November 16, 2017
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of retail sales and use tax assessments issued to ***** (the “Taxpayer”) for the period April 2013 through March 2016.
FACTS
The Taxpayer is a metal fabrication shop that was audited by the Department. A use tax liability was assessed based on a one-year sample of the Taxpayer's expense purchases. The Taxpayer contests the inclusion in the audit sample of an untaxed purchase of high temperature masking tape. The masking tape is used in the Taxpayer's powder coating process. The Taxpayer maintains that the masking tape is a manufacturing supply that qualifies for the manufacturing exemption. The Taxpayer also contends that the expense purchases audit sample is flawed because a credit for sales tax erroneously paid to a vendor was not included in the error factor calculation.
DETERMINATION
High Temperature Masking Tape
The high temperature masking tape is used in the Taxpayer's powder coating process to cover areas of a product that are not to be powder coated. For example, the tape is used to cover fastener holes in the product prior to the powder coating process. The masking tape must withstand high temperatures because the product is heated in an oven as part of the powder coating process. The auditor denied the manufacturing exemption for the masking tape on the basis that it was not consumed in the manufacturing process and did not become a component part of the finished product.
Virginia Code § 58.1-609.3 2 (iii) provides an exemption from the retail sales and use tax for “[m]achinery 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 ....” Title 23 of the Virginia Administrative Code 10-210-920 B 2 states that “used directly” refers to “those activities that are an integral part of the production of a product, including all steps of an integrated manufacturing process, but not including incidental activities such as general maintenance, management, and administration.” The terms manufacturing and processing are defined in Va. Code § 58.1-602 to include “equipment and supplies used for production line testing and quality control.”
The high temperature masking tape is used during the Taxpayer's powder coating process and is an integral part of the process. The masking tape serves a quality control function. The use of the tape is essential to the integrity of the final product because it prevents powder coating from being applied to undesired parts or areas of the product. As such, the masking tape is an exempt manufacturing supply that is consumed during actual production. The purchase of the high temperature masking tape will be removed from the audit.
Audit Sample
The Taxpayer paid a vendor sales tax on the purchase of exempt manufacturing supplies. The invoice was paid during the period that was sampled in the audit. The Taxpayer contends that the erroneous payment of the tax should be reflected as a credit in the expense purchases sample. The Taxpayer contends that the omission from the sample of the tax paid in error skews the sample results and overstates the audit liability.
Sampling is an audit technique of significant value that is widely used in the public and private sectors. The Department uses sampling in sales and use tax audits where a detailed audit would not prove beneficial to either the auditor or the taxpayer. The findings that result from an audit sample are intended to estimate the taxable sales or purchases measure for the entire population of sales or purchase transactions during the audit period. When sampling techniques are properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit.
Pursuant to Va. Code § 58.1-205 1, an assessment of tax by the Department is deemed prima facie correct. This means that the burden of proof is upon the Taxpayer to establish that the assessment is incorrect. The purpose of the expense purchases sample is to determine the Taxpayer's consumer use tax compliance. When vendors do not charge the retail sales tax, taxpayers are responsible for reporting and remitting the applicable consumer use tax on any purchases from the vendor that do not qualify for an exemption from the tax.
In the instant case, the Taxpayer erroneously paid the sales tax to a vendor. The inclusion in the expense purchases sample of a credit for the erroneous payment of sales tax is not proper because the sample is used to measure consumer use tax compliance. Thus, the inclusion in the sample of a credit for sales paid in error distorts the calculation of the Taxpayer's consumer use tax compliance.
Moreover, the Department's longstanding policy is for taxpayers to obtain refunds of erroneously paid sales taxes from the vendor that made the sale. This insures that the local tax portion of the refund is allocated to the locality for which the tax was originally reported and paid. The dealer's discount must also be considered. Vendors are entitled to claim a dealer's discount for collecting and remitting the tax to the Department. When a vendor refunds the sales tax to a customer, the vendor takes a credit on the sales tax return for the amount of tax refunded or credited to the customer. When the credit is claimed on the vendor's return, the credit amount is reduced by the dealer's discount that was taken by the vendor when the tax was reported and paid.
In summary, the computation of the purchases sample in the audit is correct. There is no basis to include the credit for erroneously paid sales tax in the sample. I do note that the three-year statute of limitations has expired for filing a refund claim with the vendor. Therefore, a credit for the tax paid of ***** will be allowed in the audit.
The audit will be returned to the auditor to revise the audit based on this determination. The Code of Virginia sections and regulation 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/1141.S