Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Quality control exemption
Topic
Taxability of Persons and Transactions
Date Issued
06-04-1993
June 4, 1993
Re: §58.1-1821 Application: Sales and Use Tax
Dear*************
This will reply to your letter of October 20, 1992 in which you seek correction of a sales and use tax assessment for your client,***********(the "Taxpayer"). The original assessment has already been adjusted on two separate occasions. This letter will first address your supplemental letter of March 8, 1993 in which the Taxpayer has offered to not pursue a refund of an alleged sales and use tax overpayment during the period of January through May of 1988 in full satisfaction of the outstanding assessment.
The Taxpayer claims that it erroneously billed a customer for sales and use tax which was not due on a sale. The Taxpayer further claims that, although it did not collect the tax from its customer, it remitted an amount equal to the tax to the department. The Taxpayer further claims that it has never requested a refund of the amount incorrectly remitted to the department.
Va Code §58.1-1823 provides that any person required to file a tax return with the department may, within three years from the last day upon which the original returns was to be filed, file an amended return to claim a refund. As the alleged erroneous overpayments were made from January through April 1988, clearly the period during which the Taxpayer could have claimed a refund has expired. Taxpayer is, therefore, offering to forego rights that it does not possess.
Consequently, the Taxpayer's request that the department abate the assessment is denied. The remainder of this letter is devoted to the audit issues raised in your original letter.
FACTS
The Taxpayer is a manufacturer of nose cones for jet fighter and missile heads, and mobile military hospitals. The Taxpayer primarily contracts with the federal government. The Taxpayer protests the imposition of use tax upon various items included in the audit.
DETERMINATION
The Taxpayer's arguments are primarily based upon its assertion that the contested items are used in a quality control function and are, therefore, not subject to taxation.
VR 630-10-63(C)(2) provides that equipment used for production line testing and quality control is exempt from taxation. The department has interpreted this regulation to only include equipment that is directly used in a testing or quality control function. Additionally, the quality control exemption only applies to the testing or monitoring activities that occur during the manufacturing process. Such activities be intended to maintain the integrity of the products being produced for the activity to be exempt from taxation. Testing which occurs away from the production line, such as post-production testing to determine whether or not the product meets contract specifications or applicable safety standards or for some other reason, is not exempt from taxation.
For simplicity reasons, I shall address each contested item separately.
Plotters and Printers
The Taxpayer uses plotters and printers to record and document quality control test results. The Taxpayer contends that it uses the items in an exempt function and should not be subject to taxation. This claim is based upon the Taxpayer's belief that items exclusively used in a quality control function are exempt from taxation.
The quality control exemption does not include equipment that is used to record the results of the production line testing or quality control activity regardless of the use of the recorded information. See P.D. 86-46 (March 14, 1986).
The equipment is used to produce a report that the Taxpayer provides to the government. Unlike equipment that is used directly in the testing of products on the production line, the plotters and the printers are used to record the test results conducted by equipment. Since the Taxpayer uses the plotters and printers in a support/administrative capacity, and not directly in the testing activity, the items are not exempt from taxation.
Alternatively, the Taxpayer asserts that since the plotters and the printers produce reports that are tendered to the government along with the products, the Taxpayer is engaged in the manufacturing of reports and the equipment used directly in the processing of such reports is exempt from taxation.
Va. Code §58.1-608(A)(3)(b)(i) provides an exemption from the sales and use tax for equipment used directly in the manufacturing of products for resale. In Golden Skillet v. Commonwealth of Virginia, 214 Va. 276 (1973), the Supreme Court of Virginia determined that the manufacturing exemption applied to machinery used in the manufacturing of products only in the industrial sense.
The taxpayer in Golden Skillet argued that its purchase of machinery and equipment used to prepare chicken for resale was not subject to taxation pursuant to the manufacturing exemption. The Court held that the use of the equipment to prepare the raw materials for use by its customers was processing; however, such activities were clearly ancillary to the services rendered by the restaurant and thus the operation was nonindustrial.
Like the taxpayer in Golden Skillet, the Taxpayer is not a manufacturer in the industrial sense with regard to its production of the quality control reports. The Taxpayer's use of the plotters and printers to produce the reports is, therefore, not exempt from taxation pursuant to the manufacturing exemption. However, since the Taxpayer tenders the reports to the government along with the products, it shall not be required to pay use tax on its purchase of the supplies (ink and paper) which ultimately become the reports.
