Was a fertilizer-additive plant properly classified as a 'processor' rather than a 'manufacturer' for Virginia BPOL tax purposes?

Subject

Classification : Manufacturer - Sustainability

Plain-English summary

A taxpayer operating a plant that produces fertilizer additives appealed its city's Business, Professional and Occupational License (BPOL) tax classification. The City classified the Taxpayer as a "processor," but the Taxpayer argued it should instead be classified as a "manufacturer" -- a classification that Virginia law exempts from local license taxation on sales at wholesale at the place of manufacture.

At the plant, raw materials -- copper, zinc, manganese, magnesium, iron, and boron -- are mixed in a specific ratio and fed into a rotating granulator drum along with sulfuric acid. A reaction between the acid and the dry materials produces heat and partially converts the metal oxides into sulfates, granulating the product; water, drying, cooling, screening, and an anti-dust oil round out the process. The City relied on prior cases and an Attorney General opinion involving fertilizer blending operations to argue this was mere processing, since (in the City's view) the raw materials were micronutrients and the end product was micronutrients too.

The Tax Commissioner disagreed with the City and sided with the Taxpayer. Applying the Virginia Supreme Court's three-element manufacturing test (raw material, a process that changes it, and a resulting product substantially different in character from the original), the Commissioner found that the chemical reaction here -- converting a portion of the metal oxides into water-soluble sulfates -- produced a resulting product substantially different from the raw oxides, unlike the mere blending activities in the cases the City cited. As a result, the Taxpayer was determined to be a manufacturer, not a processor, for BPOL tax purposes, and the City's contrary classification was overturned.

What this means for you

Fertilizer and chemical processors weighing BPOL classification

Whether an operation is a "manufacturer" (largely exempt from local license tax on wholesale sales at the place of manufacture) or a "processor" (which may be taxed) turns on whether raw materials undergo a chemical or physical transformation into something substantially different in character -- not merely on whether inputs and outputs fall into the same general category (here, "micronutrients"). A genuine chemical reaction, such as the partial conversion of metal oxides to sulfates through a reaction with sulfuric acid, can support manufacturer status even when the finished product serves a similar general purpose as the raw materials.

Distinguishing manufacturing from blending or mixing

The ruling contrasts this case with fertilizer-blending operations (cited by the City) where ingredients were simply combined by machinery with no chemical transformation -- those were held to be processing, not manufacturing. Businesses in similar industries should closely examine whether their operations involve an actual chemical or physical transformation of raw materials, rather than assuming that any activity resulting in a finished product for sale automatically qualifies as manufacturing.

Localities and BPOL classification determinations

Local commissioners of the revenue administer the BPOL tax and bear the burden of a correct initial classification, but that classification is presumed correct on appeal until the taxpayer shows otherwise. This ruling illustrates that the Department of Taxation will look closely at the specific facts of a taxpayer's production process -- rather than resting on classification precedents from other cases involving generally similar products -- when the taxpayer meets its burden of proof.

Common questions

Q: Did the Taxpayer win its appeal?
A: Yes. The Tax Commissioner determined that the Taxpayer is a manufacturer for BPOL tax purposes, overturning the City's classification of the Taxpayer as a processor.

Q: What test does Virginia use to decide if a business is a "manufacturer"?
A: The Virginia Supreme Court's three-element test: (1) an original material, referred to as raw material; (2) a process whereby the original material is changed; and (3) a resulting product that, by reason of that processing, is different from the original material. See Title 23 VAC 10-500-520 B and County of Chesterfield v. BBC Brown Boveri, 238 Va. 64, 380 S.E.2d 890 (1989).

Q: Why did the City think the Taxpayer was only a processor?
A: The City argued, citing Richmond v. Dairy Co. and Solite Corporation v. County of King George, that the Taxpayer's plant was merely processing because the raw materials were micronutrients and the end product was also micronutrients, and it relied heavily on Department of Taxation v. Orange-Madison Cooperative Farm Service and a 1976-1977 Attorney General opinion involving fertilizer-blending operations.

Q: What made this case different from the fertilizer-blending precedents the City relied on?
A: In Orange-Madison and the cited Attorney General opinion, the operations simply blended fertilizer ingredients together with no chemical reaction transforming the materials. Here, by contrast, the sulfuric acid reacted with the metal oxides, causing heat and a partial conversion of the oxides into sulfates -- a genuine chemical transformation the Commissioner found comparable to the transformation recognized as manufacturing in P.D. 04-21, where a chemical reaction converted lye soap stock into edible fatty acid and glycerin.

Q: Does this ruling mean all fertilizer producers are manufacturers for BPOL purposes?
A: No. The Commissioner specifically noted that fertilizers are produced through a variety of processes, and cases cited by a locality "cannot be expected to cover the classification of every business that produces fertilizer." Each business's activities must be analyzed against the applicable statutes, ordinances, and regulations to determine its correct classification.

Q: Why does the manufacturer classification matter for BPOL tax?
A: Virginia Code § 58.1-3703 C 4 prohibits localities from imposing a license fee or tax on a manufacturer for the privilege of manufacturing and selling goods, wares, and merchandise at wholesale at the place of manufacture, while processors do not receive this same exemption.

