Was a Virginia facility that assembled raw materials into prefabricated home components a manufacturer for local property-tax purposes?

Subject

Taxpayer is a manufacturer in accordance with the Virginia Supreme Court.

Plain-English summary

Virginia classified the taxpayer as a manufacturer and ordered county refunds for 2005 through 2008. At its facility, the taxpayer combined wood, nails, brackets, glue, steel, insulation, sheathing, concrete, and aggregates into foundation walls, floor-truss systems, insulated exterior wall panels, and steel-framed interior walls.

The Virginia Supreme Court's test asks whether original materials undergo a process that produces something substantially different. The transformation can be one step toward a finished market product; it need not complete the entire home at the factory. Sales-tax or BPOL contractor classifications did not control this local property-tax question.

The taxpayer was also a separate legal entity from its general-contractor parent, so the parent's nonmanufacturing activity did not determine the taxpayer's classification. Even assuming 25% of costs involved nonmanufacturing delivery or training, production remained substantial rather than trivial or incidental.

Equipment used in the manufacturing process was subject to machinery-and-tools tax. Other qualifying manufacturing capital was exempt from local property tax under the cited intangible-property provision.

What this means for you

• Manufacturing can occur off-site before components reach a construction project.
• Focus on the raw materials, transformation process, and resulting products.
• A mixed business can remain a manufacturer when production is substantial.
• Separate-entity status and asset-by-asset use still matter.

Common questions

Did installation-related costs prevent manufacturer status?

No. Even treating 25% of costs as nonmanufacturing, Virginia found the production component substantial.

What relief was ordered?

The case was remanded for county refunds consistent with the manufacturer classification.

Citations and references

• Va. Code §§ 58.1-3980, 58.1-3983.1, 58.1-1101 A(2), and 58.1-3507 A.
• 23 VAC 10-500-520 C.
• County of Chesterfield v. BBC Brown Boveri, 238 Va. 64 (1989).
• Commonwealth v. Meyer, 180 Va. 466, 23 S.E.2d 353 (1942).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-44

Original ruling text

March 23, 2011

Re: Appeal of Final Local Determination

Taxpayer: *

Locality: *

Machinery and Tools Tax

Dear *:

This final state determination is issued upon the application for correction filed by you on behalf of * (the "Taxpayer") with the Department of Taxation. The Taxpayer appeals an assessment of Machinery and Tools (M&T) tax issued to the Taxpayer by the *** (the "County") for tax years 2005 through 2008.

The M&T tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 authorizes the Department to issue determinations on taxpayer appeals of M&T tax assessments. On appeal, a M&T tax assessment is deemed prima facie correct, i.e. , the local assessment will stand unless the taxpayer proves that it is incorrect.

The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections 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.

FACTS

The Taxpayer operates a facility in the County that assembles prefabricated components that are used to construct homes. These components were sold exclusively to the Taxpayer's parent company (the "Parent") and delivered to the Parent's job sites. The Parent, a general contractor of single family homes, employed third-party subcontractors to install the finished components.

The Taxpayer had reported all of its assets on business tangible personal property (BTPP) tax returns for the 2005 through 2008 tax years. The Taxpayer filed an administrative appeal with the County seeking to reclassify itself as a manufacturer and as such, have its assets that are used in the process of manufacturing taxed at the machinery and tools tax rate and have all other business assets exempt from local tax. The County issued a final determination denying the Taxpayer's amended returns on the basis that the Taxpayer was a contractor subject to the BTPP tax on all of its tangible personal property.

The Taxpayer appeals the County's final determination, contending it is a manufacturer. The County counters that the Taxpayer is not a manufacturer and, therefore, is subject to tax on its, tangible business personal property at the BTPP tax rates. The County also asserts that the Department lacks jurisdiction to address the Taxpayer's appeal for the 2005 and 2006 tax years.

ANALYSIS

Jurisdiction

Virginia Code § 58.1-3980 provides that any person aggrieved by an assessment of local taxes "may, within three years from the last day of the tax year for which such assessment is made, or within one year from the date of the assessment, whichever is later, apply to the commissioner of the revenue or such other official who made the assessment for a correction thereof."

Under this procedure, if the taxpayer disagrees in whole or in part with the local assessing officer's determination, the taxpayer may then take its grievance to the circuit court under the provisions of Va. Code § 58.1-3984.

Virginia Code § 58.1-3983.1 B 1 provides that any person assessed with a "local business tax as defined in this section may appeal such assessment within one year from the last day of the tax year for which such assessment is made, or within one year from the date of such assessment, whichever is later, to the commissioner of the revenue or other assessing official." Under this provision, if the Taxpayer's appeal is denied in part or whole by the local assessing official, the taxpayer may, within 90 days, appeal the assessment to the Tax Commissioner.

