We refused to sign the auditor's waiver, but the audit still grew from three years to six — and can't our purchases share our sister company's manufacturing exemption since we jointly bought the equipment?

Plain-English summary

A distributor of pharmaceutical products (manufactured by an unrelated entity) was assessed use tax on untaxed purchases and fixed assets for March 2013 through February 2019 — six years, even though the original audit period was January 2015 through December 2017 and the taxpayer had refused to sign the auditor's requested six-year Extension of Time Limitation Agreement. It appealed both the audit period and the denial of a manufacturing exemption claim. The result is a split, with a rule worth remembering.

Refusing the waiver was the taxpayer's right. Waivers extending the assessment period must be written agreements signed by both the Tax Commissioner and the taxpayer (Va. Code § 58.1-220; 23 VAC 10-20-80). "Taxpayers are not obligated to sign time extension agreements," and this one "acted within its rights to decline."

Backward extension — upheld. The taxpayer wasn't registered for sales tax before the audit (it registered during the audit with a liability date of September 1, 2017), and the auditor concluded it should have been filing consumer use tax returns in the initial period (23 VAC 10-210-6030 E). Va. Code § 58.1-634 allows assessment within six years where a required return wasn't filed, and permits examining records beyond three years on reasonable cause to believe a return was required and not filed. Longstanding authority — P.D. 05-43, P.D. 92-61, and a 1976 Attorney General Opinion — reads the six-year clause to let the Department assess unreported back taxes for the fourth through sixth preceding years. So January 2013 through December 2014 properly came into the audit, no consent needed.

Forward extension — reversed. The months January 2018 through February 2019 came after the taxpayer registered, and weren't closed-period back taxes. Under P.D. 21-141, an audit period cannot be brought forward beyond the set period without a mutual agreement. Since the taxpayer declined the waiver, the post-December 2017 liability will be removed from the audit.

The de minimis argument failed twice. The taxpayer said only one purchase exception was found in the initial period and it was trivial; the audit report actually lists six, and in any event § 58.1-634 has no de minimis standard.

The manufacturing exemption — denied. The taxpayer's owner formed a separate legal entity (the "Company") in 2013 to manufacture pharmaceutical products the taxpayer would sell, and the taxpayer claimed the manufacturing was a joint venture making its equipment and supply purchases exempt. The Department disagreed at every step:

• The exemption (Va. Code § 58.1-609.3 2 (iii): machinery, tools, fuel, power, supplies used directly in manufacturing products for sale or resale) is strictly construed against the claimant (Community Motor Bus; Golden Skillet), and it belongs to the entity that actually manufactures — not a related entity (P.D. 04-79; P.D. 13-152).
• The taxpayer and the Company are separate entities with separate FEINs and separate industry classifications; the taxpayer is a wholesaler (NAICS 424210, Drugs and Druggists' Sundries Merchant Wholesalers) with no evidence it manufactures anything.
• Claims of joint invoicing weren't backed by any formal joint-venture agreement, and a lease agreement submitted on appeal didn't prove direct involvement in manufacturing.
• The Frank Lyon Co. v. United States substance-over-form argument missed: that case examines the substance of transactions, not the substance of entities — and Virginia's sales and use tax is a transactional tax in which the documents supporting each transaction control its taxability (P.D. 18-65, 20-113, 22-72).
• The proposed fix — amending income tax returns to transfer the equipment to the Company — changes nothing, because sales and use tax treatment follows the documentation of the original transactions.

Result: post-December 2017 liability removed; the 2013–2014 back periods stay; the exemption claim fails. The case returns to the audit staff for adjustments, an updated report, and a revised bill with interest.

What this means for you

If an auditor asks you to sign a waiver

You can say no — and this ruling shows the consequences cut both ways. Refusing didn't stop the Department from reaching back six years (nonfiler periods don't need your consent), but it did stop the audit from swallowing the forward months after your registration. Understand which direction the proposed extension runs before deciding.

