Were a paper mill's cleaning chemical, jam-clearing winch, and valve-work invoice exempt as direct manufacturing purchases?

Plain-English summary

Virginia upheld use tax on all three contested paper-mill invoices. None established an exempt direct-manufacturing purchase or prior payment of Virginia tax.

The CL207 biocide cleaned and maintained the mill's formers. Because it supported machinery maintenance rather than immediately producing the paperboard, the manufacturing exemption did not apply.

The electric winch sat behind a pulper and was used intermittently when the pulper's own remover could not clear accumulated wire and contaminants. That occasional jam-clearing role was not direct use in manufacturing.

The final invoice covered emergency valve insulation and fabrication of removable metal valve boxes. The mill had not checked whether tax applied and supplied no evidence that either it or the vendor paid Virginia sales tax, so the transaction remained in the use-tax assessment.

What this means for you

• Manufacturing exemptions are limited to items immediately and indispensably used in production.
• Cleaning production machinery can remain taxable maintenance.
• Equipment that only clears occasional jams may be too indirect for exemption.
• Keep vendor invoices and proof of sales-tax payment; otherwise Virginia use tax can apply.

Citations and references

• Va. Code §§ 58.1-609.3(2), 58.1-602, and 58.1-604.
• 23 VAC 10-210-920 and 23 VAC 10-210-6030(A).
• Commonwealth v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973).
• The source discusses P.D. 85-208, 88-129, and 92-34.

Subject

Failure to pay retail sales tax at the time of purchase; sale for resale

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 06-126

Original ruling text

October 25, 2006

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

Dear *:

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer"), for the period October 2001 through October 2004. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer operates a paper mill that produces recycled paperboard for use in its fiber-based packaging divisions and the external converting industry. At issue in this appeal is the Taxpayer's failure to remit use tax on three invoices. The Taxpayer contends that Virginia use tax is not due on these items because they are used directly in manufacturing and, therefore, qualify for the industrial manufacturing exemption in Va. Code § 58.1-609.3 2.

DETERMINATION

Virginia Code § 58.1-609.3 2 provides an exemption from the sales and use tax for tangible personal property 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 . . . but not including ancillary activities such as general maintenance or administration."

Title 23 of the Virginia Administrative Code (VAC) 10-210-920 further defines the term "used directly," noting 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." This section continues, "integrated manufacturing includes the production line of a plant . . . starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished . . . and conveyed to a warehouse at the plant site . . . ." Subsection C 2 of this regulation provides that equipment used for production line testing and quality control is exempt from taxation. The Department has interpreted this regulation to include only that equipment that is "used directly" in the quality control function on the production line of the plant site during the manufacturing process.

In Commonwealth of Virginia v. Community Motor Bus Co. , 214 Va. 155, 198 S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in the statute is intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. This standard established by the Court can also be found in Title 23 VAC 10-210-920, the regulation regarding manufacturing:

Items of tangible personal property which are used directly in manufacturing and processing 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 light of the above, I will address the application of the retail sales and use tax to the CL207 biocide chemical and the electric winch.

CL207 Biocide Chemical

The CL207 biocide chemical is a chlorine-based cleaner that is used to clean the formers.

In Public Document (P.D.) 85-208 (10/31/85), the Tax Commissioner draws a distinction between water treatment chemicals used in general maintenance and those that relate directly to protecting the integrity of the product. In P.D. 85-208, the Tax Commissioner concluded that anti-corrosive chemicals mixed with water used in the product itself were deemed to be an integral part of the manufacturing process; however, water treatment chemicals used to maintain machinery were not. The Department has previously determined that such chemicals are not an immediate part of the production process and, therefore, are not used directly in manufacturing. See P.D.s 88-129 (6/13/88) and 92-34 (4/23/92), which further address the Department's policy regarding this issue.

Based on the Department's long-standing policy as explained in the cited public documents and the facts presented, it is my determination that the CL207 biocide chemical is not used directly in manufacturing. The chemical is used in a taxable maintenance activity - to clean and maintain the formers. This is not an immediate part of the production process. Therefore, the manufacturing exemption does not apply and the chemicals are taxable.

Electric Winch

The electric winch is used to support a filler pulper machine. The winch assists in removing bailing wire and other containments from the pulper machine when the machine gets jammed and its self-contained remover cannot handle the amount of containments. The winch is separate from the pulper machine and resides behind the machine when not in use.

Based on a review of the audit report and the information provided with the Taxpayer's appeal, I cannot agree that the electric cable winch qualifies for the manufacturing exemption under Va. Code § 58.1-609.3 2 (iii). The facts presented indicate that the electric cable winch is used intermittently to pull jammed materials from exempt machinery. The electric winch is not used directly in manufacturing and is properly included in the audit.

Emergency Valve Insulation and Fabrication of Removable Metal Valve Boxes

Virginia Code § 58.1-604 provides that a use tax is imposed on the use or consumption of tangible personal property in Virginia. Virginia Code § 58.1-602 defines the term "use" as "the exercise of any right or power over tangible personal property incident to the ownership thereof, except that it does not include the sale at retail of that property in the regular course of business." Pursuant to Title 23 VAC 10-210-6030 A, 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."

In this case, the Taxpayer failed to review the purchase invoice to determine if the use tax was applicable. The use tax is properly imposed because the Taxpayer failed to pay Virginia retail sales tax at the time of purchase and has not provided evidence that the tax was paid by the vendor at the time of sale. Absent evidence from either the Taxpayer or the vendor that the tax has been paid on this transaction, the transaction will remain in the assessment.

CONCLUSION

Based on the above determination, the assessment is correct. An updated bill with interest accrued to date will be sent to the Taxpayer. No further interest will accrue provided the bill is paid within 30 days from the date on the bill. Please remit payment to: Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, Post Office Box 27203, Richmond, Virginia 23261-7203, Attention: *.

The Code of Virginia and regulation sections cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions about this determination, you may contact * at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/56714i