October 26, 2023
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessment issued for the period February 2013 through January 2019. The Taxpayer has paid the assessment in full. I apologize for the delay in responding to your correspondence.
FACTS
The Taxpayer, a manufacturer of hardwoods that are sold to vendors who produce furniture, flooring, and other like items, was audited for the period at issue. The auditor determined that certain items of tangible personal property purchased without payment of the retail sales and use tax were not used directly in manufacturing or processing and an assessment was issued. The Taxpayer appeals, contending two items, kiln decking, and a picture tally system, were being used directly in manufacturing and should not have been included in the audit exceptions.
DETERMINATION
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 that 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.”
All exemptions from the retail sales and use tax are required to be strictly construed against the one claiming the exemption. Golden Skillet Corp. v. Commonwealth, 214 Va. 276 (1973). With this strict construction rule in mind, Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 defines the term "used directly" as meaning "those activities that are an integral part of the production of a product, including all steps of an integrated process, but not including incidental activities such as general maintenance, management, and administration." [Emphasis added.] In conformity with the strict construction rule, this regulation further states:
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.]
Keeping the cited authorities in mind, I will address the contested items set out in the Taxpayer's appeal letter below.
Kiln Decking
The kiln decking was used to regulate air flow inside of a kiln chamber that holds wood as it arrives from lumber yards. This decking helps ensure the proper temperature of air circulating around raw lumber to more evenly dry the wood at a faster rate. The Taxpayer argues that this equipment is part of the intake process for raw wood before it is available to be processed into usable lumber.
In order for an item to qualify for the industrial manufacturing exemption, it must be both used directly in the production process and indispensable and an immediate part of the production process. As set out in Public Document (P.D.) 98-10 (1/20/1998), the fact that an item is essential to production is not sufficient grounds for exemption based on the Virginia Supreme Court's holding that “essential items which are not an immediate part of actual production are not exempt.” Webster Brick Company, Inc. v. Department of Taxation, 219 Va. 81 (1978). In addition, when there is any doubt as to whether an exemption applies, the Department must adhere to the rule of strict construction of the statutory exemptions as established by the Virginia courts and deny the exemption.
As provided above, in order for the manufacturing exemption to apply, an item must be used directly in the manufacturing process. In this case, the kiln deck merely aids in the drying of raw wood before the wood is put into production. While drying the wood may be helpful to the production process, the kiln deck was not an immediate part of actual production and, therefore, does not qualify as exempt equipment.
Picture Tally System
The picture tally system, consisting of both computer hardware and, cameras, lights, and controls combined to track and measure boards of wood in bundles of lumber, in order to ensure the proper, precise measurement, and efficient tracking of lumber during its transformation. The main part of the system is located in a steel cab enclosure separate from the production line and is fitted with doors and safety glass that allows an individual to enter and operate the machine.
The Taxpayer contends that the picture tally system is used in a number of ways throughout the lifecycle of their operations and is exempt manufacturing equipment. Based on the information provided on appeal, the picture tally is utilized at various stages in the Taxpayer’s operations, but is primarily utilized as a way of tracking and managing inventory after the raw wood has been processed into usable lumber.
Title 23 VAC 10-210-920 C 1 provides that the managerial, sales, and non-operational aspects of manufacturing and processing, which includes selling, marketing and record keeping, are indirect to the actual production of a product and are, therefore, taxable. Such property includes:
Office furniture, supplies and equipment, textbooks and other educational materials, books, and records, and all other items used in record keeping and other administrative or managerial activities, whether on or off the assembly line. Also included are computer hardware and canned software, calculators, and other such items used to record the quality and quantity of work in production or goods in storage, the flow of work, and the results of inspections… [Emphasis added].
While some of the functions of the picture tally system aided in the manufacturing process, the evidence provided does not clearly show that the system was an integral part of the production of the Taxpayer’s product. In addition, many of the functions of the system were administrative and occurred after the raw wood has been processed into usable lumber. Under these circumstances, the picture tally system does not qualify for the manufacturing exemption.
Based on this determination, the assessment is correct as issued. The Taxpayer has paid the assessment in full and no further action is required.
The Code of Virginia sections, regulation, and public document cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section for the Department's website. If you have any questions about this determination, you may contact ***** in the Department’s Office of Tax Policy, Appeals and Rulings, at (804) *****, or via email at *****@tax.virginia.gov.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/2221.C