Multi-entity businesses sharing equipment

The manufacturing exemption follows the manufacturing entity. If one affiliate manufactures and another distributes, the distributor cannot buy the plant's machinery and supplies exempt — no matter who is invoiced — without being the entity that uses them directly in manufacturing. If a true joint venture exists, paper it: a formal agreement, consistent invoicing, and matching registrations. Retroactive fixes through amended income tax returns won't rewrite the sales tax character of past purchases.

Distributors and wholesalers with unregistered use tax exposure

The trap pattern repeats across this corpus's 2025 rulings: an unregistered business that should have filed consumer use tax returns faces a six-year look-back, not three. Registering promptly — before the auditor calls — is what caps the exposure window.

Common questions

Q: We never signed the waiver. How did the audit still cover six years?
A: Consent is only needed to extend periods that are otherwise closed by agreement or to move the period forward. Because the taxpayer failed to file required consumer use tax returns, § 58.1-634's six-year clause independently authorized reaching the 2013–2014 back periods. The forward months (2018–2019) did require consent — and were removed.

Q: Only trivial amounts were found in the initial audit. Doesn't that matter?
A: No. The Department counted six exceptions (not the claimed one), and § 58.1-634 contains no de minimis threshold for applying the statute.

Q: The equipment was jointly invoiced with our manufacturing affiliate. Why no exemption?
A: The exemption applies to the entity engaged in manufacturing, not a related entity (P.D. 04-79). The taxpayer is classified as a drug wholesaler, produced no joint-venture agreement, and the lease it submitted didn't show it directly used the property to manufacture products for sale.

Q: What about substance over form — the Frank Lyon argument?
A: The Department read Frank Lyon as addressing the substance of a transaction, not the substance of entities. Virginia's sales and use tax is transactional: the documents supporting each purchase control its taxability, and those documents showed a wholesaler buying property it didn't use in manufacturing.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-1821 — administrative appeal (application for correction) to the Tax Commissioner
• Va. Code § 58.1-220 — written waiver agreements extending assessment time
• Va. Code § 58.1-634 — six-year window for failure to file; examination beyond three years on reasonable cause
• Va. Code § 58.1-609.3 2 (iii) — manufacturing exemption (machinery, tools, fuel, power, supplies used directly)
• 23 VAC 10-20-80 — waiver form requirements
• 23 VAC 10-210-920 B 1 — industrial manufacturers defined
• 23 VAC 10-210-6030 E — consumer use tax return obligation

Authorities the Department relied on (described here, not linked): P.D. 21-141 (11/9/2021) (audit period cannot be brought forward without mutual agreement); P.D. 05-43 (3/28/2005), P.D. 92-61 (5/1/1992), and Va. Att'y Gen. Op. 300 (Nov. 5, 1976) (six-year reach-back for unfiled returns); Commonwealth v. Community Motor Bus Co., 214 Va. 155 (1973), and Golden Skillet Corp. v. Commonwealth, 214 Va. 276 (1972) (strict construction); P.D. 04-79 (8/25/2004) and P.D. 13-152 (8/2/2013) (exemption belongs to the manufacturing entity); Frank Lyon Co. v. United States, 435 U.S. 561 (1978) (distinguished); P.D. 18-65 (5/2/2018), P.D. 20-113 (8/6/2020), and P.D. 22-72 (4/13/2022) (transactional-tax documentation policy).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 25-29

Original ruling text

February 27, 2025

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessments issued for the period March 2013 through February 2019.

FACTS

An audit was conducted on the books and records of the Taxpayer, a distributor of pharmaceutical products manufactured by an unrelated entity. As a result of the audit, use tax was assessed for untaxed purchases and fixed assets. The Taxpayer filed an application for correction contending that the audit period was erroneously extended beyond the three-year audit period indicated on the signed waiver. Further, it asserts that it qualifies for the manufacturing exemption.

DETERMINATION

Time Limitation Agreement

The original audit period was January 2015 through December 2017. The auditor subsequently requested that the Taxpayer sign an additional Extension of Time Limitation Agreement for the six-year period March 2013 through February 2019. The Taxpayer declined to do so.

Virginia Code § 58.1-220 provides for the waiver of time limitation on the assessment of omitted or additional state taxes and provides:

Where before the expiration of the time prescribed for the assessment of an omitted or additional state tax, both the Tax Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

Title 23 of the Virginia Administrative Code (VAC) 10-20-80 further provides that “[s]uch agreements shall be in writing, on forms prescribed by the Tax Commissioner, and shall extend the period for assessing a tax for all issues relevant to the tax and taxable period for which the agreement is executed ... .“ As such, taxpayers are not obligated to sign time extension agreements. The Taxpayer, in this case, acted within its rights to decline an additional waiver of time.

Statute of Limitations

The Taxpayer asserts that the periods prior to 2015 are outside the three-year statute of limitations, and the auditor lacked reasonable cause to expand the audit period to these closed periods. In addition, the Taxpayer claims that only one purchase exception was found during the initial audit period, and that the purchase price and tax due are de minimis in nature. Virginia Code § 58.1-634 addresses the period of limitations for the retail sales and use tax. This statute states that:

In the case of a false or fraudulent return with intent to evade payment of the taxes imposed by this chapter, or a failure to file a return, the taxes may be assessed, or a proceeding in court for the collection of such taxes may be begun without assessment, at any time within six years from such date. The Tax Commissioner shall not examine any person’s records beyond the three-year period of limitations unless he has reasonable evidence of fraud, or reasonable cause to believe that such person was required by law to file a return and failed to do so.

Prior to the audit, the Taxpayer was not registered for the collection or remittance of retail sales and use tax. Upon inquiry from the audit staff, the Taxpayer registered for a sales tax account with a beginning liability date of September 1, 2017. Once the audit process began, the auditor found tax liability and concluded that the Taxpayer should have filed consumer use tax returns in the initial audit period. See Title 23 VAC 23 10-210-6030 E. Once it was established that the Taxpayer was required to file returns during the initial period, the auditor extended the audit period to include the period March 2013 through February 2019.

In Public Document (P.D.) 21-141 (11/9/2021), the Department decided that a period set for an audit cannot be brought forward beyond the statutory period without a mutual agreement between a taxpayer and the Department. However, in P.D. 05-43 (3/28/2005), the Department found that Virginia Code § 58.1-634 allowed for the examination of a dealer’s records beyond the three-year limitation period for assessments when there is reasonable evidence that shows that such dealer was required by law to file a return and failed to do so.

This interpretation is consistent with a 1976 Attorney General Opinion in which the Attorney General opined that the six-year clause of Virginia Code § 58.1-634 (formerly Virginia Code § 58-441.38) permits the Department, at its discretion, “to assess any back taxes for the fourth through sixth preceding years that went unreported.” See Va. Att’y Gen. Op . 300 (Nov. 5, 1976); P.D. 92-61 (5/1/1992).

Thus, the auditor appropriately included the January 2013 through December 2014 periods in the audit, because such periods were within the statutory six-year statute of limitations applicable when a Taxpayer fails to file a return. The periods January 2018 through February 2019, however, were after the Taxpayer registered for a sales tax account and did not comprise periods for which the Department needed to assess back taxes that were otherwise beyond the three-year statute of limitations. Therefore, the auditor should not have extended the audit period beyond December 2017 without a mutual agreement with the Taxpayer.

Further, contrary to the argument that only one item was identified during the initial three-year period, six such exceptions are listed in the audit report. Regardless of the number of exceptions or amount of tax measure found in the initial audit period, Virginia Code § 58.1-634 does not establish a de minimis standard to enforce the statute.

Manufacturing Exemption

The Taxpayer’s owner formed a new legal entity, * (the “Company”), in 2013 for the purpose of manufacturing pharmaceutical products that would be sold by the Taxpayer. The Taxpayer claims that the manufacturing was a joint venture with the Company and, therefore, the untaxed purchases qualify for the manufacturing exemption.

The Department is bound by the doctrine of strict construction in interpreting the retail sales and use tax exemptions. The Virginia courts have consistently held that exemptions from the tax must be strictly construed and where there is any doubt, that the doubt must be resolved against the person claiming the exemption. See Commonwealth v. Community Motor Bus Co., Inc. , 214 Va. 155 (1973) and Golden Skillet Corp. v. Commonwealth, 214 Va. 276 (1972). No evidence has been provided to show that the Taxpayer was engaged in manufacturing in accordance with Virginia Code § 58.1-609.3 2.

With this doctrine in mind, Virginia Code § 58.1-609.3 2 (iii) provides an exemption from the retail sales and use tax for “[m]achinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in processing, manufacturing, refining, mining or converting products for sale or resale ... .” Title 23 VAC 10-210-920 B 1 provides that industrial manufacturers include establishments engaged in the mechanical or chemical transformation of materials and substances into new products.

The auditor determined the Taxpayer who purchased the tangible personal property did not qualify for the manufacturing exemption because it is not engaged in manufacturing.

During the audit, the Taxpayer and the Company were identified as separate entities with one owner. The Taxpayer and the Company have separate Federal Employer Identification Numbers and separate industry classifications. While the Company may have qualified for the manufacturing exemption, the Taxpayer operated as a wholesaler in accordance with the North American Industry Classification System (NAICS) code 424210 (Drugs and Druggists’ Sundries Merchant Wholesalers) and no evidence has been provided that the Taxpayer is engaged in manufacturing products for sale or resale.

In P.D. 04-79 (8/25/2004), the Department ruled that the industrial manufacturing exemption applies to the entity conducting the manufacturing, not to a related entity. See also P.D. 13-152 (8/2/2013).

The Taxpayer claims the invoices were jointly invoiced for at least some of the equipment but has failed to provide a formal contract or agreement, such as a joint-venture agreement, to substantiate the business structure. Although the Taxpayer submits a lease agreement with its appeal, the document does not prove that the Taxpayer was directly involved in manufacturing or that it qualifies for the exemption. The Taxpayer cannot claim an exemption for tangible personal property that it does not directly use to manufacture products for sale or resale.

The Taxpayer also believes that the auditor ignored the substance of the transactions and relied on the business form to disallow the manufacturing exemption. It cites Frank Lyon Co. v. United States , 435 U.S. 561 (1978) to claim that it qualifies for the manufacturing exemption when viewing the substance of the Taxpayer’s business structure over the form of its transactions. The cited court case involves a sale-and-leaseback agreement between multiple parties and looked to the substance of the agreement and specific circumstances surrounding the parties’ transactions to determine whether one party qualified for the federal income tax deductions at issue. Thus, the decision in Frank Lyon is limited to the substance of the transaction and not the substance of the entities engaged in the transaction.

The Department has a longstanding and established policy that the retail sales and use tax is a transactional tax. See P.D. 18-65 (5/2/2018) and P.D. 20-113 (8/6/2020). Under this regimen, the determination as to the taxation of a specific transaction is based on the underlying documents that support the transaction. See P.D. 22-72 (4/13/2022). Thus, the form of the transaction as evidenced by the available documents controls the taxability of the transaction.

In order to remedy this issue, the Taxpayer proposes to amend income tax returns in order to transfer the equipment to the Company for state and federal tax purposes. Regardless of the income tax treatment of the purchased equipment and supplies, the documentation supporting the specific transactions would control the treatment for sales and use tax purposes.

CONCLUSION

Based on the determination above, the liability for the periods that occurred after December 2017 will be removed from the audit. However, the Taxpayer has not shown it was eligible to purchase assets and supplies exempt from the tax. In addition, the audit was appropriately extended back to January 2013.

The case will be returned to the audit staff to make adjustments based on this determination. Once the auditor’s review is complete, an updated audit report, a written explanation of any changes, and an updated bill with accrued interest to date will be mailed to the Taxpayer.

The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/2115.B

Related Documents

92-61

04-79

05-43

13-152

18-65

20-113

21-141

22-72