The administrative appeals process involving the Tax Commissioner is separate and distinct from the general appeals process afforded to taxpayers with local tax grievances under Va. Code § 58.1-3980. The procedures for the process are clearly defined in the statute.

Under § 1.4 of the Guidelines for Appealing Local Business Taxes, issued as Public Document (P.D.) 04-28 (6/25/2004), an "assessment" is defined as "a determination as to the proper rate of tax, the measure to which the tax rate is applied, and ultimately the amount of tax, including additional or omitted tax, that is due." When a taxpayer files an amended local business tax return, the local taxing authority must make a determination as to the proper amount of the tax. If the locality denies the refund, it has made a determination as to the proper amount of tax, even if the assessment on that locality's books is not changed. Consequently, the denial of a refund by a local taxing authority would constitute an assessment for purposes of filing an appeal under Va. Code § 58.1-3983.1.

In this case the Taxpayer filed its local appeal under Va. Code § 58.1-3980 for the 2005 and 2006 tax years. It contends that the denial of its appeal by the County constituted an assessment from which it could appeal to the Tax Commissioner under Va. Code § 58.1-3983.1. The County, citing P.D. 07-191 (11/21/2007), argues that the denial of the Taxpayer's appeal did not constitute another assessment from which it could appeal. In this ruling, the Department held that a final local determination under Va. Code § 58.1-3980 does not create an assessment subject to an appeal to the locality under Va. Code § 58.1-3983.1.

The Department has also ruled that a locality's denial of an amended return requesting a refund constitutes an assessment from which a Taxpayer would become eligible to file an appeal under Va. Code § 58.1-3983.1. See P.D. 10-103 (6/18/2010). Because a denial of a refund request does create an assessment as defined in P.D. 04­28, a taxpayer denied a refund by a locality is eligible to appeal under Va. Code § 58.1-3983.1, provided such appeal is timely filed.

In this case, the County denied refunds for the 2005 and 2006 tax years upon the Taxpayer's request to be reclassified as a manufacturer. The denial of the refund request constitutes an assessment subject to appeal to a locality under Va. Code § 58.1-3983.1. As such, the Department has jurisdiction to address the Taxpayer's appeal with regard to the 2005 and 2006 tax years.

Taxation of Machinery and Tools

All tangible personal property, unless declared intangible under the provisions of Va. Code § 58.1-1100 et seq. , is reserved for local taxation by Article X, § 4 of the Constitution of Virginia . Included in the category of tangible property that is declared intangible and subject to state taxation only is "[c]apital which is personal property, tangible in fact, used in manufacturing (including, but not limited to, furniture, fixtures, office equipment and computer equipment used in corporate headquarters)." See Va. Code § 58.1-1101 A2.

The machinery and tools, motor vehicles and delivery equipment of a manufacturing business are not defined as intangible personal property. Such property is to be taxed locally as tangible personal property. Virginia has elected to create a separate classification of tangible personal property for machinery and tools used in manufacturing. Virginia Code § 58.1-3507 A provides:

Machinery and tools . . . used in a manufacturing . . . business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only.

Manufacturing

The definition of a "manufacturer" is not in the Code of Virginia . However, the Supreme Court of Virginia has developed a test involving three essential elements in determining whether a manufacturing activity is being undertaken. These elements are: (1) original material, referred to as raw material; (2) a process whereby the original material is changed; and (3) a resulting product, which by reason of being subject to such processing, is different from the original material. County of Chesterfield v. BBC Brown Boveri , 238 Va. 64 (1989). For local tax purposes, a manufacturer is one engaged in a processing activity, whereby the original materials are transformed into a product that is substantially different in character from the original materials. It does not matter whether the transformation is a step in getting the product ready for market or it is a complete process. What matters for purposes of local taxation is whether the transformation of the material takes place in the locality. See Commonwealth v. Meyer , 180 Va. 466, 23 S.E.2d 353 (1942).

In its final determination, the County concludes that the Taxpayer's prefabrication of housing parts is not manufacturing because the assembly would be considered contracting if it was conducted at a construction site. The County cites a court case that held there is no difference between a prefabricated house and one that is built on site. See Werner v. Sofios Construction Company , 176 N.E.2d 870 (1961). In reviewing this case involving a deed restriction in another state, I fail to see its applicability to the local property, tax laws of Virginia.

