June 2, 2017
Re § 58.1-1821 Reconsideration: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the reconsideration of the Tax Commissioner's determination issued to ***** (the “Taxpayer”) regarding an assessment issued for the period August 2009 through July 2012. I apologize for the delay in responding to your request.
FACTS
The Taxpayer filed an administrative appeal with the Department as the result of an audit assessment. In the appeal, the Taxpayer contested the assessment of use taxes on untaxed purchases of equipment and supplies used in a wastepaper recycling operation. The Taxpayer claimed that various purchases assessed in the audit qualified for the industrial processing exemption. The Tax Commissioner issued a determination letter dated June 16, 2015 that denied the exemption and upheld the Department's assessment.
Pursuant to Virginia Administrative Code (VAC) 10-20-165, the Taxpayer filed a request for reconsideration of the previous determination. The Taxpayer disputes the Department's classification of the recycling business under Industry 562920 of the North American Industry Classification System (NAICS) Manual. The Taxpayer further states that the determination of whether an establishment is industrial in nature should not be based solely on the NAICS classification of the business. The Taxpayer also maintains that the Department's determination was in error because it states that a change in the state or form of the wastepaper is required for the recycling operation to qualify for the industrial processing exemption. Finally, the Taxpayer contends that the Department failed to consider that its recycling operation subjects the wastepaper to additional mechanical treatments that do change the state of the paper and make the paper more marketable.
DETERMINATION
Processing Defined
The Taxpayer notes that the previous determination letter states that the state or form of the wastepaper is not changed as a result of its recycling operation. The Taxpayer maintains that a product does not have to undergo a change in state or form to qualify for the industrial processing exemption. The Taxpayer cites Title 23 VAC 10-210-920 B 1, which states, in part, that “[p]roducts need not undergo a change in state or form in order for an establishment to be classified as an industrial processor.”
In Commonwealth v. Orange-Madison Cooperative, 220 Va. 655, 261 S.E.2d 532 (1980), the Virginia Supreme Court interpreted the term “processing” to mean the treatment of a product that makes it more marketable or useful. Title 23 VAC 10-210-920 B 1 and the court's decision in Commonwealth v. Orange-Madison Cooperative are clear that processing occurs only when a product is subjected to a treatment that makes it more marketable or useful. The statement made in the previous determination was not intended to add the additional requirement that a change in the state or form of a product is required for an establishment to be classified as an industrial processor. Rather, the intent of the statement was that a change in the form or state of the wastepaper would be sufficient evidence to conclude that processing has occurred. I fully agree that processing occurs when a product is subjected to a treatment that makes it more marketable or useful.
It is instructive that the court in Commonwealth v. Orange-Madison Cooperative provided examples of processing activities. In addition to ruling that the mixing of feed and fertilizer was processing, the court noted that activities such as the pasteurization of milk and the processing of chicken were examples of processing. These activities clearly subject the respective products to treatments that make the products more marketable or useful. In contrast, the sorting and baling of wastepaper does not rise to the level of these activities.
The Taxpayer states that the wastepaper must meet certain specifications as published in the Scrap Specifications Circular published by the Institute of Scrap Recycling Industries, Inc. Based on a review of the wastepaper specifications and requirements in the publication, there is no indication that the paper requires any special treatments other than the removal of contaminants and the sorting of the paper into different grades. Consistent with the Department's policy, the paper is not made more marketable or useful, based on the published specifications.
Public Document (P.D.) 14-153 (8/28/14) addresses the issue of whether a paper and metal recycling operation qualifies for the industrial processing exemption. P.D. 14-153 discusses a waste collection and recycling business that collected and recycled paper and metal waste products. At the recycling site, the waste material was sorted based on the type of material and then transported to the appropriate processing equipment for manual and automated sorting. Foreign materials were removed from the products, which were then sized by type based on customer specifications. Finally, the products were baled and shipped to customers.
The facts of this ruling are on point with the Taxpayer's operations. This ruling states that the sorting of metal and paper materials does not make the materials more marketable or useful. As a result, the ruling concludes that the industrial processing exemption does not apply to the recycling operation. Consistent with the other public documents cited in the previous determination, the Department's longstanding policy is that the mere sorting and baling of wastepaper is not a treatment that makes the actual paper more marketable or useful. The decision in this ruling and the policy upon which it is based does not require a change in the state or form of the products.
Industrial in Nature
The Taxpayer takes exception to the Department's position that its recycling operation is not industrial in nature. To qualify for the manufacturing and processing exemption in Va. Code § 58.1-609.3 2, manufacturing and processing activities must be “industrial in nature.” The term “industrial in nature” is defined in the definition of manufacturing and processing in Va. Code § 58.1-602, which states, in part, that the term “shall include, but not be limited to, those businesses classified in codes 10 through 14 and 20 through 39 published in the Standard Industrial Classification (SIC) Manual for 1972 and any supplements issued thereafter.” [Emphasis added.]
