88-70 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Product consignment sales; Test cells for quality control

Topic

Exemptions

Taxability of Persons and Transactions

Date Issued

05-02-1988

May 2, 1988

Re: §58.1-1821 Application/Sales and Use Tax

Dear****************

This will reply to your letter of February 4, 1988, in which you submit an application for correction of sales and use tax assessed to **************** as the result of a recent audit.

FACTS

A recent audit of ********** (Taxpayer) produced an assessment for various untaxed purchases of tangible personal property, including articles used in production activities, products consigned to salesmen, and demonstrators used by manufacturer's representatives. In addition, untaxed sales of tangible personal property were included within the audit, including property the taxpayer claims was delivered to a customer in another state.

The taxpayer contests various of the purchases and sales included in the department's audit and requests the waiver of penalty.

DETERMINATION

Due to the large number of issues raised, I will address each on a separate basis below:

Products delivered in Maryland

The taxpayer contests the inclusion in the audit of products sold to a Virginia customer who took delivery of the products at the taxpayer's Maryland warehouse. As the invoices from these transactions demonstrate that delivery was taken by the customer within Maryland, the department will delete these transactions from its audit.

Test Cells

Test cells are free standing enclosures in which quality control testing of two-way radios produced by the taxpayer is conducted. Test cells are specifically constructed so that outside radio signals will not interfere with the testing of radio frequencies. Such interference might limit the accuracy of frequency testing.

§58.1-608.1 of the Code of Virginia provides an exemption from the sales and use tax for machinery, tools, supplies-, etc. "used directly" in the manufacturing of tangible personal property for sale or resale. Included in the definition of "manufacturing" contained in 58.1-602.9 of the Code of Virginia are "equipment and supplies used for production line testing and quality control." Thus, tangible personal property used directly in production line testing and quality control is exempt from the sales and use tax.

§58.1-602.22 of the Code of Virginia defines the term "used directly" as "those activities that are an integral part of the production of a product." (Emphasis added) Expanding on this, Virginia Regulation 630-10-63 provides that:

- Items of tangible personal property which are used directly in manufacturing...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. (Emphasis added)

In this instance, the test cells are used in exempt quality control activities; however, the cells themselves are not used in an exempt manner. The cells do not play an active role in the actual frequency testing process; rather, they are facilitative to the process by shielding the tests from outside radio interference. As such, I do not find basis for the removal of these items from the department's audit.

Purchase from

The order in question was placed by the taxpayer's division located in Virginia; however, it is not apparent whether delivery was taken within Virginia. This transaction will be removed from the department's audit if the taxpayer can provide documentation from its vendor that delivery occurred in another state.

Proration of Advertising and Promotional Purchases

The department's Technical Services Section will review the previous audit of the taxpayer in order to determine how the transactions in question were treated. In the event that the taxpayer's assertions are verified, the department will revise its current audit in the manner requested by the taxpayer. The Technical Services Section will advise the taxpayer of its findings in this regard.

For the period since the conclusion of the current audit, it should be noted that:

- (1) prior to July 1, 1986, an exemption applied only to catalogs and similar printed materials used to advertise tangible personal property for sale when stored for 12 months or less in Virginia for ultimate distribution outside Virginia, and
  
  (2) from July 1, 1986 to June 30, 1990, the exemption has been expanded to include catalogs, letters, brochures, reports, and similar printed materials, except administrative supplies, when stored for 12 months or less in Virginia for ultimate distribution outside Virginia (see enclosed Virginia Regulation 630-10-86).

In addition, purchases of media advertising were exempted from the tax effective July 1, 1986 (see enclosed Virginia Regulation 630-10-3).

Consignment of Products for Sale

The taxpayer contests the assessment of use tax on products consigned to direct sales personnel. These products were assessed under the provisions of §58.1-623.C of the Code of Virginia, which provides:

- If a taxpayer who gives a certificate (of exemption)...makes any use of the property other than an exempt use or retention, demonstration, or display while holding property for resale...in the regular course of business, such use shall be deemed a taxable sale to the taxpayer.

Based upon the taxpayer's Marketing Administrative Manual (manual), consignments are issued only upon the request of a salesman. In order to receive a consignment, the salesman must identify his prospective customer and the intended duration of the demonstration period. Further, the manual states that consigned products furnished to a prospective customer must be retrieved from or sold to the customer within three months.

If the prospective customer chooses to purchase the consigned product, he must pay the new equipment price set by the taxpayer. If the prospective customer does not agree to purchase the product, it may be sold to another customer at up to 40% off the new equipment price or may be returned to the taxpayer's Virginia facility. The manual states that consignments should not be utilized for more than one year.

Based upon the information presented, the products in question are intended for resale at the time that they are withdrawn from the taxpayer's resale inventory for shipment to salesmen. As such, the tax does not apply under §58.1-623.C of the Code of Virginia. Only in the event that consigned products are subsequently used in Virginia for purposes other than product demonstration would a taxable use occur. Examples of taxable usage would be product samples provided to customers at no charge, products used for office or employee purposes, products used in the training of employees, etc. The department will revise its assessment accordingly.

Demonstrators Consigned to Manufacturer's Representatives

The taxpayer contests the assessment of use tax on products consigned to independent manufacturer's representatives. These products are used for demonstration purposes with prospective customers. The taxpayer's manual requires manufacturer's representatives to purchase or return to the taxpayer's Virginia facility within six months any consigned products. If a manufacturer's representative chooses to purchase a consigned product, he may resell the product to anyone of his choosing.

As is the case above, these products are intended for resale at the time they are withdrawn from inventory. Accordingly, the tax will only apply if a taxable use is later made in Virginia. Based on these facts, the department will resolve this issue in a manner consistent with the above consignments.

Product Sold but Retained as a Consignment

Based upon the facts presented, the department will review this transaction in light of a recent opinion of the Virginia Attorney General, copy enclosed.

Missing Invoices

Based upon the facts presented and the limited number of invoices involved, the department will remove these transactions from its audit sample and compute the tax on a separate basis.

Penalty

Due to the taxpayer's strong use tax compliance at two of its Virginia facilities, as well as its strong sales tax compliance, the department will abate all penalties assessed. It should be noted, however, that significant improvement in use compliance by the taxpayer's other Virginia facilities will be expected in future audits.

The department's audit will be revised based upon the findings contained herein and a revised notice of assessment will be issued to the taxpayer as soon as practicable.

Sincerely,

W. H. Forst
Tax Commissioner

Rulings of the Tax Commissioner