Did manufacturing prototype cellular phones and circuit boards for a customer qualify for Virginia's production exemption?

Subject

Manufacturer of prototype cellular phones and printed circuit boards

Plain-English summary

Virginia reversed its earlier treatment and found that producing prototype cellular phones and printed circuit boards qualified for the manufacturing exemption. The taxpayer supplied a specific supply agreement and additional facts showing that it manufactured tangible products for sale to its customer.

The production process was industrial in nature, and the prototype work occurred separately from the facility responsible for later mass production. On those facts, the prototypes were the products sold to the customer rather than nonexempt preproduction activity.

Virginia returned the audit for adjustment and removed the transactions related to manufacturing the prototypes.

What this means for you

• Prototype production can qualify when the prototype itself is a tangible product manufactured for sale or resale.
• Contracts should clearly identify what product the customer is buying.
• Facility and entity separation can help distinguish a sold prototype from internal preproduction work.
• The process must still be industrial in nature under the manufacturing rule.

Common questions

Q: Why did Virginia reconsider the earlier decision?
A: The taxpayer supplied additional agreement and facility facts showing industrial production of prototypes for sale.

Q: Were the prototypes treated merely as research or preproduction activity?
A: No. The ruling treated them as tangible products sold to the customer.

Q: What happened to the audit?
A: The related prototype-manufacturing transactions were removed and the audit was returned for adjustment.

Citations and references

• 23 VAC 10-210-920 A.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-71

Original ruling text

May 29, 2008

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

Dear *:

This is in response to your letter submitted on behalf of * (the "Taxpayer"), in which you request a reconsideration of the prior determination issued to the Taxpayer, regarding the sales and use tax assessment issued for the period May 2001 through January 2002. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer maintains that the production of prototype cellular phones and printed circuit boards for its customer does not represent preproduction activities as concluded in the prior determination. Relying on Title 23 of the Virginia Administrative Code (VAC) 10-210-920, the Taxpayer contends that the manufacturing exemption applies to the production of the prototypes because a tangible personal product was produced for sale or resale, and because the production process was industrial in nature. The Taxpayer states that the * facility (where the prototypes are produced) and the *** facility (where the mass production of the final product is completed) are separate legal entities. The Taxpayer contends that the customer contracted with the Taxpayer for the production of the prototypes and that the prototypes were the final product presented to the customer. The Taxpayer provides a copy of the Specific Supply Agreement (the "SSA") entered into with its customer.

DETERMINATION

Title 23 VAC 10-210-920 A provides, in pertinent part, that "for a business to obtain the [manufacturing] exemption, it first must be manufacturing or processing products for sale or resale and secondly, such production must be industrial in nature."

Based upon the facts presented in the Taxpayer's request for reconsideration, the manufacturing of the prototype cellular phones and the printed circuit boards meets the test to qualify for the manufacturing exemption. The additional evidence presented demonstrates that the prototypes were manufactured by the Taxpayer for sale to its customer and the process was industrial in nature. The facts also more clearly demonstrate that during the audit period the Taxpayer manufactured prototypes in a separate location from where final production of prototypes was conducted. Accordingly, the transactions related to the manufacturing of these products will be removed from the audit.

The audit will be returned to the audit staff to make the adjustments to the audit as required by this determination. An updated bill, with interest accrued to date, will be mailed to the Taxpayer once the audit adjustments are complete. No additional interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

The regulation cited is 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 Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/55418P