June 29, 2018
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 ***** (the “Taxpayer”), with the Department of Taxation. You appeal assessments of Machinery and Tools (M&T) tax issued by the ***** (the “City”) for the 2014 and 2015 tax years and the City's denial of refunds for the 2012 and 2013 tax years.
The 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 M&T tax assessments. On appeal, a M&T tax assessment is deemed prima facie correct, i.e., the local tax 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 is a soft drink manufacturer located in the City. The City adjusted the Taxpayer's M&T tax returns for the 2014 and 2015 tax years and issued assessments. The Taxpayer appealed the assessments to the City and at the same time submitted amended returns for the 2012 and 2013 tax years, consistent with the list of taxable equipment it submitted for the 2014 and 2015 tax years.
In its final determination, the City upheld the assessments and denied the refunds. The City concluded that the assets the Taxpayer had excluded from its list of taxable equipment for the 2012 through 2015 tax years were used in its manufacturing process and thus were subject to the M&T tax.
The Taxpayer appealed to the Department, contending that certain categories of equipment, namely shipping and packaging equipment, storage systems and warehouse equipment were not used in its manufacturing process and thus were properly excluded from its list of taxable equipment.
ANALYSIS
Taxation of Machinery and Tools
All tangible personal property, unless declared intangible under the provisions of Virginia Code § 58.1-1100 et seq., is reserved for local taxation by Article X § 4 of the Constitution of Virginia. Included in the category of tangible property that is declared intangible and subject to state taxation only is “[c]apital which is personal property, tangible in fact, used in manufacturing (including, but not limited to, furniture, fixtures, office equipment and computer equipment used in corporate headquarters) ....” See Virginia Code § 58.1-1101 A 2.
The machinery and tools, motor vehicles and delivery equipment of a manufacturing business are not defined as intangible personal property. Such property is to be taxed locally as tangible personal property. Virginia has elected to create a separate classification of tangible personal property for machinery and tools used in manufacturing. Virginia Code § 58.1-3507 A also provides:
Machinery and tools . . . used in a manufacturing . . . business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only.
Used in Manufacturing
In City of Winchester v. American Woodmark, 250 Va. 451, 458, 464 S.E.2d 148, 152 (1995), the Virginia Supreme Court (the “Court”) stated, “Since 1950, the Tax Commissioner has opined that the phrase ‘machinery and tools’ contained in Virginia Code § 58.1-1101 A 2 and its precursors, means machinery used in the actual process of manufacturing.” The Court also cited previous opinions of the Attorney General in deriving the meaning of “used in manufacturing.”
In The Daily Press, Inc. v. County of Newport News, 265 Va. 304, 576 S.E.2d 430 (2003), the Court amplified the principles set forth in American Woodmark:
The principle gleaned from American Woodmark can be simply stated: personal property that may be essential to the overall operations of a manufacturing business is not ‘machinery and tools’ subject to local taxation unless the property is actually and directly used in the manufacturing process where new materials are transformed into a substantially different product or the property is connected with the operation of machinery actually and directly used in the manufacturing process. 265 Va. 304, 311.
The Attorney General has consistently opined that “machinery and tools” used in a particular manufacturing business are the machinery and tools that are necessary in the particular manufacturing business and which are used in connection with the operation of machinery that is actually and directly used in the manufacturing process. Id., citing 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317; see also 1987-1988 Att'y. Gen. Ann. Rep. 590. Id.
This language does not imply that each piece of machinery or each tool used directly in the manufacturing process must be directly connected to the complete transformation of a material into something substantially different in character. In Public Document (P.D.) 04-39 (8/2/2004), the Department found equipment and tools that did not directly transform or even touch the product being produced could be used directly in the manufacturing process. The question, therefore, is not whether a particular piece of machinery transforms a product, but whether such machinery or tool is used directly in a manufacturing process.
Shipping and Packaging Equipment
The Taxpayer contends that a certain category of assets it has identified as “Palletizer-Shipping/Packaging” consisted of non-taxable assets used in the packaging process. The City asserts that all of this equipment was essential to the manufacturing process.
Generally, the Department considers machinery used for packaging a product for shipping purposes as not directly used in the manufacturing process and, therefore, not subject to the machinery and tools tax. See P.D. 04-39. In P.D. 08-30 (4/2/2008), the Tax Commissioner recognized that many food products are not marketable without additional packaging. Therefore, the Department must consider whether some packaging “is an integral part of the making of a substantially different product.” In considering this issue, the Department identified three main factors that contribute to how food is packaged. These include government regulations, industry practices, and market or consumer demands. Thus, to the extent that packaging has to meet performance (industry standards), sanitation (government regulations), or product quality (consumer demands) standards, equipment used for such packaging is considered to be used directly in the manufacturing process.
The Department has applied these principles to a drink bottling operation. In P.D. 13-63 (5/10/2013), the Department determined that the manufacturing process ended once the product was packaged into whatever unit it would be sold to the consumer. In that case, the products were variously sold in packs of six or ten or individually. Any subsequent packaging equipment would be considered part of a logistical process and exempt from the M&T tax.
The Taxpayer contends that the category of assets identified as “PalletizerShipping/Packaging” consisted of non-taxable assets that were used in such a logistical process. The Taxpayer's appeal, however, merely makes conclusory statements regarding what items were used in that process.
Although the City's final determination references P.D. 13-63, it is unclear whether the City considered that equipment used to ship and package a product once the initial packaging of the consumer unit is complete would not be part of the manufacturing process. The letter merely refers to case packaging being included in the manufacturing process in P.D. 13-63 and the Taxpayer's process being the same as the process in that case. As stated above, however, the Department recognized in P.D. 13-63 that some packaging equipment may be involved in a manufacturing process and some may not.
