May 16, 2018
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This will reply to your letter in which you seek the correction of assessments issued to ***** (the “Taxpayer”) for the period February 2012 through January 2015. It is noted that the assessment bills are paid in full. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer mines, manufactures, processes and sells construction aggregate, mine safety dust, lime and mineral fillers. The Taxpayer also produces and sells concrete masonry products. The Department audited the Taxpayer and assessed retail sales and use taxes on various untaxed sales, fixed asset purchases and expense purchases.
The Taxpayer contests the sales tax assessed in the audit on certain untaxed sales. The Taxpayer disputes the assessment of use tax on certain fixed asset purchases on the basis that the purchases qualify for the mining exemption. The Taxpayer also maintains that various expense purchases assessed in the audit are exempt from the tax, including tools to repair and maintain manufacturing equipment, lubricants, repair and replacement parts and labor charges. Finally, the Taxpayer contests the assessment in the audit of the use tax compliance penalty.
DETERMINATION
Strict Construction of Exemptions
The Virginia courts have consistently required the strict construction of sales and use tax exemptions. 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. See Commonwealth of Virginia v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973). In addition, Virginia Code § 58.1-205 1 states that any assessment of a tax by the Department shall be deemed prima facie correct. This means that the burden is on taxpayers to prove that an assessment issued by the Department is not correct. Keeping the cited authorities in mind, I will address the contested transactions set out in the Taxpayer's appeal letter by reference to the exception numbers in the audit report.
Sales
Exception #s 1 and 2
The Taxpayer states that these untaxed cash sales were made to a mining business. An exemption certificate cannot be located to support the exempt sales to this customer. Virginia Code § 58.1-623 A states, in part, that:
All sales or leases are subject to the tax until the contrary is established. The burden of proving that a sale, distribution, lease, or storage of tangible personal property is not taxable is upon the dealer unless he takes from the taxpayer a certificate to the effect that the property is exempt under this chapter.
Virginia Code § 58.1-633 A also provides that:
Every dealer required to make a return and pay or collect any tax under this chapter shall keep and preserve suitable records of the sales, leases, or purchases, as the case may be, taxable under this chapter, and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner.
While the Taxpayer states the sales were made to a mining business, this fact alone is not sufficient to conclude that the sales are exempt. The Taxpayer did not produce an exemption certificate for this customer and has not provided any documentation to support the removal of these sales transactions from the audit.
Exception #s 3 and 4
The Taxpayer maintains that the materials sold in these sales transactions were delivered to a mining business located in another state. The sales invoices indicate a Virginia billing address for the customer. The information in the “ship to” address field of the invoices provides insufficient information regarding the shipping or delivery address of the customer. The customer also furnished the Taxpayer a sales and use tax exemption certificate for the state where delivery is claimed to have been made.
Virginia Code § 58.1-609.10 4 exempts from the sales and use tax the “[d]elivery of tangible personal property outside the Commonwealth for use or consumption outside of the Commonwealth.” Title 23 of the Virginia Administrative Code (VAC) 10-210-780, which interprets the exemption, states in subsection A 1 that one example of an exempt sale in interstate commerce is “[t]he sale of tangible personal property delivered to the purchaser outside of the state in the seller's vehicle.” The sales transactions at issue may qualify for exemption if the Taxpayer delivered the goods to the customer's location in another state. However, the Taxpayer has not furnished the Department adequate information to confirm the place of delivery.
The Taxpayer's customer presented a Kentucky resale exemption certificate that also applies to manufacturing and industrial processing businesses. Regardless that the exemption certificate was provided, the Department is unable to confirm that delivery occurred in Kentucky, where the exemption is applicable. To remove these sales from the audit, the Taxpayer must present to the Department documentation that proves delivery was made to the customer in the state of Kentucky.
Exception #7
The Taxpayer maintains that sales exception #7 is an exempt charge for freight or delivery that was billed to the customer. The auditor held the sale taxable because the invoice appears to indicate that the transaction was for the sale of stone. The sales invoice states “Haul bill for stone” but also contains two line items that appear to be charges for gravel.
