I bought equipment to test my manufactured products for quality control before final assembly -- does that equipment qualify for Virginia's manufacturing sales tax exemption?

Plain-English summary

A manufacturer of electronic components used mainly in telecommunications sought a refund of Virginia sales tax it paid on equipment it uses to test its products, arguing the equipment qualifies for the manufacturing exemption. The Department initially denied the refund, concluding the equipment was used to test FINISHED products rather than as part of the manufacturing process itself.

The manufacturing exemption's "used directly" test includes production-line QC and testing. Va. Code § 58.1-609.3 2 exempts property purchased for direct use in manufacturing. Virginia's regulations define "used directly" broadly: it covers every step of an INTEGRATED manufacturing process, from handling raw materials at the plant through the last production step where the product is finished for sale -- and this integrated process specifically INCLUDES production-line testing and quality control. The key distinction: equipment used for production-line testing or quality control is exempt production equipment, but testing done merely to improve administrative efficiency, or any testing unrelated to quality control, is taxable.

Timing was the deciding fact. On appeal, the taxpayer showed its testing equipment was actually used BEFORE the final stage of assembly -- specifically, before the component was placed into its housing and labeled for sale. Because the testing happened DURING the manufacturing process (mid-production), rather than after the product was already complete, it counted as production-line quality control testing, not post-production testing of a finished good.

Result. Because the equipment was used directly in the manufacturing process for quality control and testing during production, it qualified for the manufacturing exemption, and the Department approved the refund of sales tax paid on it.

What this means for you

Manufacturers using testing or quality control equipment

The timing of your testing matters as much as its purpose: equipment used to test or inspect products DURING the production process (before the product is finished, packaged, or labeled for sale) can qualify for the manufacturing exemption. Equipment used to test already-finished products, or for administrative efficiency rather than quality control, will not.

Businesses seeking a refund on manufacturing equipment purchases

If your refund claim is denied because the Department views your equipment as testing "finished products," gather documentation showing exactly WHERE in your production sequence the testing occurs -- proving it happens before final assembly, packaging, or labeling can be the difference between a taxable and an exempt purchase.

Common questions

Q: Does Virginia's manufacturing exemption cover testing and quality control equipment, or just production machinery?
A: It covers both. The "integrated manufacturing process" specifically includes production-line testing and quality control, as long as the testing occurs during production and relates to quality control rather than administrative efficiency.

Q: My testing happens after the product is fully assembled and labeled -- does that still qualify?
A: Likely not. The exemption is for testing that occurs DURING the manufacturing process. Testing performed on an already-finished product is generally treated as testing a finished good, not manufacturing.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-609.3 2 -- exemption for property purchased for direct use in a manufacturing process
• 23 VAC 10-210-920 A -- manufacturing exemption covers machinery, tools, repair parts, and supplies used directly in manufacturing/processing
• 23 VAC 10-210-920 B -- "used directly" defined; the integrated manufacturing process includes production-line testing and quality control
• 23 VAC 10-210-920 C 2 -- production-line testing/quality control equipment is exempt; testing for administrative efficiency or unrelated purposes is taxable

Prior rulings the Department relied on (described here, not linked): P.D. 93-135 (6/4/1993) and P.D. 18-86 (5/16/2018) -- the manufacturing exemption applies only to testing/quality control activities occurring during the manufacturing process.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-69

Original ruling text

July 9, 2024

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

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you request a refund the Virginia retail sales and use tax for the period October 2018 through November 2020. I apologize for the delay in responding to your request.

FACTS

The Taxpayer, a manufacturer of electronic components used primarily in telecommunications, filed for a refund of sales tax paid on purchases of property it believes is exempt because it was used directly in its manufacturing process. The Department denied the refund request, concluding the property was not used in the manufacturing process, but rather used for testing finished products. The Taxpayer filed an application for correction contesting the denial of the refund.

DETERMINATION

Virginia Code § 58.1-609.3 2 provides an exemption from the sales and use tax for property purchased for direct use in a manufacturing process. Title 23 of the Virginia Administrative Code (VAC) 10-210-920 A provides that the exemption applies to “machinery, tools or repair parts…or supplies used directly in manufacturing or processing.” Title 23 VAC 10-210-920 B defines “used directly” as “those activities that are integral part of the production of a product, including all steps of an integrated manufacturing process, but not including incidental activities such as general maintenance…” This definition further states that “[t]he integrated manufacturing process…includes the production line of a plant...starting with the handling and storage of raw materials at the plant site and continuing through the last step of production where products are finished or completed for sale…and also includes production line testing and quality control.”

With regard to quality control and testing, Title 23 VAC 10-210-920 C 2 explains that “[e]quipment used for production line testing or quality control is classified as exempt production equipment. Testing for the purpose of improving administrative efficiency or any other testing not relating to quality control is taxable.” Consistent with this regulation, the Department has ruled that the manufacturing exemption only applies to testing or quality control activities that occur during the manufacturing process. See Public Document (P.D.) 93-135 (6/4/1993) and P.D. 18-86 (5/16/2018).

The Taxpayer submitted additional information with its appeal indicating it used the equipment for testing, or quality control, during the manufacturing process. Specifically, the documentation indicates that testing occurs before the final stage of assembly. Because the testing is conducted before the product is placed into its housing and labeled, the Taxpayer’s property at issue is used directly in its manufacturing process for quality control and testing during the production process. Therefore, the testing equipment at issue is eligible for the manufacturing exemption and a refund for the sales tax paid on the property will be issued.

The Code of Virginia sections, regulation and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department’s website. If you have any questions about this response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at (804) ***.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/4153.B

Related Documents

93-135

18-86

17-98