Which drink-packaging and bar-coding equipment counted as taxable manufacturing machinery rather than exempt logistics equipment?

Plain-English summary

Virginia drew the machinery-and-tools tax line at the point the drink product reached its marketable retail package. Equipment used after that point only for larger shipping cases, cartons, pallets, or logistics was not machinery used directly in manufacturing.

For Drink Mix 1, manufacturing included packing bottles into the six-unit package sold to consumers. For Drink Mix 2, it included packing pouches into the ten-unit retail case. Later outer cases and palletizing were logistical.

Drink Mix 3 bottles were sold individually, so manufacturing ended after the drink was placed in bottles, sealed, shrink-wrapped in groups, and labeled. Later placement into shipping cases and cartons was outside manufacturing.

Bar-coding and date-stamping equipment followed the same functional test. Coding required by government standards or customer point-of-sale demands could be manufacturing; inventory tracking applied after production ended was not.

The Department remanded the case for the county to determine when the laser coding occurred and to remove logistical packaging equipment from the M&T assessment.

What this means for you

• Identify the exact product form sold to the ultimate customer.
• Packaging needed to satisfy government, industry, product-quality, or consumer standards may be part of manufacturing.
• Later packaging solely for storage and shipment is generally logistics, not taxable M&T machinery under this determination.
• Bar-code treatment depends on purpose and timing within the production process.
• M&T classification is distinct from Virginia's sales-tax manufacturing exemption analysis.

Common questions

Q: Were all packaging machines taxable as M&T?
A: No. Only equipment used through completion of the retail product package counted as manufacturing here.

Q: Were palletizers and outer-case equipment taxable?
A: Not when used only for logistical shipping after the product was marketable.

Q: Were laser coders taxable?
A: It depended on whether they coded before production ended for required product purposes or afterward for inventory tracking.

Citations and references

• Va. Code §§ 58.1-1101 A 2, 58.1-3507 A, and 58.1-3983.1.
• City of Winchester v. American Woodmark, 250 Va. 451, 464 S.E.2d 148 (1995).
• The Daily Press, Inc. v. County of Newport News, 265 Va. 304, 576 S.E.2d 430 (2003).
• Virginia Public Documents 04-39 and 08-30.

Subject

Determine the point M&T tax is applied in the use of manufacturing equipment

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-63

Original ruling text

May 10, 2013

Re: Appeal of Final Local Determination

Taxpayer: *

Locality Assessing Tax: *

Machinery and Tools Tax

Dear *:

This final state determination is issued upon the application for correction filed by you on behalf of your client, * (the "Taxpayer"), with the Department of Taxation. You appeal the assessment of certain equipment for purposes of machinery and tools tax issued by *** (the "County") for the 2007 through 2010 tax years.

The machinery and tools tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 authorizes the Department to issue determinations on taxpayer appeals of machinery and tools tax assessments. On appeal, the machinery and tools tax assessment is deemed prima facie correct, i.e. , the local assessment will stand unless the taxpayer proves 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 in the Laws, Rules and Decisions section of the Department's web site, located at www.tax.virginia.gov .

FACTS

The Taxpayer, a manufacturer located in the County, filed amended machinery and tools tax returns for the 2008 through 2011 tax years. The Taxpayer requested removal of certain equipment included on the original returns as machinery and tools. The County agreed to some of the Taxpayer's amendments and refunded the associated tax but declined to remove the entire list of equipment as requested by the Taxpayer.

The Taxpayer filed an appeal with the County, contending the equipment at issue was used for packaging and shipping. In its final determination, the County held that the coding and packaging of the goods for shipment was a part of the manufacturing process. The Taxpayer appeals the County's final determination, contending the manufacturing process ends once its products are packaged for resale and any additional packaging is not a part of the manufacturing process.

ANALYSIS

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 A 2.

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 § 58.1-3507A also 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.

Used in Manufacturing

In City of Winchester v. American Woodmark , 250 Va. 451, 458, 464 S.E.2d 148, 152 (1995), the Virginia Supreme Court (the "Court") stated, "Since 1950, the Tax Commissioner has opined that the phrase 'machinery and tools' contained in Va. Code § 58.1-1101 A 2 and its precursors, means machinery used in the actual process of manufacturing." The Court also cited previous opinions of the Attorney General in deriving the meaning of "used in manufacturing."

In The Daily Press, Inc. v. County of Newport News , 265 Va. 304, 576 S.E.2d 430 (2003), the Court amplified the principles set forth in American Woodmark :

The principle gleaned from American Woodmark can be simply stated: personal property that may be essential to the overall operations of a manufacturing business is not 'machinery and tools' subject to local taxation unless the property is actually and directly used in the manufacturing process where new materials are transformed into a substantially different product or the property is connected with the operation of machinery actually and directly used in the manufacturing process. 265 Va. 304, 311. [Emphasis added.]