Virginia Code § 58.1-609.5 2 exempts from the sales and use tax separately stated charges for the transportation or delivery of tangible personal property. Based on the manner that the Taxpayer invoices its customers, the Department must verify that the charges at issue are for freight or delivery only. The Taxpayer must demonstrate through its accounting records that this transaction was accounted for as freight or delivery sales revenue and that there was no sale of stone. The Department's auditor will review the necessary accounting records for this transaction and remove the transaction from the audit, if warranted.
Exception #s 16 and 17
The Taxpayer states that exempt freight or delivery charges were improperly included in the taxable sales amounts for these audit exceptions. These transactions were for the sale of mine dust and an unknown item. Each invoice contains a line item for a fuel surcharge, which appears to also list a freight charge. Due to the confusing nature of the Taxpayer's invoices, the Department must verify that the invoice amounts represent the actual freight charges that are contested by the Taxpayer. Upon verification that the contested exception amounts are freight charges, the taxable measure for these sales will be reduced by $300.53 and $107.09 on invoice #s 43101 and 43102, respectively.
Exception #s 19, 20, 21, 22 and 24
The Taxpayer provided the Department copies of two types of exemption certificates received for these sales transactions from the customer. A Form ST-10, resale exemption certificate, was received from the customer and is dated January 1, 2014. Form ST-14 exemption certificates with various dates ranging from June 2, 2014 to June 30, 2014 were also received from the customer. The ST-14 is for use by out-of-state dealers that purchase property in Virginia for resale in another state and immediately transport the property in the purchaser's vehicle to the other state.
The Taxpayer contends that these sales exceptions qualify for the resale exemption on the basis that the items sold were picked up by the customer and transported immediately to another state for sale there. Virginia Code § 58.1-623 B addresses the use of exemption certificates and states, in part:
The certificate mentioned in this section shall relieve the person who takes such certificate from any liability for the payment or collection of the tax, except upon notice from the Tax Commissioner that such certificate is no longer acceptable. Such certificate shall be signed by and bear the name and address of the taxpayer; shall indicate the number of the certificate of registration, if any, issued to the taxpayer; shall indicate the general character of the tangible personal property sold, distributed, leased, or stored, or to be sold, distributed, leased, or stored under a blanket exemption certificate; and shall be substantially in such form as the Tax Commissioner may prescribe.
Title 23 VAC 10-210-280 A interprets Virginia Code § 58.1-623 and states that “a certificate that is incomplete, invalid, infirm or inconsistent on its face is never acceptable, either before or after notice.” A review of the Department's records indicates that the customer is a Virginia dealer. Form ST-14 is a resale exemption certificate for use by out-of-state dealers. In addition, Form ST-14 states that the customer's business activity is “gas well road maintenance.” This business activity is not consistent with the use of a resale exemption certificate because the customer is acting as a using and consuming contractor. Thus, the use of Form ST-14 is invalid.
The Form ST-10 furnished by the customer lists the business activity as “trucking and excavating.” Again, this business activity is not consistent with the use of a resale exemption certificate. The customer is acting as a using and consuming service provider and real property contractor. Based on the provisions of Title 23 VAC 10-210-280 A, the certificates received by the Taxpayer from this customer are invalid. There is no basis to remove the contested sales transactions from the audit.
Fixed Assets
The Taxpayer contests the assessment of use tax on the purchase of repair and replacement parts for a water truck. The Taxpayer contends that the water truck is used directly in mining activities and qualifies for exemption pursuant to Virginia Code § 58.1-609.3 2 (iii). The Taxpayer states that federal and state regulations require mining businesses to control the amount of dust created at mining sites and facilities.
Public Document (P.D.) 95-231 (9/12/95) discusses a business that used water trucks in its surface mining operations to control dust. The mining business contested the use tax assessment on the water trucks. The Tax Commissioner ruled that the water trucks did not qualify for the exemption because they were not used directly in mining activities. I find that the facts of this case are consistent with this prior determination. Based on the policy set out in P.D. 95-231, the use tax assessment on the water truck parts, listed as exception #s 2 and 3 in the audit's fixed asset list, is correct.
