IPT 2013 Sales & Use Tax Symposium – Monterey, CA

Industry Issues -

Manufacturing

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Presenters

Denton Childs – Tyson Foods, Inc.

Adam Scheele – Deloitte Tax LLP

At a Glance

Manufacturing definitions vary from state to state, but are

generally divided into two categories:

- Integrated Plant Theory – Very broad in application and usually

includes machinery and equipment that is essential to the process,

transportation equipment, and other support equipment that is

used during the manufacturing process.

- Direct Use – Narrow in application and usually requires

machinery and equipment must make a direct chemical or physical

change to the product being manufactured to qualify for

exemption.

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At a Glance

Most states provide an exemption for manufacturing

machinery and equipment.

- Most states require that the machinery and equipment be used

“directly” in manufacturing process.

- Fourteen states have adopted the broader integrated plant theory

for purposes of qualifying for the exemption.

- States that do not provide a full exemption may apply a special or

reduced rate.

- Some states require registration and certification as a

manufacturer and may define manufacturing based on SIC or

NAICS industry codes.

- Twelve states do not have a full exemption for pollution control

equipment. Seven of those states apply a special reduced rate.

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At a Glance

Common distinctions in state-by-state manufacturing

exemptions:

– Interplant transportation

– Chemicals, Lubricants, and Fluids

– Replacement Parts

– Pollution Control M&E - Sometimes certification is required

– Quality Control, Testing, and Monitoring equipment

– Packaging and Shipping materials

– Divergent use

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At a Glance

Almost all states have some exemption for utilities used in

the manufacturing process.

– The types of energy and the requirements for the

exemption vary greatly.

– Six states do not have an exemption.

– A few states have reduced rates.

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At a Glance

Non-Traditional “Manufacturers”

Other industries that may qualify for manufacturing exemptions:

– Mining and aggregate

– Oil & Gas production and extraction

– Poultry and Livestock

– Telecommunications

– Software

– Restaurants

– Recycling

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Recent Legislation

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Recent Legislation

Arkansas - New Law Expands Manufacturing Exemption for

M&E Used in Petroleum Refining

H.B. 1281 – Amends the sales tax exemption for pollution control

equipment used in manufacturing operations to include sulfur removal

processes during petroleum refining and extends exemption to cities and

towns. Includes repair parts and repair labor of equipment required by

state and federal law or regulations to be used in the refining of

petroleum-based products to remove sulfur pollutants. Effective October

1, 2013.

Recent Legislation

Arkansas – New Law Provides Partial Refund on Certain

Replacement/Repair of Manufacturing M&E

S.B. 334 – Provides a 1% reduction in the form of sales and use taxes for

expenditures on repairs and replacement of certain machinery and equipment used

directly in manufacturing beginning July 1, 2014. The refund will be allowed on

machinery and equipment purchased to modify, replace, or repair either in whole or

in part, existing machinery and equipment used directly in producing,

manufacturing, assembling, processing, finishing, or packaging articles of

commerce at a manufacturing or processing plant or facility in Arkansas and may

only be claimed by holders of direct pay permits.

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Recent Legislation

Arkansas – New Law Reduces Tax Rate on Utilities Sold to

Manufacturers

S.B. 791 - Beginning July 1, 2014, new law imposes in lieu of the state gross

receipts or gross proceeds tax an excise tax on the gross receipts or gross

proceeds derived from the sale of natural gas and electricity to a manufacturer for

use directly in the actual manufacturing process at the rate of 1%, rather than the

current rate of 4.375%.

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Recent Legislation

California - AB 93 Eliminates Current Enterprise Zone

Program and Creates New Economic Development Incentives

and a Partial Sales Tax Exemption for Manufacturers

AB 93 - Replaces the current California EZ program with a 4.19% statewide sales

and use tax exemption for manufacturing and biotechnology equipment, including

research and development equipment. Qualified property includes but is not limited

to machinery and equipment with a useful life greater than one year, used primarily

in manufacturing, processing, fabricating, refining or recycling of tangible personal

property, as well as research and development, anywhere in California. The

exemption applies to the first $200 million in qualified property purchases made in a

calendar year by a qualified taxpayer. The exemption also applies to, otherwise

qualified purchases by a construction contractor. The exemption sunsets June 30,

2022.

