When did purchased idle manufacturing equipment become taxable machinery and tools, and which owner's cost controlled its valuation?

Subject

Advisory opinion regarding idle machinery and tools.

Plain-English summary

Virginia answered three questions about idle manufacturing equipment purchased from another business.

First, rebuilding a machine so it could make lower-grade recycled products did not keep it outside the machinery-and-tools class. Once the machine was necessary to the buyer's manufacturing business and actually and directly used in production, it was subject to M&T tax.

Second, equipment bought in April 2012 but delayed by financing and testing did not become used manufacturing machinery merely on purchase. It became used in the manufacturing business when it started producing products in February 2013. The opinion recognized that some machinery needs preparation and testing before production.

Third, the statutory "original total capitalized cost" generally meant the cost paid by the owner who first bought the asset new, not the discounted price paid by the later purchaser. The county nevertheless had to use a permitted valuation method that reasonably approximated fair market value; if its ordinary method produced an assessment well above fair market value, another statutory method could be appropriate.

What this means for you

• Modification of used equipment does not prevent M&T classification when the rebuilt machine enters actual production.
• Purchase or receipt is not always the placed-in-service date for manufacturing tax treatment; preparation and testing facts matter.
• A later bargain purchase does not automatically replace the first owner's original capitalized cost in the statutory depreciation method.
• Local officials administer the tax and must keep the resulting assessment reasonably tied to fair market value.

Common questions

Q: Did destroying components and rebuilding the machine make it exempt?
A: No. Its necessity and actual direct use in the buyer's manufacturing process controlled.

Q: When did the delayed equipment become used machinery?
A: When it began producing products in February 2013, ten months after purchase.

Q: Whose cost generally supplied original total capitalized cost?
A: The first owner's cost when the asset was purchased new, not the later buyer's discounted price.

Citations and references

• Va. Const. art. X, §§ 1, 2, and 4.
• Va. Code §§ 58.1-1101(A)(2), 58.1-3103, 58.1-3507(A), (B), and (G), and 58.1-3983.1(J)(2).
• Tuckahoe Women's Club v. County of Richmond, 119 Va. 734, 101 S.E.2d 571 (1958).
• Samson v. Board of Supervisors, 257 Va. 589, 514 S.E.2d 345 (1999).
• Public Documents 05-129, 12-27, and 13-20.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-55

Original ruling text

April 24, 2014

Re: Request for Advisory Opinion

Machinery and Tools Tax

Dear *:

This is in response to your letter in which the * (the "County") requests an advisory opinion regarding idle machinery and tools.

The machinery and tools (M&T) tax is imposed and administered by local officials. Virginia Code § 58.1-3983.1 J 2 authorizes the Department to issue advisory opinions on local business tax matters. The following opinion has been issued subject to the facts presented to the Department summarized below. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections 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 County presents several scenarios regarding the application of the M&T tax to idle equipment purchased by Business B from Business A. Under Va. Code § 58.1-3507 G, the Tax Commissioner shall have the authority to issue advisory written opinions in specific cases to interpret the provisions of this section related to idle machinery and tools.

OPINION

Scenario 1

Business B purchased an idle machine from Business A for the purpose of manufacturing recycled materials used to produce certain commercial grade products. Business A originally used the machine to manufacture fine grade products. According to the purchase agreement, Business B is prohibited from using the machinery to produce fine grade products. The agreement requires that certain components in the machinery be destroyed to prevent the machinery from ever producing fine grade products. The machine is then rebuilt using components that would only allow it to manufacture lower commercial products. The County asks whether the machine is subject to the M&T tax because it was altered.

All tangible personal property, unless declared intangible under the provisions of Va. Code § 58.1-1100 et seq. , is reserved for local taxation by Article X, § 4 of the Constitution of Virginia . Included in the category of tangible property that is declared intangible and subject to state taxation only is "[c]apital which is personal property, tangible in fact, used in manufacturing (including, but not limited to, furniture, fixtures, office equipment and computer equipment used in corporate headquarters)." See Va. Code § 58.1-1101 A2.

The machinery and tools, motor vehicles and delivery equipment of a manufacturing business are not defined as intangible personal property. Such property is to be taxed locally as tangible personal property. Virginia has established a separate classification of tangible personal property for machinery and tools used in manufacturing. Virginia Code § 58.1-3507 A provides:

Machinery and tools, except idle machinery and tools . . . used in a manufacturing . . . business shall be listed and are hereby segregated as a class of tangible personal property separate from all other classes of property and shall be subject to local taxation only. [Emphasis Added.]