Expense Purchases
Tools
The Taxpayer contests the assessment of use tax on purchases of various types of tools, including but not limited to, screwdriver sets, air hoses, drill bits, hole punches and box wrenches. The Taxpayer asserts that the purchases are exempt from the tax because the tools are used to work on exempt manufacturing equipment.
Virginia Code § 58.1-609.3 2 (iii) exempts from the retail sales and use tax “[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 ....” [Emphasis added.] The term “used directly” is defined in Virginia Code § 58.1-602 as “those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing ... process, but not including ancillary activities such as general maintenance or administration.”
In Commonwealth v. Community Motor Bus, the Virginia Supreme Court held that the use of the word “directly” in the statute was intended to narrow the scope of the exemption. The manufacturing exemption, therefore, applies only when an item is indispensable to actual production and is used or consumed immediately in the actual production of products. This standard established by the Court is also reflected in the Department's manufacturing regulation. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 interprets the used directly requirement of the manufacturing exemption statute and states that:
Items of tangible personal property which are used directly in manufacturing and processing are machinery, tools and repair parts therefor, fuel, power, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt production machinery. Furthermore, the fact that the use of a particular item, such as firefighting and safety equipment, may be required by federal, state or local law is not, by itself, dispositive of direct usage in manufacturing or processing. [Emphasis added.]
The Department's longstanding policy is that the repair and maintenance of manufacturing equipment is a taxable activity. Title 23 VAC 10-210-920 C 2 provides that tangible personal property used to repair, service and maintain production machinery is taxable. These types of activities typically occur before or after actual production or when production stops due to the need to repair production equipment. As such, tools and equipment that are used in repair and maintenance activities are not an immediate part of production and, for this reason, are not considered to be used directly in manufacturing.
P.D. 09-170 (10/23/09) discusses a manufacturer that contested the Department's use tax assessment on the purchase of torque wrenches. The wrenches were used daily to install die heads on production machinery prior to production runs and were also used to remove and replace damaged die heads. The Tax Commissioner ruled that, while the torque wrenches were essential to production, they were not an immediate part of the actual production process. The types of tools purchased by the Taxpayer are used in taxable maintenance and repair activities consistent with the facts in P.D. 09-170.
A review of the contested tool purchases reveals that exception #178 is a purchase of steel chain, hooks, chain slings and eyebolts. The items are described in the appeal aspurchases of tools used to work on raw material bins. It is not clear how the steel chain, hooks, chain slings and eyebolts were used by the Taxpayer or if any of the items are replacement parts for raw material bins. The purchases were not coded to a specific expense account. For these reasons, the Taxpayer will be allowed to provide documentation regarding this transaction to the auditor for review. If the auditor determines that some or all of the items are used directly in the Taxpayer's manufacturing process, the audit will be adjusted accordingly.
Based on the information provided, the Taxpayer has not met its burden of proving that the remaining contested tool purchases qualify for exemption from the tax. The items purchased were used to repair and maintain production machinery, which is a taxable activity. The use tax was properly assessed on exception #s 66, 97, 118, 129, 166, 184, 185, 187, 191, 193, 195, 205, 206 and 217.
Quality Control
The Taxpayer maintains that some of the items assessed in the audit are used in exempt quality control activities. Title 23 VAC 10-210-920 C 2 states that “[e]quipment used for production line testing or quality control is classified as exempt production equipment.” To qualify for the exemption, the property must be used directly in the production process and the activity must occur during actual production. I understand that the Taxpayer performs quality control activities in a laboratory after production.
The Department's policy regarding this issue is set out in P.D. 93-135 (6/4/93), which discusses a manufacturer's use of production line testing and quality control equipment. P.D. 93-135 states that the quality control exemption only applies to testing or quality control activities that occur during the manufacturing process. Testing that is performed away from the production line, such as post-production testing, is not exempt from taxation.
The Taxpayer has not presented evidence that the items listed as exception #s 140 and 212 are used in quality control activities that occur during the production or manufacturing process. These exceptions will remain in the audit. In contrast, the auditor confirms that the items purchased and listed in the audit as exception #s 179 and 180 were used on the production line to remove contaminants from raw materials during the production process. Exception #s 179 and 180 will be removed from the audit.
