Technical Assistance Advisory No. 88-012 Re: Request for a Technical Assistance Advisory Relating to Sales Tax and the Property Factor Used in Apportionment for Corporation Net Income Tax and Business Franchise Tax Purposes The Tax Department has received a request for a Technical Assistance Advisory relating to the sales tax consequences of certain transactions and relating to the property factor to be used in apportionment of business income and capital for purposes of the West Virginia Corporation Net Income Tax and Business Franchise Tax. The request describes a hypothetical situation where a company is preparing to enter into agreements with the West Virginia Industry and Jobs Development Corporation and with a county development authority. The proposed agreements contemplate an arrangement whereby the company would construct a manufacturing facility in West Virginia. The company and the West Virginia Industry and Jobs Development Corporation would enter into a lease agreement pursuant to which the company would lease the land and buildings from the West Virginia Industry and Jobs Development Corporation. The West Virginia Industry and Jobs Development Corporation would own the land on which the plant would be constructed and the company would construct the plant but title to the plant would remain in the West Virginia Industry and Jobs Development Corporation. The arrangement would constitute a sale and leaseback arrangement for the building. The county development authority would purchase $20 million worth of machinery and equipment to be used in the facility. The company would lease this equipment from the county development authority under a capital lease. Title to the machinery and equipment would remain in the county development authority during the term of the lease. The company would also pay the county development authority a one-time development fee, as well as the reasonable costs incurred by the county development authority to issue notes to raise capital to purchase the equipment. The request sets forth four propositions for Tax Department response, each of which is set forth below. Each is immediately followed by the Tax Department response to it.PROPOSITION 1: (1) The company's renting from the West Virginia Industry and Jobs Development corporation of the land and buildings would not be subject to West Virginia consumers sales tax, and the company's use of the land and buildings would not be subject to West Virginia use tax.RESPONSE TO PROPOSITION 1: The West Virginia Consumers Sales and Service Tax and the West Virginia Use Tax are applied against sales, or the use of, tangible personal property and certain services. The renting of real estate does not constitute a purchase of tangible personal property or taxable services within the meaning of West Virginia Consumers Sales and Service Tax or the West Virginia Use Tax.PROPOSITION 2: (2) The company's renting from the county development authority of tangible personal property would be exempt from West Virginia sales tax.RESPONSE TO PROPOSITION 2: The company would constitute a manufacturer for purposes of the West Virginia Consumers Sales and Service Tax. Under Section 11-15-9(g) of the West Virginia Code, sales of property or services directly used or consumed in the activity of manufacturing to the manufacturer are exempt from the West Virginia Consumers Sales and Service Tax. Section 11-15-2(n) of the West Virginia Code defines the term directly used or consumed as follows: (n)(1) "Directly used or consumed" in the activities of contracting, manufacturing, transportation, transmission, communication or the production of natural resources shall mean used or consumed in those activities or operations which constitute an integral and essential part of such activities, as contrasted with and distinguished from those activities or operations which are simply incidental, convenient or remote to such activities. (2) Uses of property or consumption of services which constitute direct use or consumption in the activities of contracting, manufacturing, transportation, transmission, communication or the production of natural resources shall include only: (A) In the case of tangible personal property, physical incorporation of property into a finished product resulting from manufacturing production or the production of natural resources or resulting from contracting activity; (B) Causing a direct physical, chemical or other change upon property undergoing manufacturing production or production of natural resources or which is the subject of contracting activity; (C) Transporting or storing property undergoing transportation, communication, transmission, manufacturing production, or production of natural resources or which is the subject of contracting activity; (D) Measuring or verifying a change in property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (E) Physically controlling or directing the physical movement or operation of property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (F) Directly and physically recording the flow of property undergoing transportation, communication, transmission, manufacturing production or production of natural resources or which is the subject of contracting activity; (G) Producing energy for property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (H) Facilitating the transmission of gas, water, steam or electricity from the point of their diversion to property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (I) Controlling or otherwise regulating atmospheric conditions required for transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (J) Serving as an operating supply for property undergoing transmission, manufacturing production or production of natural resources or which is the subject of contracting activity or for property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (K) Maintenance or repair of property directly used in transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity; (L) Storage, removal or transportation of economic waste resulting from the activities of contracting, manufacturing, transportation, communication, transmission or the