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Recent Legislation

Georgia - Georgia Legislature Broadens Manufacturing

Exemption

HB 386 - O.C.G.A. § 48-8-3.2 as enacted by Ga. L. 2012, p. 257, § 5-2/HB 386

exempts from tax machinery or equipment which is necessary and integral to the

manufacture of tangible personal property as well as industrial materials, and

packaging supplies.

Additionally, energy used in manufacturing is subject to a four year phase-out.

However, localities may impose an “energy excise tax.”

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Recent Legislation

Florida – New Law Provides for Temporary Expansion of

Manufacturing Exemption

H.B. 7007 - Effective April 30, 2014, new law under Fla. Stat. § 212.08(7)(kkk) temporarily

expands Florida’s sales/use tax exemption for manufacturers. Under current law, only new or

expanding businesses are eligible for this manufacturing exemption. An eligible manufacturing

business under these new provisions is defined as a business whose primary business activity

(activity representing greater than 50% of all activities) at the location where the industrial

machinery and equipment is located is within the industries classified under 2007 NAICS codes

31, 32, and 33. This new temporary sales/use tax manufacturing exemption is part of a broad

economic development accountability bill and is set to expire April 30, 2017. Note that

taxpayers not meeting the eligibility requirements for this new temporary exemption

nevertheless may find relief under Fla. Stat. § 212.08(5)(b), which will continue to provide a

state sales/use tax exemption for new and expanding manufacturing businesses.

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Recent Legislation

New Mexico - New Law Expands Manufacturing Exemption to

Include TPP Consumed in Process

H.B. 184 - Effective January 1, 2013, new law expands an existing gross receipts tax (GRT)

manufacturing deduction for tangible personal property to include the property consumed in the

manufacturing process, provided that the tangible personal property is not a tool or equipment

used to create the manufactured product. The existing deduction extends only to tangible

personal property incorporated as an ingredient or component part of the products that the

buyer is in the business of manufacturing. Accordingly, because utilities are defined as “tangible

property” for GRT purposes, the amended deduction would cover utilities. This expanded

deduction is permitted on a phased-in basis, with 100% of such receipts eventually deductible

on or after January 1, 2017. The new law contains other tax-related changes in the

manufacturing and construction industries which are intended to reduce the incidence of

“pyramiding” or multiple points of taxation of manufactured goods.

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Recent Legislation

North Carolina - Exemption for Electricity Used in Operation

of Manufacturing Facility

Effective July 1, 2010, state law provides that sales at retail and the use, storage,

or consumption in North Carolina of electricity sold to a manufacturer for use in

connection with the operation of a manufacturing facility is exempt from state

sales/use taxes. The exemption applies to electricity used both inside and outside

of the facility, including electricity used for parking lot lighting at the facility.

On July 23, 2013, Governor Pat McCrory signed legislation, House Bill 998 (“H.B.

998”) in an effort to boost the state’s economy. The bill, known as the Tax

Simplification and Reduction Act, provides changes to the corporate income tax,

individual income tax, and sales and use tax. There were no significant changes or

additions to exemptions available to manufacturers.

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Recent Legislation

Mississippi – New Law Partially Exempts Fuel Used in Certain

Manufacturing Activity

H.B. 844, signed by gov. 4/23/13. Effective July 1, 2014, new law partially exempts

from state sales/use taxation sales of electricity, current, power, steam, coal,

natural gas, liquefied petroleum gas or other fuel to certain manufacturers, custom

processors, technology intensive enterprises or public service companies for

industrial purposes.