The Attorney General has consistently opined that "machinery and tools" used in a particular manufacturing business are the machinery and tools that are necessary in the particular manufacturing business and which are used in connection with the operation of machinery that is actually and directly used in the manufacturing process. See 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317 and 1987-1988 Att'y. Gen. Ann. Rep. 590. So long as the machine is necessary for Business B's manufacturing business and it is actually and directly used in Business B's manufacturing process, it would be subject to M&T tax.

Scenario 2

In April 2012, Business B purchased recycling equipment and two machines from Business A that qualified as idle machinery. The requirement for additional financing and testing delayed the equipment from being put into use. The equipment started producing its products in February 2013. The County inquires whether the machinery purchased by Business B was considered put back into service when it was purchased or when

production began.

Generally, tangible personal property is presumed to be used from the date it is placed in service, usually the date it is purchased or received by the business. As indicated above, machinery and tools are considered to be used in a manufacturing business if they are necessary in the manufacturing business and are either used in the manufacturing process or are used in connection with the operation of machinery used in the manufacturing process. See 1985-1986 Att'y. Gen. Ann. Rep. 316 at 317 and 1987-1988 Att'y. Gen. Ann. Rep. 590. According to these opinions, machinery and tools may not be considered to be used in a manufacturing business until they are actually used in the manufacturing process. I recognize that some manufacturing machinery requires a period of preparation and testing before it is used to manufacture a product.

Business B purchased machinery from Business A with the intent to make it operational. In this scenario, the machinery was not operational until ten months after its purchase. Based on the Attorney General's opinions, the machinery at issue would be considered to be used in a manufacturing business when it began producing products.

Scenario 3

Business B purchased Business A's machinery and tools at a price that was significantly less than Business A's original cost. The County inquires whether the M&T tax should be based on the value of the seller's original cost or the buyer's purchase price.

Article X, §§ 1 and 2 of the Constitution of Virginia provide that all property, unless specifically exempted within the provisions of the Constitution , shall be taxed at a uniform rate among classes, and that "all assessments of real estate and tangible personal property shall be at their fair market value to be ascertained as prescribed by general law." This provision of the Constitution contains the presumption that the General Assembly's prescribed valuation method will both standardize valuation practices across all the local governments in the Commonwealth and result in something approximating fair market value. Virginia Code § 58.1-3103 specifically charges local commissioners with the responsibility of assessing property at fair market value.

Fair market value is generally defined as the price a property will bring when offered by one who desires, but is under no obligation, to sell it, and the buyer has no immediate necessity to purchase it. See Tuckahoe Women's Club v. County of Richmond , 119 Va. 734, 101 S.E.2d 571 (1958). If the valuation methodology employed by a locality results in an assessment well above fair market value, the locality may use another methodology prescribed in Va. Code § 58.1-3507 B. See P. D. 05-129 (8/03/2005).

In attempting to achieve property valuations that reasonably approximate fair market value, the General Assembly has statutorily prescribed different methodologies for use in the valuation of different classifications of property. For purposes of business tangible personal property taxation, the machinery and tools of manufacturers are separate from the general classification of tangible personal property. The method of valuation to ascertain the fair market value of machinery and tools used in a manufacturing business is set forth in Va. Code § 58.1-3507 B. Machinery and tools segregated for local taxation . . . shall be valued by means of depreciated cost or a percentage or percentages of original total capitalized cost excluding capitalized interest.

The General Assembly has not provided a definition for the term "original total capitalized cost" within the context of Va. Code § 58.1-3507 B. Absent a statutory definition, the plain and ordinary meaning of the term is controlling. See Samson v. Board of Supervisors , 257 Va. 589, 514 S.E.2d 345 (1999). Original cost means "[a]n asset's net price; the original cost of an asset." Black's Law Dictionary 371 (8th Edition 2004). Based on this reasoning, the original total capitalized cost refers to the original price of an asset purchased new. Thus, the original total capitalized cost is the cost of the tangible property paid by the owner who first purchased the property as capitalized, not the costs paid by any subsequent purchasers. See P.D. 13-20 (2/15/2013), P.D. 12-27 (3/6/2012) and Op. Va. Att'y Gen (8-109).

In accordance with established policy, the original total capitalized cost would be Business A's original cost, not the price paid by Business B. However, as provided in P.D. 05-129, it is incumbent upon the County to employ a valuation methodology that results in an assessment that reasonably approximates fair market value.

If you have any questions regarding this opinion, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5531200109.B