Was a machine dispensing exempt gloves, ear plugs, and safety glasses itself exempt manufacturing equipment?

Plain-English summary

Virginia taxed the leased vending machine even though it dispensed exempt safety gear to production employees. The machine controlled use of gloves, ear plugs, and safety glasses and helped reduce abuse, but it did not act immediately in manufacturing the taxpayer's products.

Virginia distinguished the safety supplies from the machine storing and dispensing them. Gratuitously furnished production-line safety apparel could be exempt, while stations, racks, tanks, and cabinets used to hold tools or supplies generally remained taxable. The machine was convenient but not indispensable to actual production.

The audit method did change. Nine lease payments had appeared in a six-month purchase sample that was extrapolated against gross sales. Because the lease probably ran throughout the audit, Virginia removed those payments from the sample and directly calculated all 27 months instead. The tax remained due on a revised amount.

What this means for you

• Analyze equipment separately from the exempt supplies it stores or dispenses.
• Convenience, inventory control, and reduced misuse do not establish direct production use.
• Recurring lease payments may warrant detail treatment instead of sample extrapolation.
• Pay uncontested assessment amounts while an appeal is pending to limit interest.

Common questions

Q: Were the gloves, ear plugs, and safety glasses necessarily taxable?
A: No. The ruling recognized the longstanding exemption for qualifying safety apparel furnished to production-line employees.

Q: Why was the machine taxable?
A: It stored and dispensed supplies but was not an immediate or indispensable part of production.

Q: Did Virginia leave the audit sample unchanged?
A: No. It detailed the lease payments for the full 27-month audit period.

Citations and references

• Va. Code §§ 58.1-602 and 58.1-609.3(2).
• 23 VAC 10-210-920(B)(2) and 23 VAC 10-210-920(C)(2).
• Commonwealth v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973).
• Webster Brick Co. v. Department of Taxation, 219 Va. 81, 245 S.E.2d 252 (1978).
• Virginia Public Documents 88-95, 02-140, 07-81, and 10-239.

Subject

The vending machine does not qualify for exemption from the retail sales and use tax.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-168

Original ruling text

September 29, 2011

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

Dear *:

This will reply to your letter in which you seek the correction of a retail sales and use tax assessment issued to * (the "Taxpayer") for the period April 2007 through June 2009. I apologize for the delay in this response.

FACTS

The Taxpayer is a manufacturer that was audited by the Department and assessed use tax on lease payments made for a vending machine. The vending machine was used to dispense safety equipment, such as gloves, ear plugs and safety glasses, to production employees in the Taxpayer's manufacturing area. The Taxpayer states that the vending machine controls the use and minimizes the abuse of the safety equipment furnished to production employees. The Taxpayer maintains that use of the vending machine replaces the cost of packaging that is normally included in the price of the safety equipment provided to employees. The Taxpayer claims that the vending machine qualifies for the manufacturing exemption. In addition, the Taxpayer contests the inclusion of the vending machine lease payments in the sample extrapolation of untaxed purchases identified in the audit.

DETERMINATION

Manufacturing Exemption

Virginia Code § 58.1-609.3 2 provides an exemption from the sales and use tax for tangible personal property used directly in 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 ... process, but not including ancillary activities such as general maintenance or administration."

In the case of Commonwealth of Virginia v. Community Motor Bus Co. , 214 Va. 155, 198, S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in a statute was intended to narrow the scope of the exemption. In Webster Brick Company, Inc. v. Department of Taxation , 219 Va. 81, 245 S. E.2d 252 (1978), the Virginia Supreme Court stated that "essential items which are not an immediate part of actual production are not exempt." Therefore, the manufacturing exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 B 2 interprets the "used directly" requirement of the manufacturing exemption statute and states:

Items of tangible personal property which are used directly in manufacturing ...are machinery, tools and repair parts therefor, fuel, 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. Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items that are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing .... [Emphasis added.]

Public (Document (P.D.) 88-95 (5/10/88) provides that apparel worn by production line employees primarily for the safety of the employees is exempt if provided gratuitously by the employer. This is based on the provisions of Title 23 VAC 10-210-920 C 2, which lists "safety apparel furnished gratuitously by manufacturers to production line employees ...." as an example of a nontaxable item used by manufacturing businesses. This policy is longstanding.

However, P.D. 10-239 (9/30/10) addresses the taxability of various safety supplies purchased for use by manufacturing businesses. This determination states that ear plug stations, which hold ear plugs when not in use by production personnel, are taxable when purchased for use by a manufacturer.

Other public documents issued by the Department, such as P.D. 07-81 (5/18/07), P.D. 96-107 (5/30/96) and P.D. 02-140 (11/5/02), discuss the use by manufacturers of warehouse racks, tanks and cabinets for the storage of various manufacturing supplies. These documents state that, while the storage of raw materials by manufacturers is an exempt activity, other storage activities at manufacturing sites are taxable activities. Thus, the exemption does not extend to the storage of fuel, tools, equipment and similar items used by a manufacturer in its production process, regardless that the items stored may be used directly in that production process.

The vending machine at issue it is not used directly in the Taxpayer's manufacturing process. The vending machine is not indispensable to the Taxpayer's production process and it is not an immediate part of production. Further, while the vending machine may dispense exempt safety items, the machine itself does not qualify for this exemption. Based on the above, the vending machine does not qualify for exemption from the retail sales and use tax.

Audit Sample

The Taxpayer asserts that the lease payments for the vending machine were improperly included in the audit sample of untaxed purchases. The auditor conducted a six-month sample of the Taxpayer's purchases. Nine lease payments for the vending machine are listed as exceptions for the six-month sample period. The sample results were extrapolated against the Taxpayer's gross sales.

A review of the sample methodology used for the lease payments reveals that it is more appropriate to detail the vending machine lease payments for the audit period. In a phone conversation with a member of my staff, the Taxpayer indicated that it was probable that the vending machine lease was in effect during the entire audit period. The lease payments have been removed from the audit sample and the taxable measure for the lease payments has been recalculated to be *. This amount was calculated by multiplying the monthly lease payment amount of by the 27 months in the audit period. The revised tax due is **.

CONCLUSION

The audit assessment has been adjusted in accordance with this determination. Bill * has been corrected to reflect the revised tax, penalty and interest amounts due and a copy will be issued to the Taxpayer. The bill will also reflect interest accrued to date on the revised bill amount. The Taxpayer should pay the bill within 30 days to avoid the accrual of additional interest. The Department's records indicate that the Taxpayer has not paid the uncontested portion of the audit assessment that was issued as bill ***. This bill is currently due and interest will continue to accrue on the bill until paid.

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 Tax Policy Library 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/1-4699312520.S