Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Computer systems
Topic
Taxability of Persons and Transactions
Date Issued
09-27-1993
September 27, 1993
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear*****************
This will reply to your letter of August 25, 1992 in which you seek correction of sales and use tax assessments for the above-named taxpayers.
FACTS
The taxpayers are in the business of manufacturing (sewing) garments. All three taxpayers purchased a computer system to assist in the production process. You contend that the computer systems are used directly in the manufacturing process and qualify for the manufacturing exemption provided in Va. Code §58.1609.3(2) (formerly Va. Code §58.1-608(A)(3)(b)). The auditor determined that the computer systems were not predominantly used in the manufacturing process and assessed use tax. Penalty was also assessed because each of the taxpayers had a zero use tax compliance ratio.
DETERMINATION
Va. Code §58.1-609.3(2) provides an exemption from the sales and use tax for machinery used directly in manufacturing products for sale or resale. The term "used directly" is defined in Va. 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."
Virginia Regulation (VR) 630-10-63 further defines the term "used directly," noting that "[i]tems of tangible personal property which are used directly in manufacturing ... are machinery, tools, and
repair parts therefor, fuel, 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." However, this section continues, "items which are essential to the operation of a business but not an immediate part of the actual production are not used directly in manufacturing."
In this case, the taxpayers use the computer systems for various functions, including use in production activities qualifying for the exemption. Under Va. Code §58.1-609.3(2), equipment is exempt if the preponderance of its use is used directly in manufacturing products for sale or resale. Therefore, the computer systems in this case will be totally exempt if they are used directly in manufacturing more than 50% of the time. However, if used directly in manufacturing 50% or less of the time, the tax applies in full to the computer systems.
You contend that 1,200 to 1,500 of the 20,000 to 25,000 interactions between the operators and the computer are administrative (a taxable activity). However, other functions which you believe are an immediate part of the production process and which may be necessary to the operation of the business as a whole do not touch directly on production as is necessary to gain exemption under the statute.
You note that "the computer controls the plant operation by analyzing vast amounts of product and production line data and optimizing plant production levels by directing the flow of work through the manufacturing process and relieving line supervision and operators of such process." This function appears to relate to production scheduling as it allows production personnel to plan production by telling them which machines and which operators are performing the best. Under VR 630-10-63 C.2., this function (monitoring the efficiency of production machinery) does not touch directly on the manufacturing process and is nonexempt in nature. Similarly, the "count down clock" feature which displays on an operator's terminal the amount of time available to perform a given job is a nonexempt monitoring function.
While it is recognized that some of the functions performed by the computer systems are used directly in the manufacturing process, there is no evidence to prove that the computers are used directly in manufacturing more than 50% of the time. In fact, the auditor noted that the taxpayers acknowledged that it was difficult to know what percentage of time is devoted to what activity, as several activities are occurring simultaneously. Because exemptions from the tax are construed strictly against the taxpayer, and the taxpayers could not document that the preponderance of the computer systems' use was directly in manufacturing products for sale or resale, the auditor properly held the purchases of the computer systems to be taxable.
You cite P.D. 88-154 (6/23/88) to support your position that the computer systems are used directly in manufacturing and, therefore, are tax exempt. However, in that case it was documented that the preponderance of the computer's use was in processing ongoing production line data and providing equipment operators with the information to enable them to make the constant equipment adjustments necessary to ensure correct and continuous production of the product. In the taxpayers' situation, there no documentation that the preponderance of the computers' use is directly in manufacturing.
Regarding the penalty assessment, the use tax compliance ratio of 0% for each of the taxpayers is not deemed acceptable for a fifth generation audit (or a second generation audit in the case of one of the taxpayers). Moreover, the taxpayers have not demonstrated any exceptional mitigating circumstances to warrant waiver of the penalty. Accordingly, the penalty was properly assessed in this case.
However, if you can provide documentation showing that, during the period in question, the preponderance of the computer systems' use was in exempt activities, then the audit will be adjusted accordingly. The information should be sent to the Office of Compliance, Audit Review Unit, P.O. Box 615, Richmond, Virginia 23205-0615, within 30 days. If the requested information is not timely submitted, the information on which the assessment was originally based will be presumed to be the best available.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/7053F
Rulings of the Tax Commissioner