Were a water utility's treatment purchases exempt because they processed water or because Virginia Health required them?

Plain-English summary

Virginia returned the audit for an item-by-item manufacturing-exemption review but rejected the claim that Health Department requirements automatically made purchases exempt. The water utility had been assessed after the former broad public-service-corporation exemption was repealed effective September 1, 2004.

Water-treatment facilities qualified as industrial processors. Chemicals, machinery, tools, equipment, and supplies used directly to enhance, purify, process, or treat water for sale could therefore qualify under the manufacturing and industrial-processing exemption.

The appeal record did not show which purchases met that direct-use test, so the audit staff had to remove qualifying items. A federal, state, or local requirement by itself did not create an exemption.

Virginia lacked authority to reimburse the utility's attorney and administrative appeal costs. For recovery of tax from customers, it directed the utility to the State Corporation Commission.

P.D. 11-131 is a separately published official page with the same substantive facts and holding.

What this means for you

• Water treatment can qualify as industrial processing.
• Classify each purchase by direct production use after the utility exemption's repeal.
• Regulatory necessity alone does not establish sales-tax exemption.
• Customer cost recovery is separate from the Department's exemption analysis.

Citations and references

• Va. Code § 58.1-609.3(2) and former § 58.1-609.3(3).
• Va. Code §§ 58.1-1825 through 58.1-1829.
• 23 VAC 10-210-920.
• Virginia Public Documents 04-122 and 10-198 (August 31, 2010).
• P.D. 11-131 is the separately published companion determination.

Subject

Mandated purchases by the Virginia Department of Health are taxable.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-130

Original ruling text

July 21, 2011

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

Dear *:

This reply is in response to your letter in which you request correction of the retail sales and use tax assessment issued to * (the "Taxpayer"), for the period November 2004 through September 2009. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a public water service corporation. Following an audit by the Department, the Taxpayer was assessed use tax on purchases of materials and equipment. The Taxpayer protests the assessment and argues that the purchases are exempt in accordance with Public Document (P.D.) 10-198 (8/31/10). The Taxpayer also asserts that these purchases should be exempt of the tax because they were required by the Virginia Department of Health.

The Taxpayer requests abatement of the assessment and reimbursement of all attorney and administrative fees incurred during the appeals process. Alternatively, if the assessment is upheld, the Taxpayer asks for guidance regarding the recovery of the assessed use tax from its customers as provided in P.D. 04-122.

DETERMINATION

Manufacturing Exemption

Virginia Code § 58.1-609.3 2 provides an exemption from the retail sales and use tax for material, equipment, tools and supplies used or consumed directly in the manufacturing process. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 defines industrial processing as the treatment of materials, substances or other products in such a way as to render the product more marketable. The regulation further states that the products need not undergo a change in state or form for the process to be considered industrial in nature. The exemption includes tangible personal property incorporated into the product or used directly in the industrial process.

Previously, Va. Code § 58.1-609.3 3 allowed public service corporations such as water, gas and sewer utilities to purchase or lease tangible personal property used or consumed directly in the provision of their public service exempt of the retail sales and use tax. Effective September 1, 2004, the exemption was repealed. The guidelines for the repeal set out in P.D. 04-122 state the public service corporation exemption is no longer available for water utilities such as the Taxpayer. Although P.D. 04-122 repeals the public service corporation exemption, the document provides that there may be other exemptions available to these companies, including the manufacturing and industrial processing exemption.

In P.D. 10-198 (8/31/10), the Tax Commissioner determined that water treatment facilities are industrial processors, and chemicals used by these facilities to enhance or purify water qualify for exemption. Similarly, the machinery, tools, equipment and other supplies used directly in the processing and treatment of water for sale or resale qualify for the manufacturing and industrial processing exemption.

In the audit, the Taxpayer's purchases were assessed based on the repeal of the public service corporation exemption. However, based on the foregoing, certain purchases made by the Taxpayer may qualify for the manufacturing and industrial processing exemption. As I am unable to determine the nature of the contested purchases based on the documentation presented in the appeal, the audit will be returned to the audit staff and all purchases that qualify for the manufacturing and industrial processing exemption will be removed from the assessment.

Other Issues

The Taxpayer requests reimbursement of the legal and administrative costs it incurred in the submission of its appeal. The Code of Virginia does not provide for the reimbursement of the Taxpayer's expenses incurred during the appeal process. Furthermore, Va. Code § 58.1-1829 provides "in no event shall any costs be taxed against the Commonwealth in any proceeding" under Va. Code §§ 58.1-1825 through 58.1-1828. Therefore, I have no authority to grant the Taxpayer a reimbursement of attorney and administrative fees, associated with the appeal of the Department's assessment.

The Taxpayer argues that purchases assessed in the audit are required by the Virginia Department of Health. Title 23 VAC 10-210-920 (B) instructs that the requirements of federal, state or local law do not automatically render the purchases made under such requirements tax exempt. Although certain purchases by the Taxpayer may be required by the Virginia Department of Health, those requirements do not make the purchases at issue exempt from the retail sales and use tax. The purchases must qualify for a specific exemption under the Virginia Retail Sales and Use Tax Act. Therefore, I find no basis to adjust the assessment for purchases solely on the basis that they are mandated by the Virginia Department of Health.

Recovery of Tax

The Taxpayer requests guidance as to the collection of the assessed use tax from its customers. P.D. 04-122 allows public service corporations to recover from their customers any sales or use tax imposed as a result of the repeal of the public service corporation exemption. The Taxpayer should contact the State Corporation Commission for instructions as to the proper method to recover sales or use taxes it must pay.

CONCLUSION

This matter will be referred to the audit staff to make the appropriate adjustments as warranted. A revised audit report and updated bill will be provided to the Taxpayer. The Taxpayer should pay the revised bill within 30 days of the bill date to avoid the accrual of any additional interest charges.

The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions about this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4642417521.M