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Recent Rulings and Cases

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Recent Rulings and Cases

Colorado - DOR Holds that Certain Gases Qualify as Exempt

"Fuel" Used in Manufacturing

Private Letter Ruling, No. PLR-12-005, Colo. Dept. of Rev. (11/6/12). Regarding a company

selling industrial, medical, and specialty gases and various goods, including welding machinery

and associated tools, parts, and attachments to manufacturers in Colorado, the department

explains that welding gases that are a fuel or energy source used in one of the enumerated

"manufacturing/processing" industries are exempt from Colorado sales/use tax. In this respect,

the company's sale of acetylene used in manufacturing qualifies for this exemption. However,

oxygen and inert gases used in welding are not exempt gases because they do not constitute

"fuel." Additionally, hand-held torches and welding attachments, parts, and related tools are not

exempt from Colorado sales/use tax because they are not considered qualifying "machinery or

machine tools."

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Recent Rulings and Cases

Illinois - Storage Tank Used to Hold Chemical in Liquid State

Qualifies for Manufacturing Exemption

Private Letter Ruling, ST 12-0002-PLR, Ill. Dept. of Rev. (3/30/12). The

department explains to a chemical company that its chemical storage tank

would qualify for Illinois’ manufacturing machinery and equipment

exemption if it is used primarily (i.e., over 50% of the time) to store

chemical in its liquid state as an integral part of the chemical production

process at its plant. However, storage tanks or other equipment that are

used after production of the chemical by a distributor or transporter in

order to store the product would not qualify for this exemption.

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Recent Rulings and Cases

Indiana – “Essential” Items Do Not Necessarily Fall Under

Manufacturing Exemption

Letter of Findings No. 04-20120255, Ind. Dept. of Rev. (2/27/13). The department held that an

Indiana steel products manufacturer did not qualify for Indiana’s sales/use tax manufacturing

exemption on certain purchased transformers, filter reactors, reactor coils, harmonic filters, and

bushing replacement, because it failed to show they were directly used in its direct production

process. The department generally explained that state law exempts items and equipment

directly used by the purchaser in the production process provided that such items have an

immediate effect on the article being produced. While the items at issue were arguably

essential to conducting its manufacturing business, the “fact that particular property may be

considered essential to the conduct of the business of manufacturing because its use is

required either by law or by practical necessity does not itself mean that the property has an

immediate effect upon the article being produced.”

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Recent Rulings and Cases

Indiana - Bleach Manufacturer's Steel & Fiberglass Tanks Fall

Under Manufacturing Exemption

Letter of Findings No. 04-20120532, Ind. Dept. of Rev. (3/27/13). The department held that a

bleach manufacturing company did not owe Indiana use tax on purchased steel tanks and

fiberglass tanks, because the tanks fell under Indiana's manufacturing exemption as directly

used in the direct production of bleach. Regarding the steel tanks, the tanks were used to

continuously circulate sodium hydroxide, and this continuous circulation of sodium hydroxide is

a necessary step in the company's integrated bleach production process. The circulation of

sodium hydroxide occurs after the production process begins and continues during the

integrated process of producing bleach. Regarding the fiberglass tanks, the unfinished bleach is

required to settle for several hours to allow particles to be separated from the remaining bleach.

This settling process occurs during the company's integrated production process. The settling

process has an immediate effect on the bleach and occurs prior to the completion of the bleach

production process. Therefore, the fiberglass tanks were directly used in the company's direct

production of bleach and qualified for Indiana's manufacturing exemption.

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Recent Rulings and Cases

Indiana - Certain Purchased Equipment & Computer Software

Fall Under Manufacturing Exemption

Letter of Findings No. 04-20120467, Ind. Dept. of Rev. (3/27/13). Regarding a coal company's

purchased equipment, the department held that only equipment directly used to process coal

would fall under Indiana's manufacturing exemption and the company's "integrated production

process" began at the point where the coal was initially sized, manipulated, and sorted at its

"grizzly" which caused a "substantial change" in the form, composition and character of the coal

itself. The equipment which followed continued within the integrated process and were also

entitled to the manufacturing exemption until "Transfer Tower Three," which marked the final

point at which the coal underwent any "substantial change." Equipment and devices used

subsequent to Transfer Tower Three were not entitled to the manufacturing exemption because

the "integrated production process" had concluded and the coal had been altered to its

completed form. The department also held that certain purchased software qualified for the

manufacturing exemption in functioning as "an integral and essential part of the integrated

production process" by which the company controlled and operated its coal processing facility.