The County also argues that Virginia considers contracting to be the sale and installation of tangible personal property to real estate under Title 23 of the Virginia Administrative Code (VAC) 10-210-410. It is important to note that local taxes have their own characteristics, separate and distinct from the retail sales and use tax. As such, it is possible that a taxpayer's business activities may not be treated the same under Virginia's sales and use tax rules and local taxing statutes.

In addition, the County cites Title 23 VAC 10-500-250, which includes a list of contracting occupations. This regulation provides that a person engaged in building, cementing, foundations, and structural metal work is contracting. While this regulation interprets the general classification system for the business, professional and occupational license (BPOL) tax under Va. Code § 58.1-3706, the BTPP tax statutes do not separately classify taxpayers as contractors. The relevant questions for BTPP purposes are whether a taxpayer is a manufacturer and whether its machinery and tools are used in manufacturing. As stated above, the Virginia Supreme Court has set forth the criteria for manufacturing in BBC Brown Boveri .

The County contends the Taxpayer is not a manufacturer because it has a unitary relationship with the Parent, which is not a manufacturer. When a taxpayer holds a certificate of incorporation from the State Corporation Commission (SCC) and has its own federal employer identification number (FEIN) for federal income tax purposes, it is considered a separate taxable entity for local business tax purposes. See P.D. 07-191. Moreover, even if an entity is disregarded for federal and state income tax purposes, performs no business activities, and has no FEIN, the owner of the property would be subject to the local business tax. See P.D. 09-22 (2/6/2009). As such, in this case any unitary relationship that the Taxpayer has with the Parent has no bearing on the Taxpayer's local tax liability.

The Taxpayer counters that it is a manufacturer because it is listed as a manufacturer on documentation it filed with the County and the SCC, as well as being described as a manufacturer according to its NAICS number. The Taxpayer has the burden of producing evidence regarding its classification for local business tax purposes. See P.D. 10-232 (9/29/2010). A taxpayer's self classification on documentation filed with a locality or the SCC, without other evidence, is insufficient to meet this burden. The NAICS is used in determining a Taxpayer's business for income tax and sales and use tax purposes. While not the determinative factor to be used in classification for local tax purposes, it is instructive. See P.D. 06-79 (8/23/2006).

By applying the tests set forth in BBC Brown Boveri , the evidence provided indicates that the Taxpayer used raw materials such as wood, nails, brackets, glue, steel, insulation, sheathing, concrete and aggregates in a number of processes that result in concrete moisture residential foundation walls, open-web floor truss systems, structured insulated external wall panes, and steel framed interior walls. Based on the Department's understanding of the Taxpayer's operations, raw materials were transformed by an assembly process into a new products that were substantially different in character from the original materials.

The County further arguers that the Taxpayer is a not a manufacturer because it reported "installation costs" as an expense on its income statement. The Taxpayer contends that this income statement account is associated with the cost to deliver the Taxpayer's finished goods to the Parent's home sites and includes limited costs associated with the training of subcontractors. The County concludes that the Taxpayer's installation costs were too excessive to be for training and delivery costs. Further, the County asserts that the Taxpayer failed to provide sufficient documentation to demonstrate that it is a manufacturer and included non-manufacturing related activities.

In BBC Brown Boveri , the Virginia Supreme Court held that when an entity is engaged in both manufacturing and non-manufacturing activities, it will nonetheless be classified as a manufacturer for tax purposes if the manufacturing portion of its business is substantial. The Court offered several constructive measures to be used in determining whether a business should be classified as a manufacturer for local business tax purposes. These are: (1) the manufacturing component's financial receipts or proportion of total corporate income; (2) the percentage that manufacturing equipment, inventory, etc., comprises of the total capital investment; (3) the number of employees working in the manufacturing component as compared with the total number of employees; or (4) the ratio of manufacturing activities to the entire business. Thus, the test of substantiality has no rigid definition and the business as a whole must be considered. Under Title 23 VAC 10-500-520 C, a manufacturing component of a multipurpose business must be deemed substantial if it is not de minimis , merely trivial, or only incidental to its principal business.

In the instant case, 25 percent of the Taxpayer's costs in 2005 were installation costs. Even if these costs resulted from non-manufacturing activities, the evidence provided indicates activities related to processing raw materials into new products were clearly substantial during all of the tax years at issue.

DETERMINATION

Based on the foregoing, I find that the Taxpayer is a manufacturer in accordance with the Virginia Supreme Court's test outlined in BBC Brown Boveri . As such, the Taxpayer is subject to the M&T tax on equipment used in its manufacturing processes. The tangible property not used in the manufacturing process is exempt from local property taxation as provided under Va. Code § 58.1-1101 A 2.

I am remanding this case back to the County to issue refunds for the 2005 through 2008 tax years in accordance with this determination. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4506487923.B