Did a packaging wholesaler's machine qualify for Virginia's manufacturing exemption because it folded corrugated cardboard into self-locking boxes?

Plain-English summary

Virginia denied the manufacturing exemption for the packaging wholesaler's box-converting machine. The machine folded flat corrugated cardboard into self-locking boxes at a customer's manufacturing plant, and the wholesaler's employees delivered the boxes to production lines as needed.

The Department agreed that erecting the boxes could be processing. But Virginia's exemption covered processing for sale or resale only when the activity was industrial in nature. The company's primary business was wholesale sales of packaging materials, matching a nonmanufacturing NAICS classification.

The earlier ruling cited by the company involved a business primarily performing extensive contract processing—laminating, cutting, coating, shaping, and packaging customer materials. Virginia found that operation materially different from the wholesaler's limited box-folding activity.

Use tax on the machine, repair parts, and operating supplies therefore remained due. Virginia separately refunded, with interest, an overpayment from the company's April 2011 return that had mistakenly been applied to the contested bill; that refund did not reverse the audit holding.

Common questions

Q: Was folding cardboard into boxes considered processing?
A: It could be, but that alone did not make the company's primary business industrial.

Q: Did the company receive a refund of the machine tax?
A: No. The refund was for an unrelated return overpayment applied to the audit bill by mistake.

Citations and references

• Va. Code §§ 58.1-602 and 58.1-609.3(2)(iii).
• 23 VAC 10-210-920(A), (B)(1).
• Virginia Public Document 93-127 (May 14, 1993).
• Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973).
• Commonwealth v. Orange-Madison Cooperative Farm Service, 220 Va. 655, 261 S.E.2d 532 (1980).

Subject

Does not qualify for the manufacturing exemption based on its business classification in SIC and NAICS manuals

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-119

Original ruling text

July 25, 2012

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

Dear *:

This will reply to your letter in which you seek correction of a retail sales and use tax assessment issued to your client, * (the "Taxpayer"), for the period April 2008 through March 2011. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer sells and distributes packaging products. The Taxpayer was audited by the Department and assessed use tax on the purchase of a piece of machinery that converts corrugated cardboard into self locking boxes. The machine is located at a customer's manufacturing facility and is operated by the Taxpayer's employees. The Taxpayer purchases flat, corrugated cardboard that the machine folds and converts into boxes. The Taxpayer's personnel deliver the desired quantities of boxes to the production lines at the customer's plant as the boxes are needed. The Taxpayer states that the production of the boxes at the customer's manufacturing site allows for more timely delivery of the boxes at a competitive cost. The Taxpayer contends that the machine and the supplies and parts to maintain and operate the machine qualify for the manufacturing exemption in Va. Code § 58.1-609.3 2.

DETERMINATION

The Taxpayer maintains that the conversion of corrugated cardboard into self locking boxes produces a more marketable and useful product. As such, the Taxpayer asserts that the production of the boxes is processing as interpreted by the Virginia Supreme Court in Commonwealth v. Orange-Madison Cooperative Farm Service , 220 Va. 655, 261 S.E.2d 532 (1980). The Taxpayer also notes that Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 1 states that a change in the state or form of products is not necessary to classify an establishment as an industrial processor. In addition, the Taxpayer takes issue with the Department's determination that it does not qualify for the manufacturing exemption based on its business classification in the Standard Industrial Classification (SIC) and North American Industry Classification System (NAICS) manuals. The Taxpayer states that the Department's use of business classifications to determine eligibility for the manufacturing exemption fails to recognize that a business may conduct distinct operations, one of which could be considered industrial manufacturing or processing.

Industrial Processing

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 ... used directly, in processing, manufacturing, refining, mining or converting products for sale or resale ...." This statute was interpreted by the Virginia Supreme Court in Golden Skillet Corporation v. Commonwealth , 214 Va. 276, 199 S.E.2d 511 (1973). The court held that the exemption was available only for processors of products for sale or resale in the industrial sense. In Orange-Madison , the court noted that not all processing qualifies for the industrial manufacturing exemption because the exemption is limited to processing operations that are industrial in nature.

The opinions rendered in the court cases cited above are reflected in the Department's manufacturing regulation. Title 23 VAC 10-210-920 A states that for a business to obtain the exemption, it must be manufacturing or processing products for sale or resale and such production must be industrial in nature. The Department's reliance on business classifications for purposes of determining whether manufacturing or processing activities are considered industrial in nature is based on the statutory definition of manufacturing and processing in Va. Code § 58.1-602. Included in this definition is an explanation of the term "industrial in nature." As this term is defined, businesses are considered industrial in nature if classified in codes 10 through 14 and 20 through 39 in the SIC Manual for 1972 and in supplements issued thereafter. The SIC has since been replaced by the NAICS. Both the SIC and NAICS assign industrial classifications according to the primary business activity of the business. Unless the primary, business activity is a manufacturing activity in accordance with these classifications, the Department does not consider the business activity to be industrial in nature. Thus, the business may not claim the manufacturing or processing exemption.

The Taxpayer's NAICS classification is most similar to businesses classified under 423840, wholesalers of packaging and packing materials. This is not a manufacturing business classification. While I agree that the erection of self locking boxes may be processing, the Taxpayer's primary business activity is making sales at wholesale of packaging materials and supplies. In this case, the Taxpayer's primary business activities are not industrial in nature based on the statutory definition of manufacturing and processing in Va. Code § 58.1-602.

To support its position, the Taxpayer cites P.D. 93-127 (5/14/93). In this ruling, the Tax Commissioner concluded that a business that processed and packaged materials on a contract basis for other manufacturing businesses qualified for the manufacturing exemption. However, the facts of the Taxpayer's case are not on point with the facts in P.D. 93-127. The taxpayer in P.D. 93-127 was primarily engaged in the business of processing and packaging raw materials furnished to it by other manufacturers. The processing activities conducted by that taxpayer included laminating, cutting, coating, shaping and various other operations performed on raw materials provided by customers. Based on the extensive processing performed by that taxpayer, I do not agree that P.D. 93-127 supports a conclusion that the Taxpayer's operation of the box machine in this instance qualifies for the industrial processing exemption.

CONCLUSION

The audit assessment of use tax on the box machine and the supplies and parts necessary to operate the machine is correct. According to the Department's records, the Taxpayer has paid the contested bill in full. While there is no basis to refund the Taxpayer's bill payment, the Department's records indicate that an overpayment from the Taxpayer's April 2011 sales and use tax return was applied in error to the contested bill. The overpayment of * will be refunded to the Taxpayer with applicable interest.

The Code of Virginia sections, regulation and public document 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 concerning this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4851178128.S