Were chemicals used between printing-ink production runs exempt as supplies used directly in manufacturing?

Subject

Ink-equipment cleaning chemicals were not used directly in production

Plain-English summary

Virginia held the cleaning chemicals taxable because the ink manufacturer used them between production runs, not during actual production. The manufacturer cleaned mixers, mills, and vessels several times a day to prevent cross-contamination among different ink colors and product lines.

The Department accepted that cleaning was essential to product integrity. But the manufacturing exemption was narrower: an item had to be indispensable to actual production and used as an immediate part of that process. Production stopped before the equipment was cleaned, and the chemicals were not actively and continuously consumed while ink was being manufactured.

The use therefore resembled taxable maintenance and purging between runs, not exempt production-line testing, quality control, or specialized cleaning conducted during production. The paid audit assessment remained correct.

What this means for you

• Necessity to product quality does not by itself satisfy the used-directly test.
• Timing matters: cleaning between runs can be taxable even when production cannot safely continue without it.
• Virginia distinguished cleaning during production from cleaning after the process stops.
• Document exactly when and how cleaning supplies enter the production process.

Citations and references

• Va. Code §§ 58.1-609.3 2 iii and 58.1-602.
• 23 VAC 10-210-920 B 2.
• Commonwealth v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-114

Original ruling text

July 18, 2014

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

Dear *:

This will reply to your letter in which you request the correction of a retail sales and use tax assessment issued to * (the "Taxpayer") for the period April 2010 through March 2013. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a manufacturer of printing inks. The Taxpayer manufactures inks in 15 to 17 different base colors for eight product lines. In addition, four process colors are produced for each series of inks. Because the various ink products are manufactured in different colors and have different characteristics, it is imperative to thoroughly clean the mixers, mills and vessels used in the Taxpayer's production process. This equipment is cleaned several times a day after each production run of ink. The cleaning of the equipment ensures that there is no cross contamination of different batches of ink during the manufacturing process.

The Department audited and assessed the Taxpayer consumer use tax on untaxed purchases of the industrial chemicals used to clean the mixers, mills and vessels. The Taxpayer maintains that the use of the cleaning chemicals qualifies for the retail sales and use tax exemption for industrial manufacturing in Va. Code § 58.1-609.3 2.

DETERMINATION

The Department's auditor determined that the Taxpayer's use of the cleaning chemicals was taxable because production was stopped to clean the mixers, mills and vessels. Thus, the chemicals were not used directly in production and were not an immediate part of the production of the printing inks. The Taxpayer contends that the cleaning chemicals are an integral and necessary part of the manufacturing and quality control process. Without the cleaning of the production equipment, any further production runs of different ink series or base colors would be contaminated. The batches produced are unsellable and useless if the equipment is not cleaned to remove the previous production residue before the start of a new production run. The Taxpayer asserts that, in this situation, the use of the cleaning chemicals is not a general or routine maintenance activity.

Virginia Code § 58.1-609.3 2 iii provides an exemption for "[m]achinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in processing, 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 or mining process, but not including ancillary activities such as general maintenance or administration."

In the court case Commonwealth of Virginia v. Community Motor Bus Co. , 214 Va. 155, 198 S.Ed.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in the manufacturing exemption statute was intended to narrow the scope of the exemption. Therefore, the exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. This standard established by the Court is also reflected in the Department's manufacturing regulation. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 interprets how the term "used directly" applies to manufacturing activities and states:

The integrated manufacturing process ... includes the production line of a plant, factory, mill, etc., starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished or completed for sale and conveyed to a warehouse at the same plant site, and also includes production line testing and quality control.

This same subsection of the regulation later states, "Items of tangible personal property which are used directly in manufacturing and processing are machinery, tools and repair parts therefor, fuel, power, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process." (Emphasis added.) Title 23 VAC 10-210-920 B 2 also states that for an item to be used directly in manufacturing, it must be used in an activity that occurs during the actual production process. This means that production line testing, quality control and cleaning activities must occur during production.

In Public Document (P.D.) 96-337 (11/19/96), the Department addressed a similar issue regarding chemicals used to clean Teflon roll covers used in the manufacture of industrial felts. The roll covers were cleaned after each batch run of a different type of felt. The roll covers were sometimes cleaned daily, but typically they were cleaned after several days of production. The Department ruled that the cleaning chemicals were not actively and continuously consumed in the production process. The cleaning chemicals were deemed to be used in a general maintenance function and were held taxable.

P.D. 10-244 (10/21/10) discusses a manufacturer that used purging compounds to clean and remove different color resins from production machinery prior to each production run in which a product with a new color was manufactured. It was ruled in this case that the cleaning process was not an exempt part of production because the cleaning occurred between production runs. Although the purging compounds were necessary to maintain and ensure product integrity and quality control, the machinery was only cleaned after the manufacturing process for a particular product had stopped. Thus, the cleaning compounds were not an immediate part of production because they were not actively and continuously used while manufacturing took place. As a result, the "used directly" requirement of the manufacturing exemption was not satisfied.

In addition, P.D. 12-173 (11/2/12) is on point with this issue and discusses a power wash cleaning system used by a manufacturer of paint and coating products. The power wash system and the repair parts for the system were deemed taxable because the system was not used directly in the manufacturing process. The cleaning system was not an immediate part of that taxpayer's production process and was not actively and continuously used during manufacturing as required. Based on the cited authorities, the chemicals were properly held taxable in the audit.

The Taxpayer cites P.D. 92-65 (5/11/92) and P.D. 02-62 (4/22/02) to support its position. In both of these cases, manufacturers of food and dairy products performed cleaning activities to sanitize production equipment. Based on the specialized nature of the cleaning and the regular frequency with which it occurred, the cleaning activities were deemed to qualify for the manufacturing exemption. However, the Taxpayer's cleaning activities more closely resemble those discussed in P.D. 96-337, P.D. 10-244 and P.D. 12-173.

While it may be true that the chemicals at issue are essential to ensure the integrity of the products manufactured by the Taxpayer, I do not agree that the chemicals qualify for the manufacturing exemption. The use of the cleaning chemicals is not an immediate part of the Taxpayer's production process. Rather, the chemicals are used before and after production. Production must stop before the cleaning of the mixers, mills and vessels can occur. For this reason, the chemicals are not actively and continuously used in the Taxpayer's manufacturing process and do not meet the used directly requirement of the exemption statute.

CONCLUSION

Based on this determination, the cleaning chemicals were properly held taxable in the audit. The Department's records indicate that the Taxpayer has paid the contested audit assessment in full.

The Code of Virginia sections, regulation and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions concerning this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5551581356.S