Virginia – Manufacturing Machinery Did Not Qualify for Manufacturing Exemption

SALT Report 2975 – The Virginia Tax Commissioner issued a letter ruling regarding an audit assessment of consumer use tax against a wholesale distributor’s purchases of tangible personal property.  In this case, the Taxpayer purchased manufacturing machinery that was not used by the Taxpayer; rather, the Taxpayer’s sister corporation used the equipment to produce specialized items on behalf of the Taxpayer, who then resells the items.

However, the sister corporation does not have any employees and does not own any capital equipment.  Because of this, the Taxpayer hired several employees who are responsible for operating the machinery that manufactures the specialized items at the sister corporation’s facility.

In the Taxpayer’s audit review, it argued that the manufacturing equipment qualifies for the industrial manufacturing exemption because the Taxpayer is “the alter ego of its sister corporation.”  Specifically, the Taxpayer argued that the sister corporation is a manufacturer who is eligible for the industrial manufacturing exemption, and that the contested machinery is used in the exempt production process of its sister corporation.

In its response, the Commissioner stated that the industrial manufacturing or processing exemption is only available to purchasers who are industrial manufacturers or industrial processors. While the Taxpayer purchased the machinery and argued that it should be recognized as a manufacturing operation, there is no indication that it manufactures or processes products for sale, or that it used the machinery in its own industrial production process.  As a result, it was determined that the Taxpayer was not engaged as an industrial manufacturer or industrial processor during the audit period, and consequently it is not eligible for any of the industrial exemptions found in Va. Code §58.1-609.3(2).

Also, the Taxpayer claims that it is the employer of more than 50% of the employees who manufacture products at its sister corporation’s facility.  The Commissioner dismissed this claim stating that even if the majority of the Taxpayer’s employees are dedicated to manufacturing activities, these employees are not dedicated to manufacturing processes directly performed by the Taxpayer.

Specifically, the Taxpayer’s own evidence indicated that it does not perform any manufacturing.  Therefore, the only purpose the Taxpayer had for presenting itself as an employer was to “establish itself as someone engaged primarily or substantially in industrial manufacturing in order to gain entitlement to the industrial manufacturing exemption.”  As a result, the Commissioner ruled that the Taxpayer is not engaged in manufacturing activities and is not entitled to the exemption.

Additionally, the Commissioner stated that because the manufacturing activities were completely incorporated into a separate legal entity (the sister corporation), they must be treated as separate activities, regardless of whether the ownership and control of both businesses are by the same person.  Consequently, the Commissioner determined that there is no basis to the Taxpayer’s alter ego argument.

Finally, there was no evidence that the Taxpayer resold, leased, or rented the machinery to its sister corporation. Therefore, because the Taxpayer simply loans the machinery to its sister corporation for no consideration, the sister corporation cannot be considered the purchaser, lessee or renter of the machinery.  Accordingly, the resale exemption cannot be applied to the contested machinery purchases.

For Further Information

Virginia Department of Taxation – Ruling of Commissioner, P.D. 13-152