Electronic Equipment
The Taxpayer uses certain electronic equipment to bombard the products with radar and x-rays to determine if they meet the government's contract specifications. The Taxpayer asserts that such equipment is used directly in a quality control process and, thus, is entitled to the exemption.
Unlike the plotters and printers, the Taxpayer's use of the electronic equipment is to determine whether its products are adequate and within contract specifications. Since the electronic equipment is used to test the products for quality control purposes, such equipment is exempt from taxation. However, only testing equipment used during the production process is exempt. Equipment used to test products after such products have been manufactured are not exempt from taxation. If certain equipment is used to test products both during and after the production process, the tax will not be imposed if the Taxpayer predominantly uses such equipment for quality control testing purposes.
Our determination that the electronic equipment is exempt from taxation is based upon the assertions contained in your letter. The auditor indicated that she could not determine whether or not the equipment was actually used to test the products. We shall, therefore, need to reexamine the Taxpayer's use of the equipment before actually removing these items from the audit.
Lead Doors
The Taxpayer's radar test facility includes lead doors. The Taxpayer claims that the inclusion of the lead doors in the audit is incorrect since the doors act as a safety device to protect employees from exposure to potentially harmful radar and x-rays. This assertion is based upon the sales and use tax exemption provided to manufactures that gratuitously furnish employees with safety apparel. See, VR 630-10-63(C)(2).
Although the lead doors may protect employees from exposure to harmful rays, the protective garment exemption is inapplicable to structural items. The taxpayer's assertion that the lead doors are exempt from taxation due to VR 630-10-63(C)(2) is, therefore, incorrect.
Alternatively, the Taxpayer asserts that the lead doors are used to absorb the radar and x-rays to reduce the number of stray rays that may result in erroneous testing. If the lead doors do in fact create a sanitized testing environment which increases the accuracy of the quality control function, thus increasing the integrity of the products, then it appears that the lead doors would be exempt from the imposition of taxation.
Although the taxation of the lead doors has been the subject of several pieces of correspondence and meetings between the department and the Taxpayer, the Taxpayer has only previously asserted that the lead doors are exempt from taxation based upon the argument that they serve a safety function. Since this is the first time the Taxpayer has raised the quality control argument in regard to the lead doors, the department will have to confirm the Taxpayer's assertion. The Taxpayer must, therefore, provide the department with evidence that will support its argument that the lead doors improve the environment in which quality control testing occurs.
Various Testing Equipment and Supplies
The Taxpayer also claims that it uses several other items in quality control activities which are exempt from taxation. The items include a ladder, wedge absorbers, contact cement to affix the wedge absorbers to the test facility walls, Safnshilded rolls, Sylvania viewer, lead letters, and certain chemicals.
Of the items listed, only the wedges, which absorb radar and rays, will qualify for the exemption for the reasons stated in the section above discussing lead doors. Additionally, our review of the audit work papers reveals that the chemicals included in the audit are chemicals used to purify water to maintain proper heating of items used directly in the production process. Since the chemicals maintain a stable environment which in turns ensures the products integrity, the chemicals are exempt from taxation.
The other items listed above do not qualify for the quality control exemption and are, therefore, taxable.
Chuck Keys
The Taxpayer uses various chuck keys to remove and replace drill bits from exempt production line equipment. The Taxpayer claims it uses the chuck keys directly in the manufacturing process. VR 63010-63 states that tools that are an integral part of the production process are exempt from taxation. Chuck keys used to replace machinery parts are an integral part of the manufacturing process and are exempt from taxation. The chuck keys will, therefore, be removed from the audit.
White Paper Overalls
The Taxpayer further asserts that its employees' use of white paper overalls when handling the radomes to protect the products from dust and dirt is exempt from taxation pursuant to the quality control exemption. The Taxpayer and the department came to a mutual understanding that since paper overalls were used both in the manufacturing process and the maintenance process, only the portion of the overalls used for maintenance activities would be included in the audit. The use of equipment and supplies during a maintenance process is not exempt from taxation. Of the overalls included in the audit, the Taxpayer's use of such overalls was taxable.
Penalties
Finally, the Taxpayer asserts that it is entitled to have penalties waived since it satisfied the applicable compliance ratio. However, contrary to the Taxpayer's assertion, after the final revision, the Taxpayer's compliance ratio was less than 50%. The Taxpayer has not demonstrated any basis upon which to justify the waiving of penalties. Its request is denied.
An auditor from the******* District Office will be contacting the Taxpayer in order to reexamine those items discussed herein and make the necessary changes to the assessment.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/6534O
Rulings of the Tax Commissioner