The Department now uses the North American Industrial Classification System (NAICS) Manual, which has replaced the Standard Industrial Classification Manual. Establishments classified in Sectors 31 through 33 of the NAICS Manual are considered to be industrial in nature for purposes of administering the manufacturing and processing exemption. In the previous determination, the Taxpayer's recycling operation was deemed to be classified in the NAICS Manual under industry 562920, material recovery facilities. Based on this classification, the Taxpayer's wastepaper recycling activities were deemed to not be industrial in nature.
Referencing the “but not limited to” language in the definition of manufacturing and processing, the Taxpayer maintains that its processing operation does not require classification in Sectors 31 through 33 of the NAICS Manual to be considered industrial in nature. As such, the classification of the business under industry 562920 of the NAICS Manual does not preclude the Taxpayer's recycling operation from being eligible for the industrial processing exemption.
It is true that the statutory definition of manufacturing and processing does not limit the treatment of a business as industrial in nature based solely on its SIC and NAICS classifications. This allows some flexibility in determining if a processing operation is industrial in nature when an establishment's processing operation does not fit squarely within the statutory classifications. However, the Virginia General Assembly clearly intended to limit the industrial in nature determination through the use of SIC Manual classifications, which means that similarly situated establishments must fall within the specified statutory classifications.
The Virginia courts have consistently followed the “rule of strict construction” of Virginia sales and use tax exemptions. See Commonwealth v. Community Motor Bus, 214 Va. 155, 198 S.E.2d 619 (1973). Based on this principle, if there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. The Department's longstanding policy has been that the sorting and baling of wastepaper by recycling establishments is not industrial in nature. P.D. 14-153 also affirms the Department's position with respect to this issue.
In this instance, the Taxpayer asserts that the proper NAICS classification for its recycling business is 322110 or 333999. A review of these classifications in the NAICS Manual indicates that NAICS classification 333999 is a miscellaneous classification for establishments engaged in general purpose machinery manufacturing. The Taxpayer clearly does not manufacture machinery. Classification 322110 is comprised of establishments primarily engaged in manufacturing pulp. The Taxpayer may sell recycled waste paper to pulp mills, but the Taxpayer does not manufacture or process pulp. While the Taxpayer may use machinery in its operations and sell raw materials to pulp manufacturers and processors, these activities are dissimilar from those establishments that fall within classifications 322110 and 333999. Based on the information available, the Taxpayer's proper classification in the NAICS is 562920.
Additional Processing Activities
The Taxpayer states that its recycling operation uses additional mechanical treatments that do change the state of the waste paper and make the wastepaper more marketable. The Taxpayer contends that it uses a sophisticated industrial treatment process that includes shredding, fluffing, compacting, compressing, densifying, expansion, resistance expansion and various roll cutting processes. The Taxpayer cites P.D. 96-305 (10/25/96), which discusses a paper recycling business that performed these same types of treatments to wastepaper. The taxpayer in P.D. 96-305 was deemed to be engaged in industrial processing because its activities went beyond the sorting and baling of waste paper. The Taxpayer contends that the industrial processing exemption applies to its recycling operations based on P.D. 96-305.
If the Taxpayer's recycling operation includes shredding, fluffing, compacting, compressing, densifying, expansion, resistance expansion and various roll cutting processes in addition to the sorting and baling of the waste paper, then the industrial processing exemption would apply to its recycling operation. Based on communications with the auditor and the description of the Taxpayer's recycling process in the original appeal letter, there was no claim made or information provided to suggest the Taxpayer was engaged in these additional activities.
Pursuant to Va. Code § 58.1-205 1, a tax assessment issued by the Department is deemed to be prima facie correct. The burden is upon the taxpayer to prove that an assessment issued by the Department is incorrect. To meet this burden, the Taxpayer must provide documentation and evidence to establish and support its claim that the recycling operation included the additional processes of shredding, fluffing, compacting, compressing, densifying, expansion, resistance expansion and roll cutting.
Used Directly Requirement
Because there was no claim of the industrial processing exemption made by the Taxpayer during the audit, the use of various items that were assessed in the audit was not reviewed. To qualify for the exemption, machinery, equipment and other items must be used directly in the industrial process. Title 23 VAC 10-210-920 B 2 defines “used directly” as “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.”
In the event the Taxpayer provides sufficient evidence for the Department to conclude that the recycling operation constitutes industrial processing, the use of the items held taxable in the audit must be reviewed to determine if the used directly requirements of the manufacturing and processing exemption are met. The used directly requirements are discussed in more detail in the Department's manufacturing and processing regulation, Title 23 VAC 10-210-920.
CONCLUSION
The Taxpayer is allowed 45 days to provide sufficient documentation and evidence that demonstrates the recycling operation included the activities of shredding, fluffing, compacting, compressing, densifying, expansion, resistance expansion and various roll cutting processes. If the information furnished confirms the performance of these additional mechanical treatments, those items in the audit that were used directly in the recycling operation must be identified and verified. The audit will then be adjusted accordingly and a revised assessment issued to the Taxpayer.
The Code of Virginia sections, regulations and public documents 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/616.S