The facility in the City filled four different size bottles. Most of the bottle types were sold separately to the consumer. One bottle type, however, was sometimes packaged further into a larger consumer unit. The Taxpayer also filled cans that were packaged into four different sized units that were sold to the consumer. The manufacturing process was complete once the consumer unit was packaged. Therefore, any equipment that packaged the products into units larger than the consumer unit was not involved in the manufacturing process. In this plant, the Taxpayer used palletizers and wrappers that stacked and wrapped large quantities of products in preparation for shipping in bulk and thus went beyond packaging that would be sold to a consumer.
Storage System
While conceding that certain storage tanks supported the manufacturing process and were taxable, the Taxpayer contends that another category of “auxiliary” storage equipment was merely used to store water, air and sugar and was not used directly in the manufacturing process. The City asserts that the water, air and sugar were necessary in the manufacturing process. The City refers to the water being filtered, sterilized and dechlorinated. The City also asserts that the process of mixing was completed inside the tanks and the tanks were used in the manufacturing process at various stages.
Machinery and tools used in a pre-production process not directly used in manufacturing are considered intangible property not subject to the M&T tax. See Daily Press, Inc. and P.D. 06-79 (8/23/2006). In P.D. 14-12 (1/27/2014), the Department determined that a silo used to store coal was not part of the manufacturing process. The coal was taken by a bucket loader and placed on a conveyor to an industrial kiln. Because the silo merely stored the coal and was not connected to any machinery used in the industrial process, the Department determined that it was not part of the manufacturing process.
The Taxpayer had a piping and storage system outside of the main facility where large quantities of sugar were brought to the site by rail car and stored until it was needed. The Taxpayer also had refrigeration units inside the facility where other raw materials were stored until they were needed, at which point they were manually removed. In addition, the Taxpayer had an oil storage system for vehicles used in the facility. Consistent with P.D. 14-12, it does not appear that any of these storage systems were directly involved in the manufacturing process.
In addition, the Taxpayer had a water cooling tower and pressurized air tanks that stored water and air, respectively, that were piped to the bottle molding machinery. The water was necessary to cool the blow molding equipment that the Taxpayer concedes was directly used in a manufacturing process, namely creating the bottles, and the pressurized air was used to fix labels to the bottles during the blow molding phase. While this equipment stored materials, they also assisted in delivering the materials to the manufacturing process.
In addition, it was discovered in a request for further information made by the Department that several water chilling systems may no longer have been in the facility during the tax years at issue. The Department is not aware, however, that the Taxpayer has provided any specific documentation to the City as to the disposition of such assets.
Warehouse Equipment
The Taxpayer contends that a majority of certain assets, including pallet labelers, forklifts, sweepers, scrubbers and pallet jacks, were housed and operated in the warehouse portion of the facility, away from the manufacturing lines. The City asserts that the equipment the Taxpayer labeled as warehouse equipment was used throughout the manufacturing process, both in the warehouse and on the production floor. The City concedes that sweepers were not used in the manufacturing process but states that pallet jacks and forklifts were used in various stages of the manufacturing process to move products from one station to another.
Equipment that moves semi-finished products from one stage of the manufacturing process to another is used directly in the manufacturing process and thus is subject to the M&T tax. See P.D. 04-39. Equipment used exclusively in a shipping or storage area once the manufacturing process is complete, however, would not be subject to the M&T tax. In addition, when equipment is partially used in the manufacturing process and partially used in another function, the equipment will nevertheless remain subject to the M&T tax when its use in the manufacturing process is substantial. See P.D. 04-39 and P.D. 08-88 (6/16/2008).
While it claimed equipment housed and operated in the warehouse portion of its facility was exempt, the Taxpayer concedes that at least some of the assets may not have been used exclusively in the warehouse. The City asserts that the equipment was used both in the warehouse and for production purposes.
It is unclear how substantial the use of such equipment was in any manufacturing processes. The Taxpayer has represented that the equipment was devoted to moving full finished goods about 80% of the time and raw materials 20% of the time. In the Department's opinion, the Taxpayer's representations appear anecdotal and lack objective evidence to meet its burden of proof as to whether this equipment was taxable or not.
DETERMINATION
With respect to shipping and packaging equipment, the manufacturing process was complete once the consumer unit was packaged. Any equipment that was used to further package and ultimately ship the products would not have been involved in the manufacturing process. In particular, the palletizers and wrappers the Department observed were not directly involved in the manufacturing process and thus were not subject to the M&T tax.
Sugar transportation and storage systems used outside the facility, refrigeration units inside the facility that were used to store raw materials, and the oil storage system for plant vehicles were also not directly involved in the manufacturing process. The water cooling tower and associated equipment and the pressurized air tanks used to store water and air, respectively, that were needed for the functioning of bottle molding equipment were directly involved in the manufacturing process and were thus taxable.
Finally, the Taxpayer's representations as to the warehouse equipment were inconclusive as to enable the Department to determine whether and to what extent any such equipment was taxable or not. Therefore, the City's determination that such equipment was taxable is upheld.
This case will be returned to the City to correct the assessments in accordance with this determination. In addition, the Taxpayer should provide documentation to the City within 30 days of the date of this letter to demonstrate that the systems listed on its schedule as not being on the production lines were not at the facility during the tax years at issue. If such documentation is satisfactory to the City, the assessment should further be adjusted accordingly.
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/1166.M