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Rulings of the Tax Commissioner

Document Number: 11-175 Tax Type: Retail Sales and Use Tax Brief Description: Grading and packaging of fresh shell eggs. Topics: Agricultural; Manufacturing Exemption Date Issued: 10/13/2011

October 13, 2011

Re: 58.1-1821 Application: Retail Sales and Use Tax Dear *****: This will reply to your letter in which you seek correction of an assessment issued to ***** (the "Taxpayer"), for the period January 2008 through December 2010. I apologize for the delay in responding to your letter. FACTS The Taxpayer's main operation is the grading and packaging of fresh shell eggs. The Taxpayer has an automated process that takes the eggs from the hen houses and runs them through a grading machine where the eggs are cleaned, graded and packed for sale to retail and wholesale businesses for resale. In addition, the Taxpayer processes eggs from contract growers. An audit by the Department resulted in an assessment of use tax on certain expense and fixed asset purchases made during the audit period. The Taxpayer contests the tax assessed on a plastic egg tray washer, a honey wagon and pit fans. The Taxpayer believes they sales tax exemption for processing applies to the purchase of such equipment. DETERMINATION Manufacturing Exemption Virginia Code 58.1-609.3 2 iii provides an exemption from the retail sales and use tax for "machinery or tools or repair parts therefor or replacements thereof, fuel power, energy, or supplies, used directly in processing, manufacturing, refining,

mining or converting products for sale or resale . . . ." [Emphasis added.] Virginia Code 58.1-602 defines the term "used directly" to mean "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing or mining process, but not including ancillary activities such as general maintenance and administration." Title 23 of the Virginia Administrative Code 10-210920 B 2 interprets the above statutes and states the following: Items of tangible personal property which are used directly in manufacturing and processing are machinery, tools and repair parts therefor, fuel, power, energy, or supplies which are indispensable to the actual production of products for sale and which are used as an immediate part of such production process. Convenient or facilitative items, such as fuel storage tanks, platforms, structural steel, grating, equipment supports, special flooring, etc., or items which are essential to the operation of a business but not an immediate part of actual production, are not used directly in manufacturing or processing even though such items may be directly attached to exempt production machinery. [Emphasis added]. This section further provides that "integrated manufacturing 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 . . . and conveyed to a warehouse at the plant site . . . ." In Commonwealth of Virginia v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in the statute is intended to narrow the scope of the exemption. An exemption, therefore, applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products. Keeping these statutory and regulatory provisions in mind, I will address the contested issues raised in the Taxpayer's appeal. Plastic Egg Tray Washer The contract growers use reusable plastic flats to transport eggs from the farm to the Taxpayer's processing facility. At the facility, the plastic flats run across a loader that takes the eggs from the flat and puts them on a grading machine. The empty plastic flats are placed in the egg tray washer for cleaning and disinfecting before they are reused. The Taxpayer maintains that the plastic flats must be cleaned and disinfected to ensure there are no disease contamination issues between farms. As such, the Taxpayer contends that the plastic egg tray washer is essential to the

process of grading eggs and qualifies for the processing exemption. The plastic egg tray washer is used in a general maintenance activity to clean and disinfect the plastic flats used to transport eggs from the contract farms and hen houses to the processing facility. Therefore, the plastic egg tray washer is not used directly in the manufacturing process and is taxable. Honey Wagon The cleaning of the eggs during the grading process produces a large amount of waste water that is captured in underground tanks. The honey wagon is a trailer with a 1200 gallon tank that is used to collect the wastewater from the underground tanks and spreads it on the Taxpayer's farm land as fertilizer. The Taxpayer claims that the honey wagon is an essential part of the grading process because it could not process eggs without disposing of the waste water from the process. Therefore, the Taxpayer maintains that the honey wagon is exempt of the tax. While the honey wagon may be essential to the Taxpayer's processing operation; it is not an integral or immediate part of the production process of the eggs. Rather, the honey wagon is used to dispose of waste liquid collected from the chicken coops where the chickens are housed. Based on the processing exemption statute and regulation, I find that the honey wagon does not qualify for the industrial processing exemption. Pit Fans The pit fans are located in pits under the chicken houses and are used to dry the droppings created by the birds. Once the chicken manure is dry, it is scooped out and sold to local farmers as fertilizer. The Taxpayer believes the handling of the manure, which is a by-product of the laying process, is an essential part of getting the product to market. Therefore, the Taxpayer believes that the pit fans are exempt of the tax. I cannot agree that the pit fans qualify for the industrial processing exemption. The pit fans are not used at the plant site, nor are they used directly in the industrial processing of eggs for sale. Rather, the pit fans are used by the Taxpayer to dry chicken manure that is expended during the egg laying process. While the pit fans are essential to the operation of the business, they do not qualify for the industrial processing exemption. Agricultural Exemption

Virginia Code 58.1-609.2 1 provides an exemption for: Commercial feeds; seeds; plants; fertilizers; liming materials; breeding and other livestock; semen; breeding fees; baby chicks; turkey poults; rabbits; quail; llamas; bees; agricultural chemicals; fuel for drying or curing crops; baler twine; containers for fruit and vegetables; farm machinery; medicines and drugs sold to a veterinarian provided they are used or consumed directly in the care, medication, and treatment of agricultural production animals or for resale to a farmer for direct use in producing an agricultural product for market; tangible personal property, except for structural construction materials to be affixed to real property owned or leased by a farmer, necessary for use in agricultural production for market and sold to or purchased by a farmer or contractor; and agricultural supplies provided the same are sold to and purchased by farmers for use in agricultural production, which also includes beekeeping and fish, quail, rabbit and worm farming for market. The intent of the above statute is to provide a sales and use tax exemption to a farmer who produces an agricultural product to be sold on the open market. Agriculture generally involves the cultivation of soil, production of crops, and raising of livestock. Although the Taxpayer does not cite the agricultural exemption, it has application to the pit fan purchases. The Taxpayer's egg laying operation qualifies as an operation that produces an agricultural product for market. The pit fans appear to be a part of that operation. Because the waste must be removed from the chicken houses for purposes of sanitation and the health of the chickens, the pit fans are part of the drying of the waste for subsequent removal. Accordingly, I find that the pit fans are eligible for the agricultural exemption. CONCLUSION The assessment is correct as issued with the exception of the portion related to the pit fans. I have authorized the removal of these fans from the Department's assessment. I will allow for payment of the balance of the assessment, excluding the pit fans, totaling *****. This amount must be paid within 30 days from the date of this letter to avoid the accrual of additional interest and the assessment of a 20% amnesty penalty on amnesty- eligible periods (taxable periods ending on or before May 31, 2009). Payment should be sent to: Virginia Department of Taxation, Appeals and Rulings Division, P. O. Box 27203, Richmond, Virginia 23261-7203, Attention:

*****. The Code of Virginia sections, regulation and other reference documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this determination, you may contact ***** at *****. Sincerely,

Craig M. Burns Tax Commissioner