Citations and references

Statutes:

• Va. Code § 58.1-3703.1 (Department's authority to issue determinations on BPOL appeals)
• Va. Code § 58.1-3703 C 4 (prohibition on licensing manufacturers for selling goods at wholesale at the place of manufacture)
• Title 23 VAC 10-500-520 B (three-element test for manufacturing)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-4

Original ruling text

February 2, 2021

Re: Appeal of Final Local Determination

Taxpayer: *

Locality: *

Business, Professional and Occupational License 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. You appeal the classification of the Taxpayer by *** (the “City”) for purposes of the Business, Professional and Occupational License (BPOL) tax.

The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL 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, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site.

FACTS

The Taxpayer operates a plant in the City that produces fertilizer additives that are sold to fertilizer companies to be incorporated into fertilizer. Raw materials that include copper, zinc, manganese, magnesium, iron and boron are mixed in a specific ratio pursuant to customer needs. These materials are then fed via conveyor into a rotating granulator drum at a preset rate. Sulfuric acid is also introduced into the drum at a preset rate. A reaction occurs between the acid and dry materials causing heat and a partial conversion of oxides to sulfates and granulation of the product. Water is added as needed to aid the reaction and improve granulation size. The mixture is then dried, cooled and screened. An anti-dust oil is added to retard dust exposure. Oversized materials are crushed and returns to the screening process. Undersized material is returned to the granulator in order for it to reach sufficient size.

The Taxpayer is currently classified as a processor by the City for BPOL tax purposes. The Taxpayer appeals the classification contending that it should be classified as a manufacturer.

ANALYSIS

BPOL - Manufacturing

Virginia localities are prohibited from imposing a license fee or tax on a manufacturer for the privilege of manufacturing and selling goods, wares and merchandise at wholesale at the place of manufacture. See Virginia Code § 58.1-3703 C 4.

The local business tax statutes do not define the term “manufacturer” for purposes of the local business license tax. However, the Supreme Court of Virginia (the “Court”) 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. See Title 23 of the Virginia Administrative Code (VAC) 10-500-520 B and County of Chesterfield v. BBC Brown Boveri, 238 Va. 64, 380 S.E.2d 890 (1989). As such, for local business tax purposes, a manufacturer means 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.

The Taxpayer contends that because the oxides in the raw materials react with the sulfuric acid and partially convert to a sulfates, there is a transformation into a product of substantially different character. Citing Richmond v. Dairy Co. , 156 Va. 63, 157 S.E. 728 (1931) and Solite Corporation v. County of King George , 220 Va. 661, 261 S.E.2d 535 (1980), the City asserts that the Taxpayer’s plant is merely engaged in processing because the raw materials are micronutrients and the end product is micronutrients.

The City primarily relies on Department of Taxation v. Orange-Madison Cooperative Farm Service , 220 Va. 655, 261 S.E.2d 532 (1980) and 1976-1977 Op. Atty. Gen. Va. 283 as authority regarding its conclusion that the Taxpayer’s operation constitutes processing. In Orange-Madison, a fertilizer plant blended nitrogen, potash, phosphate and other chemicals by machinery into fertilizer. The Court held that this constituted industrial processing rather than manufacturing for purposes of a sales tax exemption. The Department has repeatedly held that the BPOL tax is a local tax that is separate and distinct from Virginia’s retail sales and use tax. See Public Document (P.D.) 09-93 (6/11/2009), P.D. 09-139 (9/21/2009), P.D. 11-44 (3/23/2011), P.D. 12-220 (12/21/2012), P.D. 13-25 (3/5/2013) and P.D. 15-19 (2/11/2015). Nothing in the facts of the case indicates that any sort of heat or chemical reaction occurred to transform raw materials into a substantially different product.

In 1976-1977 Op. Atty. Gen. Va. 283, the Attorney General opines that when a farm supply merchant who purchases fertilizer ingredients and blends them to make a mixture is not a manufacturer for property tax purposes. In this opinion, like the taxpayer in Orange-Madison , the farm supply merchant merely blended fertilizer ingredients to make a specific fertilizer mixture. No activity occurred that transformed the fertilizer ingredients.

Like many products, numerous types of fertilizers produced in a variety of processes are available for flora health and growth. The cases cited by the City cannot be expected to cover the classification of every businesses that produces fertilizer. Instead, the activities of each business must be analyzed in light of the applicable ordinances, statutes and regulations in order to make an accurate classification determination.

In P.D. 04-21 (6/2/2004), a taxpayer combined lye soap stock with sulfuric acid and heat. The resulting endothermic chemical reaction produced an edible fatty acid and glycerin. The Department determined that the taxpayer’s activity was manufacturing for purposes of local tax because the lye stock soap was subjected to a process that transformed the soap into edible feed stock oil and glycerin that was substantially different in character then the original material.

The distinguishing factor here was that the chemical reaction occurs when the metal oxides were subjected to the sulfuric acid. As a result, a portion of the oxides are transformed into sulfate, a salt that is water soluble. The remaining oxide, a binary compound of an element and oxygen, takes longer to breakdown in water. Depending on the needs of the customer, 30 to 40 percent of the finished product is sulfate with the remaining 60 to 70 percent being oxides. The combination allows crops to absorb nutrients over an extended period of time, with the sulfates being absorbed first followed by the oxides. Without a product substantially different in character from the oxides, nutrients may not be absorbed in time to produce a desirable crop.

DETERMINATION

Based on the information provided, the Taxpayer mixes raw materials, subjects them to a chemical process, and the resultant product is substantially different that the raw materials. As such, I find that the Taxpayer is a manufacturer for BPOL tax purposes.

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/3566.B

Related Documents

09-93

09-139

11-44

12-220

13-25

15-19

04-21