Tax Type
Retail Sales and Use Tax
Description
Manufacturing, processing, assembling, or refining; Environmental equipment
Topic
Taxability of Persons and Transactions
Date Issued
12-05-1994
December 5, 1994
Re: §58.1-1821 Application: Sales and Use Tax
Dear*********************
This will reply to your letter of March 24, 1994 in which you seek relief for tax, penalty, and interest assessed as the result of an audit of************ (the "Taxpayer"), for the period of October, 1989 through November, 1 992.
FACTS
The Taxpayer is an operator of paper mills and the present audit represents the construction of a new mill. The basis of the Taxpayer's appeal involves three separate issues; i) fixed assets which the Taxpayer claims the auditor agreed to remove from the audit workpapers or on which the use tax had been accrued, ii) HVAC equipment the Taxpayer claims is used directly in their industrial manufacturing process, and iii) the computation of the use tax compliance ratio and the assessment of audit penalty. Each area will be discussed separately below.
Fixed Assets
During the course of the audit review, the Taxpayer contends that the auditor agreed to remove two line-item fixed assets which the Taxpayer claims are used directly in the manufacturing process and one line-item which the Taxpayer claims use tax had been accrued. Upon review of the final audit workpapers by the Taxpayer, it was discovered that such items had not been removed from the audit. The Taxpayer is requesting that such items be removed.
Manufacturing Equipment
The Taxpayer is taking exception to the taxing of 11 HVAC units, 2 Chilled Water Units, 5 Chemical Air Filtration Units, and stainless steel piping for the same. The equipment in question was purchased for the purpose of cooling, humidity control, and air filtration for certain areas of the manufacturing operation which houses motor controllers, distributed control system equipment and other environmentally sensitive electronic equipment. Without such equipment, heat and moisture generated in the processing area could adversely affect the operation of all the processing equipment. The HVAC equipment at issue in this audit is equipment used for cooling in the visitors center, plant office area, transformer rooms, motor control rooms, switch control rooms, and computer control areas.
Audit Penalty
The Taxpayer is also taking exception to the application of audit penalty. The Taxpayer feels that the method set forth in Virginia Regulation (VR) 630-10-80 for applying audit penalty does not always reflect the Taxpayer's true compliance with the sales and use tax laws. The Taxpayer feels that sales tax paid to vendors should be taken into account when calculating the use tax compliance.
DETERMINATION
The auditor is not aware of any fixed assets held in the audit workpapers which he agreed to remove from the audit or any fixed asset which the Taxpayer had accrued the use tax. However, based on the comment set forth in your letter, I will have the auditor contact the Taxpayer to determine the feasibility of removing the three assets from the audit.
In regards to the HVAC equipment, Code of Virginia §58.1-609.3.2(iii) provides an exemption from the sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in... manufacturing... products for sale or resale". The term "used directly" is defined in Code of Virginia §58.1-602 as "those activities which are an integral part of the production of a product,... but not including ancillary activities such as general maintenance and administration".
In interpreting the above statute, Virginia Regulation (VR) 630-1 0-63.B.2 provides that "convenient or facilitative items,... 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". Subsection C.2 of this regulation goes on to define those items used in manufacturing and processing activities which are deemed to be taxable and specifically holds taxable "tangible personal property used for general plant lighting, heating. air conditioning. ventilation. etc. unless such property is specifically designed to protect the integrity of the product". (Emphasis added).
In the present case, due to the temperature variation in the actual plant, the Taxpayer maintains sensitive production machinery controls in separately housed locations in the plant, i.e. transformer rooms, motor control rooms, switch control rooms, and computer control areas. Applying the above statutes and regulations to the facts presented in the present case, the department cannot agree that the HVAC equipment in question qualifies for the exemption. While I realize the equipment maintains the appropriate temperature, humidity, etc., in the control rooms for proper operation of the electronic controls, the HVAC equipment is not being used directly in the actual manufacturing process within the limitations set forth in the above statutes and regulation. The department views the climate controlled atmosphere of a control room to be one-step removed from the actual production process, i.e. climate control for actual production machinery. It should also be noted that the department's position in this area was set forth in a September 6, 1991 letter to the Taxpayer (see PD 91-206 enclosed).
Finally, the Taxpayer is taking exception to the department's method of computing use tax compliance ratios for purposes of assessing audit penalty. Specifically, the Taxpayer feels that in computing the use tax compliance ratio, the department should include the sales tax paid to vendors in the "Use Measure Reported" figure used in the numerator and the denominator. VR 630-10-109 addresses use tax and states, in part, the following:
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- The use tax applies to the use, consumption or storage of tangible personal property in Virginia when the Virginia sales or use tax is not paid at the time the property is purchased. The rate of the state and local use tax are the same as the rates of the state and local sales tax. There is no duplication of the tax. (Emphasis added).
- The use tax applies to the use, consumption or storage of tangible personal property in Virginia when the Virginia sales or use tax is not paid at the time the property is purchased. The rate of the state and local use tax are the same as the rates of the state and local sales tax. There is no duplication of the tax. (Emphasis added).
In order for penalty to be waived on third and subsequent audits, use tax compliance ratios must be a minimum of 85%. Based on the above, and the fact that the Taxpayer use tax compliance ratio on this fifth generation audit is 41%, the department is unable to waive the penalty. Subsequent to any audit revisions necessary, the use tax compliance ratio will be recomputed. Once a new compliance ratio has been established, the penalty will apply in accordance with the above tolerances.
The auditor will contact the Taxpayer to verify the use and the use tax accruals of the fixed assets in question. If you should have any further questions, please feel free to contact the department.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7809K
Rulings of the Tax Commissioner