production of natural resources; (M) Pollution control or environment quality or protection activity directly relating to the activities of contracting, manufacturing, transportation, communication, transmission or the production of natural resources and personnel, plant, product or community safety or security activity directly relating to the activities of contracting, manufacturing, transportation, communication, transmission or the production of natural resources; or (N) Otherwise be used as an integral and essential part of transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity. (3) Uses of property or services which would not constitute direct use or consumption in the activities of contracting, manufacturing, transportation, transmission, communication or the production of natural resources shall include, but not be limited to: (A) Heating and illumination of office buildings; (B) Janitorial or general cleaning activities; (C) Personal comfort of personnel; (D) Production planning, scheduling of work, or inventory control; (E) Marketing, general management, supervision, finance, training, accounting and administration; or (F) An activity or function incidental or convenient to transportation, communication, transmission, manufacturing production or production of natural resources or contracting activity, rather than an integral and essential part of such activities. Those purchases or leases of tangible personal property from the county development authority, or any other entity, not directly used in the manufacturing activity (such as office equipment and furniture) would be subject to the West Virginia Consumers Sales and Service Tax. However, we would expect that most of the purchases to be made by the company would come within the manufacturer's direct use exemption.PROPOSITION 3: (3) The use in West Virginia by the company of the tangible personal property it leases from county development authority would be exempt from West Virginia use tax.RESPONSE TO PROPOSITION 3: The West Virginia Use Tax is a counterpart to the West Virginia Consumers Sales and Service Tax. However, the use tax usually attaches in circumstances where there has been a sale of the taxable property or service outside of the State of West Virginia or across state lines for use in West Virginia. Under Section 11-15A-3(2) of the West Virginia Code, any exemption set forth in Section 11-15-9 of the West Virginia Code which will exempt a sale of property or services from the West Virginia Consumers Sales and Service Tax will apply with equal validity to likewise exempt use of such property or services from the West Virginia Use Tax. Therefore, our response to Proposition 2, above, is equally applicable to this Proposition 3. As a practical matter we doubt that a West Virginia county development authority would be in a position to make sales of tangible personal property outside the State of West Virginia. However, should it do so, the company would have the Section 11-15A-3(2) exemption available as a manufacturer.PROPOSITION 4: (4) Any property of the West Virginia Industry Assistance and Jobs Development Corporation or of a county development authority that is leased to the company shall not be included in either (a) the property factor used to apportion the company's business income for West Virginia corporation net income tax purposes, or (b) the property factor used to apportion the company's tax base for West Virginia business franchise tax purposes, until the date upon which the company is obligated to pay rent with regard to such property. After such date, such property shall be treated for said purposes as rented property and will be included in such factors if such property is used by the company in the State during the taxable year.RESPONSE TO PROPOSITION 4: We concur with Proposition 4, parts (a) and (b). Section 11-24-7(e)(2) of the West Virginia Code prescribes the valuation of property for determining the property factor for corporation net income tax purposes. That section reads as follows: (2) Value of property. - Property owned by the taxpayer shall be valued at its original cost, adjusted by subsequent capital additions or improvements thereto and partial disposition thereof, by reason of sale, exchange, abandonment, etc.: Provided, That where records of original cost are unavailable or cannot be obtained without unreasonable expense, property shall be valued at original cost as determined under regulations of the tax commissioner. Property rented by the taxpayer from others shall be valued at eight times the annual rental rate. The term "net annual rental rate" is the annual rental paid, directly or indirectly, by the taxpayer, or for its benefit, in money or other consideration for the use of property and includes: (A) Any amount payable for the use of real or tangible personal property, or any part thereof, whether designated as a fixed sum of money or as a percentage of sales, profits or otherwise. (B) Any amount payable as additional rent or in lieu of rents, such as interest, taxes, insurance, repairs or any other items which are required to be paid by the terms of the lease or other arrangement, not including amounts paid as service charges, such as utilities, janitor services, etc. If a payment includes rent and other charges unsegregated, the amount of rent shall be determined by consideration of the relative values of the rent and the other items. Section 11-23-5(c) of the West Virginia Code prescribes the same property valuation for purposes of determining the business franchise tax property factor. Please note that the leased property becomes includible when the direct or indirect rental becomes "any amount payable." Thus, the operative date is not the date on which consideration is to be paid, but rather the date upon which a legal obligation to pay accrues, no matter when the actual transfer of money or consideration will occur. As a practical matter, such a legal obligation typically accrues, by action of law, beginning on the first day the property is used or occupied by the lessee. _____________________________ Michael E. Caryl State Tax Commissioner Date: December 9, 1988