Other Manufacturing Issues
Exception #3 is an untaxed purchase of parts for a packaging machine. The auditor verifies that the packaging machine is used directly in the manufacturing process. As the manufacturing exemption applies to repair or replacement parts for exempt manufacturing equipment, this item will be removed from the audit.
Exception #169 is an untaxed purchase of high temperature grease. The Taxpayer states that the grease is used in its block curing process and qualifies for exemption from the tax. The Taxpayer also contests the inclusion in the audit of exception #226, which is a purchase of calcium chloride. The Taxpayer states that the calcium chloride is used to treat water in a steam generator that is used in its block curing process. The auditor noted that the calcium chloride purchase was expensed to a building and grounds account, which likely makes the purchase taxable. The Taxpayer must provide additional information regarding the use of the high temperature grease and the calcium chloride to support the removal from the audit of these items.
Exception #181 is the untaxed purchase of multipurpose gauges and dial thermometers. The Taxpayer states that these items are used in a crusher to measure oil temperature. A review of the invoice indicates the purchases were not coded to an expense account. I will allow the Taxpayer an opportunity to provide documentation to the auditor to verify that the parts were for use in exempt manufacturing equipment. The audit will be adjusted subject to verification of the exempt use of the parts.
Exception #203 is the untaxed purchase of parts and tools. The auditor confirms that the parts are used on the Taxpayer's conveyor system. The conveyor system is used directly in the Taxpayer's production process. As such, the belt fasteners and clips will be removed from the audit. The remaining items on the invoice are tools used to work on the conveyor system and will remain in the audit.
The Taxpayer contests three invoices from the same vendor that are listed in the audit as exception #s 222, 223 and 224. The Taxpayer purchased heat shrink guns and repair parts for heat shrink guns. The Taxpayer claims the heat shrink guns are used to apply packaging materials to its products during the production process.
Title 23 VAC 10-210-920 C 2 states that the manufacturing exemption applies to “[w]rapping or packaging equipment and supplies used at the plant site in packaging products for sale or resale.” If the application of the packaging materials occurs on the production line, the exemption would apply. The auditor will review the Taxpayer's use of the heat shrink guns to determine if these purchases qualify for exemption and adjust the audit, if warranted.
Use Tax Accruals
The Taxpayer has provided documentation that it accrued and paid to the Department use taxes on certain purchases that were assessed in the audit. The auditor confirms that the audit includes purchases on which the use tax was accrued and paid by the Taxpayer. This information will be referred to the audit staff for review and verification. The audit will be adjusted based on confirmation of the use taxes paid.
Quarry Equipment
The Taxpayer states that exception #s 64, 145 through 148 and 236 are purchases that qualify for the mining exemption. Exception #64 is the purchase of a replacement part for a tractor used directly in the mining operation. This item will be removed from the audit. Exception #s 145 through 148 and 236 are purchases that the Taxpayer charged to an expense account for water trucks. This is a taxable account based on my earlier determination that the water trucks do not qualify for the mining exemption. An exempt shipping charge was included in the taxable amount for exception #146. The taxable amount for this item will be reduced by the $33.60 shipping charge. The remaining taxable amounts for exception #s 145 through 148 and 236 were properly included in the audit.
Bulk Lubricants
The Taxpayer contends that the use tax assessment on bulk purchases of lubricants from one of its vendors is overstated. The Taxpayer has provided an analysis of what it deems to be the correct allocation of the lubricant costs to taxable and exempt equipment expense accounts. The auditor used the Taxpayer's expense codes to determine the taxable amounts of the lubricants purchased by the Taxpayer. In some instances, complete information was not available for the auditor to determine the correct expense amounts allocated to each account. The auditor also notes that some expense accounts treated by the Taxpayer as exempt did include taxable equipment and property. I will agree to have the auditor review the allocation of the lubricants purchased from this vendor, which are identified as exception #s 15, 16, 21, 27 and 35. The audit will be adjusted accordingly.
Service and Labor Charges
The Taxpayer contests the inclusion in the audit of exception #s 150, 210, 213 and 214 on the basis that the charges are for exempt labor. Virginia Code § 58.1-603 imposes the retail sales tax on “the gross sales price of each item or article of tangible personal property when sold at retail or distributed in the Commonwealth.” Virginia Code § 58.1-602 defines “sales price” as “the total amount for which tangible personal property or services are sold, including any services that are a part of the sale, ... without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever.” [Emphasis added.]
