Tax Type
Retail Sales and Use Tax
Description
Manufacturing; Computer software and equipment; Color swatches
Topic
Taxability of Persons and Transactions
Date Issued
01-11-1990
January 11, 1990
Re: §58.1-1821 Application/ Sales and Use Tax
Dear***********************
This will reply to your letter of December 13, 1988 seeking correction of an assessment in the above referenced case for the period of September 1985 through June 1988.
FACTS
************** ("the Taxpayer") is a manufacturer and retailer of silk ladies wear and men's ties ("the silkwear"). The Taxpayer was recently audited and held liable for failure to remit use tax on its purchases of computer hardware, computer software, swatches, and swatch cards and photographs used to procure customer orders.
A color computer is used by the Taxpayer to create full color designs for the silkwear. Once a design is approved by the Taxpayer, a printout is created and sent to a firm in Italy which prints the design onto silk material. The design imprinted silk materials are then returned to the Taxpayer to be manufactured into various shapes and sizes.
The computer software is used for inventory control, customer billing, and preparation of shipping and other related instructions. The software is also used to produce cutting tickets that are used in production to prevent the mixing of different grades of silk. Color swatches, utilized in product design, illustrate the various designs and materials that can be used in making the final product. Swatch cards and photographs display various patterns and designs of silkwear that the Taxpayer manufactures and are used by salesmen to procure customer orders.
The Taxpayer contests the assessment, contending that the above items qualify for the manufacturing exemption under Virginia Code §58.1-608(3)(b).
RULING
The issues raised by the Taxpayer will be addressed separately below.
Color Computer
§58.1-608(3)(b) of the Virginia Code provides an exemption from the sales and use tax for "machinery or tools or ...supplies...used directly in...manufacturing 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." The term "manufacturing" is defined in Virginia Code §58.1-602 as including "including the production line of the plant starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where the product is finished or completed for sale and conveyed to a warehouse at the production site..." (Emphasis added).
Inasmuch as the industrial manufacturing exemption is limited by statute to the production line of a plant, steps that are preparatory to production, such as product design, are not within the scope of the exemption. In this case, the Taxpayer uses its color computer to assist in creating print designs, an activity that is preparatory to production. As such, the computer is not used directly in production activities and is not within the scope of the exemption. Therefore, I find that the color computer was correctly included in the department's audit.
Computer Software
Applying the facts in this case to the provisions set forth in Virginia Regulation (VR) 630-10-63(C)(2), copy enclosed, the Taxpayer's computer software is used in a taxable administrative activity when used for inventory control, customer billing, and preparation of shipping and other related instructions. However, the software is used in an exempt activity when used to produce the cutting tickets which are deemed to be used directly in the production process. It is my understanding that in a recent telephone discussion with a member of my staff, you agreed that while the software is used in different activities, the preponderance of the software's use is in administrative activities based on the above regulation. As such, I find that the software was correctly held taxable in the audit.
Swatches
The Taxpayer indicates that the swatches are used in designing its product. Additionally, the Taxpayer has indicated that the charge of ********** in question was actually for color consulting services rather than for the tangible personal property supplied by the consulting firm.
For the reasons given above in the case with the color computer, the swatches are not used directly in production activities and are not within the scope of the manufacturing exemption. Additionally, based on the information before me, I am unable to conclude that the charge in question is for a nontaxable service. While the Taxpayer may receive color consultation services from its vendor, the true object of the transaction is to secure the property (swatches) which the service produces. As such, the charge is taxable in accordance with Virginia Regulation 630-10-97.1, copy enclosed. However, the Taxpayer may submit additional information on this issue to the department's Technical Services Section (at P.O.Box 6-L, Richmond, Virginia 23282) within 30 days for further review.
Swatch Cards
The Taxpayer sends swatches to a firm for fabrication into swatch cards. Based on Commissioner's ruling dated February 26, 1986, and Virginia Retail Sales and Use Tax Regulation §630-10-37 (Fabrication), copies enclosed, I find that the swatch cards in question were properly included in the audit.
Photographs
Based on Commissioner's ruling dated December 19, 1985, and Virginia Regulation 630-10-18.1, copies enclosed, photographs purchased by the Taxpayer for storage in Virginia for less than 12 months and for distribution outside the state will be removed from the department's audit.
The department's audit will be revised as soon as practicable to reflect the determination reached in this letter and a revised notice of assessment will be issued to the Taxpayer.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner