Which of my factory purchases qualify for Virginia's manufacturing exemption — and can the Department waive interest on tax I should have collected?

Plain-English summary

A metal fabricator audited for August 2017–December 2020 challenged the sales and use tax the Department assessed on two welding machines and 80% of two forklifts, and asked the Department to waive interest on tax it had not collected on sales to one customer. The Commissioner reached a mixed result and sent the case back to the auditor.

Welding machines — EXEMPT. Virginia exempts machinery, tools, and repair parts used directly in manufacturing or processing for sale or resale (§ 58.1-609.3); the activity must be industrial in nature (§ 58.1-602), and "processing" means treating a product to make it more marketable or useful (Commonwealth v. Orange-Madison Cooperative). The welding machines were used to join steel in fabricating products to customer specifications — used directly in production — so they qualify and were removed from the audit.

Forklifts — it depends on predominant use. When a single item is used in both exempt production and taxable activities, the preponderance-of-use rule applies: the item is fully taxable if 50% or more of its use is non-exempt, and fully exempt if the majority of its use is in production (§ 58.1-609.3 2; 23 VAC 10-210-920 D). The taxpayer claimed the forklifts were about 80% exempt but offered no objective evidence. The auditor had observed that one forklift was used mainly in the manufacturing area (may qualify) while the other was relegated to finished-goods storage (taxable). The Department remanded so the auditor can observe operations and any documentation and decide.

Interest — cannot be waived. The taxpayer sold steel to a customer without collecting tax, believing the sales were exempt sales to a railway common carrier, but the customer produced the wrong exemption certificate. The taxpayer conceded the tax and — stressing it was not trying to commit fraud — asked the Department to waive the interest. The Department could not: interest is mandatory on a tax assessment (§ 58.1-1812) and is not a penalty but a charge for the use of money over time, so the Department lacks authority to waive interest that was properly assessed.

Because the assessment was already paid, removing the welding machines (and any exempt forklift share the auditor confirms) will produce a refund.

What this means for you

Manufacturers and fabricators claiming the equipment exemption

Equipment used directly in your production process — like welding machines that join your product — qualifies for the manufacturing exemption. But the exemption is strictly construed, and dual-use equipment is the classic trouble spot. For anything that serves both production and non-production roles (forklifts, tools, vehicles), the tax turns on the 50% preponderance-of-use test, and the burden is on you to prove the split with objective evidence — usage logs, time studies, area assignments — not just an estimate.

Storage and material-handling equipment

Note the split the auditor drew between the two forklifts: one working the manufacturing area (potentially exempt) and one working finished-goods storage (taxable). Handling raw materials and work-in-process within production leans exempt; moving or storing finished product leans taxable. Assign and document each machine's primary zone of use.

On interest

Do not expect an interest waiver just because a mistake was innocent. Virginia interest is a statutory charge for the time value of the unpaid tax, not a fault-based penalty, and the Department has no authority to waive it once it is properly assessed. The way to limit interest is to get the tax right up front — including collecting the correct exemption certificate from your customers.

Common questions

Q: Is my production machinery exempt from Virginia sales and use tax?
A: Machinery, tools, and repair parts used directly in an industrial manufacturing or processing activity for sale or resale are exempt (§ 58.1-609.3). Equipment that is not used directly in production — or is only incidental to it — generally is not.

Q: How is a forklift (or other dual-use item) taxed?
A: By the preponderance-of-use rule. If 50% or more of its use is in non-exempt activities it is fully taxable; if the majority of its use is in exempt production it is fully exempt (§ 58.1-609.3 2; 23 VAC 10-210-920 D). You must be able to prove the predominant use with objective evidence.

Q: Can the Department waive interest if I made an honest mistake?
A: No. Interest is mandatory under § 58.1-1812 and is a charge for the use of money over time, not a penalty. The Department cannot waive properly assessed interest, even absent any fraud. (Penalties, which are fault-based, are analyzed separately.)

Q: My customer gave me an exemption certificate that turned out to be wrong. Am I off the hook?
A: Not necessarily. Here the customer produced the wrong exemption certificate for the claimed railway-common-carrier exemption, and the seller remained liable for the tax (and interest). Collecting the correct, valid certificate at the time of sale is what protects you.

Citations and references

Statutes and regulation:

• Va. Code § 58.1-609.3 — exemption for machinery, tools, and repair parts used directly in manufacturing or processing for sale or resale
• Va. Code § 58.1-609.3 2; 23 VAC 10-210-920 D — preponderance-of-use rule for property used in both exempt and taxable activities (the 50% test)
• Va. Code § 58.1-602 — a qualifying manufacturing/processing activity must be industrial in nature
• Va. Code § 58.1-203 — the Department's authority to interpret the tax laws; exemptions are strictly construed
• Va. Code § 58.1-1812 — interest is mandatory on a tax assessment and cannot be waived

Authorities the Department relied on (described here, not linked): Commonwealth v. Orange-Madison Cooperative, 220 Va. 655 (1980) ("processing" = treatment making a product more marketable or useful); and Commonwealth v. Community Motor Bus, Commonwealth v. Research Analysis Corp., and Golden Skillet Corp. v. Commonwealth, all 214 Va. (1973) (strict construction of exemptions).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 25-69

Original ruling text

May 21, 2025

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

Dear *:

This will respond to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the “Taxpayer”) for the period August 2017 through December 2020.

FACTS

An audit was conducted on the books and records of the Taxpayer, a metal fabricator. As a result, the Taxpayer was assessed sales and use taxes for assets, sales and purchases. The Taxpayer paid the assessment and filed an application for correction contending that two welding machines and 80% of the purchase price of two forklifts were exempt from the sales and use tax. Further, the Taxpayer requests the waiver and refund of a portion of interest for tax assessed on sales to one of its customers.

ANALYSIS

Strict Construction of Exemptions

The Department has the authority to interpret and enforce the laws of the Commonwealth governing taxes in accordance with Virginia Code § 58.1-203. With regard to such interpretations, Virginia case law requires strict construction of sales tax exemptions. Where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Commonwealth v. Community MotorBus , 214 Va. 155 (1973); Commonwealth v. Research Analysis Corporation , 214 Va. 161 (1973); and Golden Skillet Corp. v. Commonwealth , 214 Va. 276 (1973).

Manufacturing Exemption

The Taxpayer asserts that several of the purchases listed as exceptions in the audit were used in its fabrication operations. Virginia Code § 58.1-609.3 provides an exemption from the retail sales and use tax for machinery, tools, or repair parts used directly in manufacturing or processing for sale or resale. By definition, manufacturing and processing activities must be “industrial in nature” to qualify for the exemption. See Virginia Code § 58.1-602. In Commonwealth v. Orange-Madison Cooperative , 220 Va. 655 (1980), the Virginia Supreme Court interpreted the term “processing” to mean the treatment of a product that makes it more marketable or useful. Both Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 1 and the decision in Orange-Madison make it clear that processing occurs only when a product is subjected to a treatment that makes it more marketable or useful.

Welding Machines

The Taxpayer was engaged in the business of fabricating steel products for commercial customers. Based on the information provided, the two welding machines were used to attach pieces of steel together in order to fabricate products meeting customer demands. Because they were used directly in the fabrication process, the purchase of these machines qualified for the manufacturing exemption.

Forklifts

The Taxpayer indicates that the forklifts were used to bring in raw materials and to move materials around the facility in different stages of manufacturing and finished product storage. In situations where an industrial processor uses a single piece of equipment in both a taxable and an exempt manner, a preponderance of use rule determines the tax application. See Virginia Code § 58.1-609.3 2. This rule is explained in Title 23 VAC 10-210-920 D, which states:

When a single item of tangible personal property is put to use in two different activities, one of which is an immediate part of the industrial production process (exempt) and the other of which is not (taxable), the sales and use tax shall apply in full when the preponderance of the item's use (fifty percent or more) is in non-exempt activities. Likewise, the item will be totally exempt from the tax if the preponderance of its use is in exempt production activities.

The Taxpayer concedes the forklifts in question were utilized for multiple uses in the facility but argues that their principal use was in the fabricating and manufacturing areas. Under these circumstances, the Department must apply the preponderance of use rule to determine whether the primary use of the forklifts was for exempt activities. Although the Taxpayer believes the forklifts were used approximately 80% of the time for exempt purposes, no objective evidence has been provided to support this claim.

The audit report indicates that the auditor observed that one forklift appears to have been used primarily in the Taxpayer’s manufacturing and fabricating area. The other forklift, however, was relegated to use in the Taxpayer’s finished goods storage area.

Interest

The Taxpayer sold substantial amounts of structural, rail, and other steel to one customer without collecting sales tax. It reasoned that these sales were exempt sales to a railway common carrier. The Department listed these sales as exceptions because the customer provided the wrong exemption certificate. While it concedes the tax portion of the assessment, the Taxpayer stresses that it was not trying to commit fraud and requests that the Department waive interest accrued on the tax for these sales.

As a rule, Virginia Code § 58.1-1812 mandates the application of interest to any tax assessment. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it represents a fee for the use of money over a period of time. Therefore, the Department lacks the authority to waive interest properly assessed under the statute.

DETERMINATION

Based on the evidence provided, this case will be returned to the audit staff to review and adjust the assessment in accordance with the following determination.

The purchases of the two welding machines were exempt from the tax and will be removed from the audit.

While it appears that at least one of the forklifts may qualify for the manufacturing exemption, the lack of objective evidence hinders the Department’s ability to make a definitive determination. The auditor will arrange a time with the Taxpayer in order to observe its operations and any other documentation it may have in order to determine if the forklifts qualified for the manufacturing exemption.

The Department is unable to waive interest assessed on the audit liability.

Once the welding machines have been removed and the preponderance of use of the forklifts determined, the Taxpayer will be issued a revised audit report. Because the assessment has been paid, the revised liability will result in a refund that will be issued to the Taxpayer.

The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. If you have any questions regarding this response, you may contact * in the Office of Tax Policy and Legal Affairs, Adjudication and Resolution Division, at * or **@tax.virginia.gov.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/3945.B.