Absent a statutory exemption in the Code of Virginia, labor or service charges are taxable when billed in connection with the sale of tangible personal property. Generally, a sales transaction that includes charges for tangible personal property and related services is taxable on the full amount of the sale, even if charges for the services are separately stated on the invoice or record of the sale. Further, services that enjoy a statutory exemption must be separately stated on the invoice or record of the sale.
The invoice for exception #150 is for the repair of a flat tire on a water truck. The Taxpayer was billed the retail sales tax on the charge for the materials. The untaxed service charge was assessed in the audit. Virginia Code § 58.1-609.5 2 provides an exemption from the tax for “[a]n amount separately charged for labor or services rendered in installing, applying, remodeling, or repairing property sold or rented.” The labor charge at issue is referred to on the invoice as a “service call.” It is not clear from the use of this term what types of labor or services were performed.
It is likely the charge includes travel time to and from the vendor's place of business and the Taxpayer's location, which is a taxable service. See P.D. 11-74 (5/17/11) for a discussion of taxable travel, trip and similar charges as they relate to repair transactions. It is also likely the service call charge includes labor to repair the flat tire, which the repair business failed to separately state. For purposes of this issue only, I will agree to waive one-half the charge for the service call based on the assumption that the charge includes exempt repair labor.
Exception #210 is a charge for labor to repair a flat bed trailer. The invoice describes the labor that was performed as “weld and plate cracks around main frame rails...” and “weld cracks in side rubrail.” The labor charge was treated as taxable fabrication labor by the auditor. Title 23 VAC 10-210-560 A states that “an operation which changes the form or state of tangible personal property is fabrication. Fabrication is distinguished from repair which is an operation that restores a used or worn piece of tangible personal property.” Based on the invoice description for this transaction, the labor charges are for the repair of a trailer. The welding was performed to restore the condition of the trailer. Pursuant to Virginia Code § 58.1-609.5 2, exception #210 will be removed from the audit.
The invoice for exception #213 contains an untaxed labor charge described as “fixed hole in tube on tanker - bolted air tank down and welded broken cross brace.” The sales tax was charged on the materials transferred to the Taxpayer. This charge is also exempt repair labor and will be removed from the audit. Exception #214 is also an invoice that contains untaxed labor charges and a charge for materials that was taxed. The labor charges are for replacing a bent channel on a gooseneck trailer and to straighten and adjust racks. These are charges for repair labor and will be removed from the audit.
Compliance Penalty
The Department's records indicate that this was the Taxpayer's sixth audit. The Taxpayer's use tax compliance for the audit period was 79%. Pursuant to Title 23 VAC 10-210-2032 B 1, the application of a compliance penalty to audit deficiencies is mandatory and is assessed based on the taxpayer's compliance ratio as determined in the audit. The required compliance ratio for third generation and subsequent generation audits is 85%. Because the Taxpayer's compliance ratio was 79%, the penalty was properly applied in the audit.
The Taxpayer states that a substantial amount of sales and use taxes were paid to vendors during the audit period and has provided a spreadsheet with supporting payment information. The Taxpayer's compliance ratio will be recalculated to reflect the revisions to the audit as set out in this determination. If the resulting compliance ratio meets or exceeds 85%, the penalty will be waived. If necessary, the Taxpayer may also provide to the auditor during the audit revision process documentation of sales and use taxes paid to vendors for consideration of penalty waiver under the alternative method set out in Title 23 VAC 10-210-2032 B 2.
CONCLUSION
The Department's records indicate the Taxpayer has paid in full the audit assessments issued as bill ***** and bill *****. The auditor will be notified to revise the audit based on this determination and the review of additional documentation provided by the Taxpayer. The audit liability will be recomputed and the Taxpayer will be provided a copy of the revised audit report. Refunds of the bill overpayments, with applicable interest, will be issued to the Taxpayer as soon as practicable.
The Code of Virginia sections, regulations and public documents cited 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 Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/836.S