The Attorney General has consistently opined that "machinery and tools" used in a particular manufacturing business are the machinery and tools that are necessary in the particular manufacturing business and which are used in connection with the operation of machinery that is actually and directly used in the manufacturing process. Id. , citing 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317; see also 1987-1988 Att'y. Gen. Ann. Rep. 590. Id.

This language does not imply that each piece of machinery or each tool used directly in the manufacturing process must be directly connected to the complete transformation of a material into something substantially different in character. In Public Document (P.D.) 04-39 (8/2/2004), the Department found equipment and tools that did not directly transform or even touch the product being produced could be used directly in the manufacturing process. The question, therefore, is not whether a particular piece of machinery transforms a product, but whether such machinery or tool is used directly in a manufacturing process.

In its final determination, the County cites the definition of the term "manufacturing" from Va. Code § 58.1-602. This section defines "manufacturing, processing, refining, or conversion" for purposes of the sales and use tax exemption under Va. Code § 58.1-609.3 2(iii). Local property taxes have their own characteristics, separate and distinct from the retail sales and use tax. The purpose of M&T tax statutes is to establish what property may be subject to tax while the laws governing the retail sales and use tax determine which purchases are exempt from the tax. As such, it is possible that a taxpayer's manufacturing equipment may not be treated the same under Virginia's sales and use tax rules and the M&T tax statutes.

Packaging Equipment

Generally, the Department considers machinery used for packaging a product for shipping purposes as not directly used in the manufacturing process and, therefore, not subject to the machinery and tools tax. See P.D. 04-39. In P.D. 08-30 (4/2/2008), the Tax Commissioner recognized that many food products are not marketable without additional packaging. Therefore, the Department must consider whether some packaging "is an integral part of the making of a substantially different product." In considering this issue, the Department identified three main factors that contribute to how food is packaged. These include government regulations, industry practices, and market or consumer demands. Thus, to the extent that packaging has to meet performance (industry standards), sanitation (government regulations), or product quality (consumer demands) standards, equipment used for such packaging is considered to be used directly in the manufacturing process.

The Taxpayer manufactured different drink products that were packaged in three types of containers. The Taxpayer contends that manufacturing ceases once the products are completed for sale to the ultimate consumer and its packaging activities are a function of shipping. The Taxpayer believes its case packers, cartoners, palletizers, and any conveyors beginning with the end of the manufacturing process should be exempt from the M&T tax.

Drink Mix 1

After mixing, Drink Mix 1 is dispensed in plastic bottles. Bottles are grouped and placed into boxes of six for sale. These cases are then packaged into cases and palletized for shipment. Because Drink Mix 1 is generally sold to the ultimate consumer in packages of six, the initial case packers would be considered to meet product quality standards and be included in the manufacturing process.

Drink Mix 2

After mixing, Drink Mix 2 is dispensed into an aluminum pouch, which is then sealed. Pouches are grouped and placed into a case of ten for sale. These cases are then packaged into cases and palletized for shipment. Because Drink Mix 2 is generally sold to the ultimate consumer in packages of ten, the initial case packers would be considered to meet product quality standards and be included in the manufacturing process.

Drink Mix 3

After mixing, Drink Mix 3 is dispensed into a plastic bottle then shrink wrapped in groups and labeled. The shrink wrapped groups are then placed into cases, then larger cartons for shipping. Drink Mix 3 bottles are sold individually. For product quality purposes, the manufacturing process would end after the Drink Mix 3 is dispensed into bottles and sealed with the full body wrapper.

Bar Coding and Date Stamping

The Taxpayer asserts that laser coders, used during the manufacturing process, are exempt from the M&T tax because the bar coding is for internal tracking of the shipment and does not transform the products into their final stage. Equipment used for bar coding or date stamping would be subject to the same standards as packaging equipment. See P.D. 08-30. In this ruling, the Department concluded that machinery used for bar coding and date stamping required to meet government standards is used in manufacturing. Likewise, machinery that administers barcodes to products for the point of sale would be used in the manufacturing process because the barcodes are required to meet customer demand. However, bar coding for inventory tracking purposes would not be considered to be manufacturing when it is applied after the manufacturing process has been completed.

CONCLUSION

Based on the information provided, once the drink mixes are placed into the packaging to be consumed at retail, all industry, governmental, and consumer standards have been met. As such, the Taxpayer's manufacturing process included dispensing the drink mix into containers. Additionally, equipment used to pack Drink Mix 1 bottles and Drink Mix 2 pouches into six and ten pack cartons, respectively, were used in manufacturing. All subsequent packaging would be considered a logistical process and exempt from taxation as M&T.

In addition, if the bar coding administered by laser coders is performed after the end of the manufacturing process, they would not be considered to be machinery and tools for M&T tax purposes. If, however, they were used before the end of the manufacturing process, they would be subject to M&T tax.

Accordingly, I am remanding this case back to the County with instructions to determine the point at which the bar coding is applied and whether such equipment is subject to M&T tax in accordance with this determination. In addition, the County should identify and remove all machinery and equipment used in packaging for logistical purposes as indicated above.

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/1-5283287420.D