By Terry Barrett, Tax Senior Manager | State and Local Tax Team Leader
Manufacturers may have certain advantages when it comes to Virginia business personal property tax.
The only fixed assets Virginia manufacturers’ own that are taxable at the local level are machinery and tools used in the manufacturing process (generally subject to the local machinery and tools tax) and motor vehicles (including delivery trucks). Assets such as furniture, fixtures, office equipment, and computer equipment used in administrative functions are considered “capital” owned by a manufacturer which is defined by Virginia law as an intangible and taxable only at the state level. The state, however, does not tax such intangible property. Thus, with some careful scrutiny of assets, manufacturers may be able to reduce their local property taxes.
Machinery and tools used in manufacturing are segregated as a separate class of tangible personal property for local tax purposes. Localities may set their own tax rates on machinery and tools but the rates on such property may not be higher than those on other classes of tangible personal property. In many cases, the machinery and tools tax rates are actually lower than the rates on most business assets.
The classification applies to machinery and tools which are:
- actually and directly used in the manufacturing process where new materials are transformed into a substantially different product, or
- necessary to the manufacturing process and used in connection with the operation of machinery which is actually and directly used in the manufacturing process.
What this means, though, is the machinery used in preproduction or postproduction processes, raw material, and finished goods storage, etc. may not be subject to the tax. Much depends upon the actual manufacturing process, how the machinery and tools are used, and the nature of the product being produced. Further, what one might think of as manufacturing may not be manufacturing for machinery and tools tax purposes because the production process may not include the transformation of materials into a substantially different product. For example, the processing, grading, and blending of materials or the mere manipulation or rearrangement of original materials is not considered manufacturing. Once the manufacturing test if failed, all machinery and tools as well as furniture, fixtures, etc., used are generally subject to the business tangible personal property tax.
What determines the tax status of a Manufacturer’s Assets?
How a business is organized/integrated and whether there are separate lines of business may determine the tax status of its assets.
In the City of Winchester v. American Woodmark Corporation, 250 Va. 451, 464 SE2d 1458, the Virginia Supreme Court addressed a situation where a company’s headquarters was in Virginia yet manufacturing and distribution activities were in another state. The company executives, accounting personnel, IT managers and operators, senior manufacturing personnel, and other key positions were all in Virginia yet no manufacturing occurred in Virginia. The Court found that the business activity undertaken at the Virginia location was integral to the overall business of the manufacturer and in spite of the actual manufacturing process taking place outside Virginia, the company’s Virginia assets were considered “capital” used in a manufacturing business – and not business tangible personal property or otherwise subject to local taxation. The Court considered the computer and office equipment to be used in planning, directing or administering the manufacturing function.
On the other hand, in Coca-Cola Bottling Company of Roanoke, Inc., v. County of Botetourt 259, Va. 6559, 526 S.E.2d 746 (2000), the Virginia Supreme Court ruled differently. In that case, the taxpayer owned a franchise from the Coca-Cola Company for the production, distribution, and sale of its product. The taxpayer also operated and serviced vending machines that sold the product it manufactured. The Court found the vending machine operations to be a separate business activity that was not essential to the manufacturing business. The vending machines were not used in manufacturing but rather in the selling of the finished product, a separate activity. As such they were not exempt “capital” but rather subject to the business tangible personal property tax.
Recently, the Virginia Tax Commissioner issued a ruling in PD 18-212 (December 18, 2018) that embraced both the American Woodmark and Coca-Cola Bottling findings. In that case the taxpayer was a manufacturer and provider of information technology systems in Virginia and throughout the world. The taxpayer had a data center which provided a backup for all of its operations worldwide, including both its manufacturing and service sectors. A portion of the data center was dedicated to providing information technology operations services and a call center for a government agency. The Department concluded that the assets in the portion of the data center dedicated to providing information technology operations and a call center for the government agency were not capital used by a manufacturer but rather constituted assets used in a separate business activity and subject to the local business tangible personal property tax. However, the other assets used in the data center to provide backup for its operations, both manufacturing and service sector, were deemed to be capital and not subject to the local property tax.
As you can see, savings can be achieved by classifying certain assets as “capital” vs tangible personal property subject to local tax. The main question – does your business fall within the manufacturing classification?
Idle Equipment and Pollution Control Equipment Potential Tax Savings
Other areas of potential savings are with idle equipment and possibly pollution control equipment. Idle equipment is considered intangible property and not taxable. Machinery and tools are to be considered idled if they (1) have been discontinued in use continuously for at least one continuous year prior to any tax day, (2) are not in use on the tax day and (3) no reasonable prospect exists that the machinery and tools will be returned to use during the tax year. Once machinery and tools are considered idle, they are considered idle until such time as they are returned to service. In the event they are returned to use, they are not subject to tax until the next tax year. Taxpayers must maintain documentation to support their claims as to idle equipment. Virginia Code Sec. 58.1-3660 provides an exemption from state and local taxation for certified pollution control equipment and facilities. Typically though, pollution control equipment may not be used in the manufacturing process and may be considered “capital” anyway.
One area of caution, given the new De Minimis expensing rules for income tax purposes related to tangible personal property which became effective 1/1/2014, is to capture any and all items immediately expensed for income tax purposes on local property tax listings. The new De Minimis exception allows most taxpayers to deduct up to $2,500 (after 1/1/2016) of the cost of an item of property per invoice, or per item where multiple items are invoiced together. This capitalization threshold can be increased to $5,000 if the company has an audited financial statement and follows the same policy for financial accounting purposes. This rule, however, only applies for purposes of income tax, not local property tax. Taxpayers need to be sure any items expensed under the De Minimis tangible personal property rules are still captured, reported and properly categorized for local tax purposes.
Substantial Virginia tax savings for Manufacturers
In summary, substantial local tax savings can be achieved through careful review and classification of manufacturers’ assets. Keep in mind, though, that what may constitute manufacturing equipment entitled to taxation as machinery and tools at the local level may not be considered manufacturing equipment for sales and use tax exemption purposes, and vice versa.
Additional Resources for Manufacturing Companies
- 2019 U.S. Manufacturers Confident About Increasing Revenue Expectations
- How the Internet of Things (loT) and 5G Impact the Manufacturing Industry
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.