Did torque wrenches used to install die heads before production qualify for Virginia's manufacturing exemption?

Subject

Torque wrenches used before production did not qualify for the manufacturing exemption

Plain-English summary

Virginia upheld tax on torque wrenches used to install die heads before production runs. The dry-ice and liquid-gas manufacturer argued that the wrenches were indispensable to configuring exempt machinery for customer specifications.

The Department found that the wrenches were used during setup before production, not during production itself. They were also used incidentally to remove and replace damaged die heads. That made their role preparatory or maintenance-related rather than an immediate part of actual production.

The ruling distinguished an earlier exempt knife grinder because that machine fabricated or restored tooling in a qualifying subprocessing activity. These wrenches performed no comparable subprocessing and did not act on the product.

Because being essential to the business was not enough to satisfy the "used directly" test, the assessment remained correct.

What this means for you

• Manufacturing equipment must be used directly and immediately in production, not merely support it.
• Pre-run setup tools can remain taxable even when production cannot proceed without them.
• Tooling fabrication or subprocessing may receive different treatment from ordinary setup or maintenance.
• Document exactly when and how a disputed tool functions in the production sequence.

Common questions

Were the torque wrenches indispensable?

The ruling accepted that they could be essential to achieving the desired product, but that alone did not make them directly used in production.

Why did the cited knife grinder qualify?

It performed a subprocessing activity by fabricating or restoring tooling; the torque wrenches did not.

What happened to the audit assessment?

It was upheld, with the unpaid balance and accrued interest remaining due.

Citations and references

• Va. Code §§ 58.1-602 and 58.1-609.3(2)(iii).
• 23 VAC 10-210-920(B)(2) and (C)(2).
• Virginia Public Documents 08-155, 01-129, and 01-205.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-170

Original ruling text

October 23, 2009

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

Dear ****:

This is in response to your letter in which you request correction of the retail sales and use tax assessment issued to * (the Taxpayer) as a result of an audit for the period August 2005 through July 2008. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a manufacturer of dry ice and liquid gas. An audit assessed tax on certain untaxed sales and purchases of tangible personal property.

At issue is the assessment of tax on purchases of torque wrenches. According to the Taxpayer, such wrenches are used on the production line for changing die heads on exempt machinery and are indispensable to the production of the final product for sale. The Taxpayer indicates that these wrenches are not used in a repair or maintenance capacity. The Taxpayer contends that the contested torque wrenches are used directly in manufacturing and therefore should be exempt from the tax pursuant to Va. Code § 58.1-609.3 2 (iii).

A member of my Appeals and Rulings staff has communicated with the Taxpayer's eastern regional production manager about the usage of the torque wrenches at issue. In that discussion, it was stated that the torque wrenches are not used during the production process. Rather, they are used daily to setup the production machinery ( i.e. , install properly sized die heads to satisfy customer specifications) prior to the production runs. The same torque wrenches are incidentally used to remove and replace a die head should it become damaged or otherwise need repair.

DETERMINATION

Virginia Code § 58.1-609.3 2, (iii) provides an exemption from the retail 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 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."

Title 23 of the Virginia Administrative Code (VAC) 10-210-920 interprets this exemption. Pursuant to subsection B (2) of such regulation, the exempt integrated manufacturing process includes "subprocessing activities which produce tangible personal property used directly in the main manufacturing or processing activity." This subsection also states that items used directly in the manufacturing process are those items "which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process."

On the other hand, subsection B (2) of the manufacturing regulation provides that the exempt integrated manufacturing process does not include convenient or facilitative items or items which are essential to the operation of a business but not an immediate part of actual production. For example, the manufacturing exemption does not apply to tangible personal property used in the repair, servicing, or maintenance of production machinery. See subsection C 2 of the manufacturing regulation.

The Taxpayer cites P.D. 08-155 as support for claiming an exemption on the torque wrenches. In that ruling, the Tax Commissioner found that the manufacturing exemption was applicable to a knife grinder used to maintain or restore the cutting tolerances of knives by re-sharpening the knives in each head, to shape blank knives into usable knives, and to reshape used knives into new forms for a different process. In reaching this determination, the Tax Commissioner determined that such knife grinder was used directly in an exempt subprocessing activity (the fabrication of tooling supplies for exempt machinery) that was well beyond a general maintenance function.

The torque wrenches in the instant case are not used in any type of subprocessing activity as to warrant the application of the industrial manufacturing exemption. Rather, the torque wrenches are only used prior to the production process and thus not during the production process. Preparatory activities conducted prior to the production process that are not subprocessing activities do not qualify for exemption.

In addition, P.D. 01-129 (9/14/01) appears to be on point. In that ruling, hand tools and wrenches were held taxable. The Tax Commissioner ruled that "[w]hile these items are essential for work on exempt equipment, they are not used directly in drilling [ i.e. , the exempt process]." [Insert added.] In addition to the regulation cited above, the Department has previously ruled that general maintenance items used prior to or after the production process are taxable. For example, see P.D. 01-205 (12/7/01).

Based on all the foregoing, I cannot agree that the torque wrenches at issue are used directly in the actual production process. While I certainly agree that these wrenches may be essential in achieving a desired product, the wrenches themselves do not act upon the product or serve as an immediate part of the actual production process.

CONCLUSION

Based on this determination, the assessment is correct. Because the assessment is partially paid, an updated bill for the unpaid balance, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer may remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230.

The Code of Virginia sections, regulation and public documents cited 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 Tax Policy, ,Appeals and Rulings, at -***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-3190699948.R