Does a building-supply retailer's lumber mill shop qualify for the industrial manufacturing exemption when milling is only 12-15% of the business?

Plain-English summary

The taxpayer sells building materials at retail and also runs a lumber mill shop that finishes rough lumber and fabricates custom moldings, doors, windows, cabinets, and other architectural millwork. Audited and taxed on its mill equipment, it asked the Department to rule that the mill shop is industrial manufacturing so the equipment is exempt (Va. Code Sec. 58.1-609.3(2)(iii)).

The rule. The manufacturing exemption applies only to machinery used to manufacture products for sale "in the industrial sense" (Golden Skillet Corp. v. Commonwealth). Whether a business is "industrial in nature" is decided by its primary business activity under the classification manuals -- historically the SIC Manual, now the NAICS Manual (Va. Code Sec. 58.1-602; 23 VAC 10-210-920). The manuals classify a business by what it primarily does.

The number that decided it. The taxpayer pointed to NAICS code 337212 (custom architectural woodwork). But that code -- like the exemption -- turns on being primarily engaged in manufacturing, and the Department treats "primarily" or "principally" as more than 50% (P.D. 99-43). The mill shop was only 12-15% of the taxpayer's sales; the rest was retail sales of building materials the taxpayer did not produce. So the Department classified the business under the retail building-materials group, found the mill shop incidental to the retail store, and held the mill equipment does not qualify for the manufacturing exemption.

What this means for you

"Primarily engaged" means more than half

The manufacturing exemption looks at your whole business, not just the part that fabricates things. If manufacturing is a minority of your activity, the Department will classify you as a retailer (or whatever your majority activity is) and deny the exemption.

Your NAICS classification follows your dominant activity

You cannot pick the manufacturing code for a small in-house operation when the majority of your sales are retail goods you did not make. The classification -- and the exemption -- follows the primary activity.

A fabricating operation can be "incidental"

Even a genuine mill shop producing custom millwork can be treated as incidental to a retail store when it is a small share of the business, making its equipment taxable.

Common questions

We really do manufacture custom millwork -- why no exemption? Because the exemption depends on being primarily (more than 50%) engaged in manufacturing. At 12-15%, your mill shop is incidental to a retail building-materials business.

Does the NAICS code for architectural woodwork help us? Only if you are primarily engaged in that activity. The classification tracks your dominant activity, which here was retail sales.

How is this different from other manufacturing-exemption denials? The principle is the same one applied elsewhere -- a business whose processing is a minority of its activity (for example, a metal service center that only lightly processes) is not "primarily engaged" in manufacturing and is denied the exemption.

Citations and references

• Va. Code Sec. 58.1-609.3(2)(iii) / 23 VAC 10-210-920 -- industrial manufacturing exemption for machinery used directly in manufacturing for sale.
• Va. Code Sec. 58.1-602; Golden Skillet Corp. v. Commonwealth, 214 Va. 276 -- "industrial in nature" is set by primary activity under SIC/NAICS; exemption limited to manufacturing in the industrial sense.
• P.D. 99-43 -- "primarily"/"principally" engaged means more than 50%; a small in-house operation is incidental to a retail business.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-72

Original ruling text

April 28, 2020

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This will reply to your letter in which you seek a ruling regarding the application of the industrial manufacturing exemption for the purchase of equipment by * (the “Taxpayer”) used in its mill shop operation. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is in the business of selling various building materials on the retail level. In addition to the retail building supply operation, the Taxpayer also operates a lumber mill where rough lumber is finished, and custom moldings, doors, windows, cabinets and other architectural millwork are fabricated. The sale of custom architectural mill work produced by the mill shop constitutes 12% to 15% of the Taxpayer's retail business space. The Taxpayer was audited and assessed tax on the machinery and equipment used in the mill shop operation. The Taxpayer seeks confirmation that the mill shop operation constitutes industrial manufacturing and all equipment used in this operation should be exempt from the retail sales and use tax as provided under Virginia Code § 58.1-609.3(2)(iii).

RULING

Virginia Code § 58.1-609.3(2)(iii) provides an exemption from the retail sales and use tax for machinery or tools, and other items used directly in the manufacture of tangible personal property for sale or resale in the industrial sense. See also Title 23 of the Virginia Administrative Code (VAC) 10-210-920. The Virginia Supreme Court in Golden Skillet Corporation v Commonwealth , 214 Va. 276, 199 S.E. 2d 511 (1973), held that the cited statute and regulations were intended “to provide exemption for machinery and tools used in … manufacturing … products for sale or resale only in the industrial sense.” In addition, Virginia Code § 58.1-602 provides, in pertinent part, that the term “industrial in nature” shall include all businesses classified in codes 10 through 14 and 20 through 39 of the Standard Industrial Classification (“SIC”) Manual .”

The SIC Manual has since been replaced with the North American Industrial Classification System (“NAICS”) Manual, most recently updated in 2017. The Department now uses the NAICS Manual to determine those industries that qualify as industrial processors or manufacturers. Both the SIC and NAICS manuals assign industrial classifications according to the primary business activity of the business. Unless the primary business activity is a manufacturing activity in accordance with these classifications, the Department does not consider the business activity to be industrial in nature. In such cases, the business is not entitled to the retail sales and use tax exemption for industrial manufacturing and processing.

Based on the nature of the Taxpayer’s operation, there is no question that the Taxpayer is producing custom architectural millwork for sale or resale. Therefore, the availability of the manufacturing exemption to the Taxpayer hinges on the fact of whether the Taxpayer’s mill shop operation is industrial in nature. In reviewing the NAICS Manual, the Taxpayer is of the belief that its operation falls under Sector 31-33, Manufacturing . More specifically, Section 337212 provides that “establishments primarily engaged in manufacturing custom designed interiors consisting of architectural woodwork and fixtures utilizing wood, wood products and plastic laminates”. The determinative factor in the above classification rests on the word “primarily.” Based on the information provided, the mill shop operation accounts for 12% to 15% of the Taxpayer’s total sales, with the remainder being the retail sales of building material not produced by the Taxpayer.

The Department generally considers “primarily” or “principally” as being more than 50%. See Public Document (P.D.) 99-43 (03/31/1999), which addresses the application of the industrial manufacturing exemption to a similar situation as the Taxpayer. This being the case, the Department takes the position that the Taxpayer’s business is more aptly classified under Major Group 444 of the NAICS Manual, which includes retail establishments primarily engaged in selling lumber and other building materials. In light of the fact that the majority of the Taxpayer’s sales are of building materials not produced by them, I find that the Taxpayer’s mill shop operation is incidental to its retail establishment and, therefore, does not qualify for the manufacturing exemption.

Based on the above, I find that the Taxpayer is not entitled to the industrial manufacturing exemption with regard to the purchase of equipment used for its mill shop operation.

The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1588.A

Related Documents

99-43