the industrial manufacturing exemption applies to tangible personal property, used at the plant site, to convey raw materials to storage or from storage to the production line, to convey unfinished products from one step of production to another, or to convey finished products to the warehouse or storage area. Public Document (P.D.) 05-22 (3/4/05) clarifies that the exemption applies to tangible personal property used to convey finished products from the production line to the shipping area.
Subsection B 2 of Title 23 VAC 10-210-920 indicates that for an item to be used directly in manufacturing, it must be used in an activity that occurs during the actual production process. Thus, any quality control activities must occur during production. Furthermore, in order for an item to be used directly, it must be indispensable to the actual production of products for sale and must be an immediate part of the production process.
In this case, flooring products are strapped in order to prepare them for sale and convey them as bundled products from the last step of production to storage or directly to shipping. This strapping plays an essential and immediate role in the quality control conveyance of the Taxpayer's flooring to storage. Accordingly, I find that the contested strapping materials, strapping machine, and strapping tool parts are used directly in a production process. Accordingly, such contested items will be removed from the audit.
The circumstances in this case are distinguishable from the circumstances described in P.D. 10-85 (6/4/10), 10-145 (7/26/10), and 96-301 (10/24/96). In P.D. 96-301, the determination focused on the denial of the packaging exemption and treated strapping used to bind wooden products into a bundle as used only for taxable distribution purposes. The other two determinations relied upon the policy set out in P.D. 96-301 because convincing arguments were not presented for applying the production exemption. However, the Taxpayer in the instant case has made it plainly evident that it uses strapping in exempt production activities.
While I recognize in the instant case that the industrial manufacturing exemption applies, I would note that the strapping materials for unfinished flooring products do not qualify for packaging exemption, which is set out in Va. Code § 58.1-609.3 2 (iv), because such products are not placed into a package or container as required by the Supreme Court of Virginia in order to be entitled to the packaging exemption. However, the prefinished flooring is placed into a protective wrapper or box and then strapped for security. As such, the packaging exemption applies to the strapping used to strap the prefinished flooring that has been boxed. See Webster Brick Co. v. Department of Taxation, 219 Va. 81, 86, 245 S.E.2d 252, 255, 256 (1978).
Non-Contested Sales
The Taxpayer contends that the four sales made to one customer in February through October 2013 are exempt from the retail sales and use tax based on the Form ST-10 resale exemption certificate furnished by such customer. An examination of such certificate indicates that it is dated July 10, 2014, which is within the last period of the audit but well after the four contested sales were made.
In addition, the exemption certificate is not entirely completed as the customer failed to describe on the form the “kind of business engaged in by dealer.” Pursuant to subsection A of Title 23 VAC 10-210-280, a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice by the Department. Because this exemption certificate is incomplete on its face, it is not acceptable.
Moreover, further investigation indicates that this customer was not registered with the Department to collect sales tax until July 2014. As such, it was not registered or otherwise authorized to use a resale exemption certificate prior to July 2014. Furthermore, the Department's records indicate that this customer is a truck company. As such, it would appear to be engaged in the provision of transportation services. From the information available to Department, we have no evidence that this customer makes any type of retail sales of tangible personal property that may or may not be subject to sales tax collections. Because of these circumstances, the four contested sales will remain in the audit. Because this customer's exemption certificate is not acceptable, the Taxpayer should charge the retail sales tax on all sales of tangible personal property made to this customer.
Sales Sample Size
The Taxpayer indicates that the auditor did not inform the Taxpayer that a sales sample would be used in the audit. The Taxpayer appears to have assumed that sales would be audited in detail since all of the purchases were audited in detail. Generally, sales and purchases are sampled. In this case, however, I understand that the vast majority of sales involve the resale exemption for which resale exemption certificates have been provided. I also understand that a complete list of customers, access to all exemption certificates and all backup materials for monthly sales tax reporting have been provided to the auditor. Because of the low volume of potential taxable sales, a detailed audit performed under these circumstances does not appear to entail a significant amount of audit time. Accordingly, I will allow a detailed audit of the sales.
In changing from a sample audit to a detailed audit of sales, it is possible that the result may increase the Taxpayer's liability. In the event that an increase in liability is found, the Department would revise the audit and issue another assessment for the additional liability found for the audit periods still within the statute of limitations for assessing the tax. If a decrease in liability occurs, then the audit assessments will be adjusted appropriately.
Unremitted Sales
The unremitted sales sample consists of four exceptions from two customers. The Taxpayer contends that this small sample size and the methodology used to extrapolate the sales tax exceptions overstate the Taxpayer's sales tax liability. Based on the Taxpayer's analysis of sales made to these two customers during the audit period, the Taxpayer asserts that the total unremitted sales measure made to them is much less than the total unremitted sales measure projected in the audit. The Taxpayer proposes that the unremitted sales measure held in the audit in the amount of ***** should be reduced to the unremitted sales measure as shown in the Taxpayer's exhibit claiming that these two customers only had unremitted sales of *****.
While the sample extrapolation is based on the four exceptions found in the three sample months, the sales sample is based on the concept that other similar incidents of tax collected but not remitted occurred not only with the two customers in question but with other customers. Accordingly, a detailed audit of sales should discover whether the unremitted sales are greater than or equal to the amount proposed by the Taxpayer.
CONCLUSION
The sales will be audited in detail and the assessments at issue will be revised in accordance with this determination. Once the revisions have been made, revised bills, with interest accrued to date, will be sent to the Taxpayer. The outstanding balances should be paid within 30 days of the bill dates to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 23r° Floor, Richmond, Virginia 23219, Attn: *****. If you have any questions concerning payment of the assessments, you may contact ***** at *****.
The Code of Virginia sections, regulations and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this determination, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR1-5966199791.R