Did filter cartridges that cleaned and recirculated soluble oil on a beverage-can production line qualify for Virginia's manufacturing exemption?

Subject

Items used directly in the manufacturing process are eligible for exemption

Plain-English summary

A beverage-can manufacturer sought a refund of use tax paid on filter cartridges. The filters cleaned soluble oil used by the bodymaker that formed cans, kept contaminants out of the product, protected tooling, and returned the oil to a holding tank for reuse on the production line.

Virginia found the filters indispensable and immediately connected to production because they protected the cans' integrity. They qualified for the manufacturing exemption. Any refund remained conditional on the auditor confirming that the taxpayer had paid and remitted the tax.

What this means for you

• A reclamation or filtration item can qualify when it operates on the production line and directly protects the manufactured product.
• The exemption is narrower than equipment that merely supports general maintenance or administration.
• Preserve tax-payment records; an exempt-use conclusion does not establish the amount actually refundable.

Common questions

Was reuse of the filtered oil enough by itself?

The ruling emphasized more than reuse: the filters removed contaminants so they would not enter or score the cans and protected product integrity during production.

Was the refund automatic?

No. The audit staff first had to verify that use tax on the filters had been paid and remitted.

Citations and references

• Va. Code § 58.1-609.3(2)(iii) and § 58.1-602, manufacturing exemption and direct-use definition.
• 23 VAC 10-210-920, immediate and indispensable production use.
• Commonwealth v. Community Motor Bus Co., cited for the narrow direct-use standard.
• P.D. 97-20 and P.D. 95-278, analogous reclamation and filtration rulings.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-112

Original ruling text

July 19, 2007

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") by the Department for the period September 2000 through August 2003. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer manufactures two-piece beverage cans for sale to the beverage industry. As a result of the Department's audit, the auditor denied the Taxpayer's request for a refund of use tax paid on the purchase of filter cartridges. The Taxpayer contends that the filters are used directly in the manufacturing process and are eligible for exemption from the retail sales and use tax under Va. Code F 58.1-609.3 2 (iii). The Taxpayer cites Public Documents (P.D.) 97-20 (1/24/97) and 95-278 (11/2/95) to support its position.

DETERMINATION

Virginia Code § 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 processing, manufacturing, refining, mining or converting products for sale or resale . . . ." [Emphasis added.] 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."

Further, in the case of Commonwealth of Virginia v. Community Motor Bus Co., 214 Va. 155, 198 S.Ed.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in the statute was 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 of the Virginia Administrative Code 10-210-920, the regulation regarding manufacturing. This regulation states, "Items of tangible personal property which are used directly in manufacturing and processing are machinery, tools and repair parts therefore, 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 this instance, the filters are used to filter the soluble oil used by the bodymaker, which forms the beverage can. The filters remove contaminants from the soluble oil so the contaminants do not become a part of the beverage can. Once the oil is filtered, it is transferred to a holding tank, for reuse on the production line. The soluble oil is also used to protect the tooling equipment, the equipment that punches the aluminum to form the can, and to keep the tooling from scoring the can.

Based on the information provided by the auditor and the Taxpayer, I find that the filters are used on the production line to protect the integrity of the beverage can. The filters, therefore, are used directly in the manufacturing process and qualify for the manufacturing exemption.

This decision is consistent with the decisions in the prior rulings cited by the Taxpayer. In P.D. 97-20 the Department ruled that a clarifier used to reclaim a supply item in the manufacturing process qualified for the manufacturing exemption. The clarifier was used to separate water from the by-product of the manufacturing process. The reclaimed water was then re-used in the production process. In P.D. 95-278 the filters were used to maintain constant moisture content in the air to protect the integrity of the product and also to keep lint accumulations at a minimal level to prevent product defects.

Based on the foregoing, the audit will be returned to the audit staff to confirm that use tax was paid and remitted to the Department on the filters. If the auditor is able to verify that the tax was paid and remitted, the assessment will be adjusted accordingly. After the auditor makes the appropriate adjustments, the Taxpayer will receive a refund with interest based on these adjustments.

The Code of Virginia sections, regulations and public document 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 web site. If you have any questions about this determination, you may contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/55119.i