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Recent Rulings and Cases

Indiana - Corn Product Company Qualifies for Manufacturing

Exemption on Purchased Magnets

Letter of Findings No. 04-20120461, Ind. Dept. of Rev. (2/27/13). The department held that an

Indiana company producing dry milled corn product qualified for Indiana's manufacturing

exemption on three of four purchased magnets, because it successfully showed that they were

directly used in its direct production process where the corn had been milled but not yet placed

in storage. Under the facts, these three magnets check the milled corn for metal pieces before

the milled corn was placed in storage, and were components of tubes through which different

milled corn products flowed on the way to conveyors that transported the product to storage. If

metal pieces were found in the milled corn, that batch was returned for further processing. The

fourth magnet was deemed used in the post-production process and thus was not exempt from

state sales/use tax, as it was used when the stored milled corn was removed from storage for

loading into transport trucks.

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Recent Rulings and Cases

Indiana - Though Crucial to Process, Die Ovens Do Not

Qualify for Manufacturing Exemption

Letter of Finding No. 04-20120362, Ind. Dept. of Rev. (11/28/12). The department held that an

in-state aluminum extrusions producer owed state sales/use tax on its purchased die oven

because, even though the oven is a necessary and crucial part of its manufacturing process

(i.e., without heated dies, the company’s manufacturing processes could not continue), the

oven does not have an immediate effect on the aluminum billets, which are the items used to

produce the aluminum extrusions. That is, even though the die oven is critical to the company’s

process, its use – to heat dies prior to the dies' placement on the company’s presses – is one

step removed from the actual manufacturing process and thus is not directly used in direct

production as required by the manufacturing exemption statute.

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Recent Rulings and Cases

Indiana - Plastics Manufacturer’s Purchased Acetone

Qualified for Manufacturing Exemption

Letter of Finding No. 04-20120337, Ind. Dept. of Rev. (11/28/12). The department

held that a plastic container/accessory manufacturer did not owe state sales/use

tax on purchased acetone because it successfully showed that its use of the

acetone was sufficiently different from the routine use of cleaning supplies

commonly found and instead was used as an integral part of its various

manufacturing processes. Because it had acquired and directly consumed the

acetone in the direct production of its plastics products, the purchased acetone

qualified for Indiana’s manufacturing exemption.

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Recent Rulings and Cases

Indiana - Printer Ineligible for Manufacturing Exemption on

Balers/Conveyors & Other Equipment

Letter of Findings No. 04-20110282, Ind. Dept. of Rev. (10/31/12). The department held that

an Indiana printer was ineligible for Indiana’s manufacturing exemption on purchased balers,

conveyors, and related parts because the facts showed that it did not manufacture “paper

product” – only that its paper product was a byproduct of its printing process. Its use of balers

and conveyors, therefore, was used post-production and not in connection with the direct

production process of its printed products. The department likewise denied exemption for the

company’s purchase of equipment used in direct mail/fulfillment services as well as certain

packaging equipment (e.g. a "palletizer," "shrink-wrapping system," "bundling equipment,"

"conveyors and labeling," and "high speed strapping machines"), as this equipment also was

deemed used beyond its printing production process.

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Recent Rulings and Cases

Indiana - Software and Related Maintenance Agreement Fall

Under Manufacturing Exemption

Letter of Findings No. 04-20120001, Ind. Dept. of Rev. (6/27/12). The department held that an

in-state glass products manufacturer's expenses related to a software maintenance agreement

were not subject to Indiana sales/use tax because the underlying software itself fell under the

manufacturing exemption and thus any updates and patches supplied would also fall under this

exemption. Under the facts, the underlying software was used to digitize production drawings

and digitize information to guide the fabrication of the manufacturer's glass products.

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Recent Rulings and Cases

Indiana - Computer Software Qualifies for Manufacturing

Exemption; Gas Cylinders are Not Exempt

Supplemental Letter of Findings No. 04-20110214, Ind. Dept. of Rev. (3/28/12).

The department held that a corporation was eligible for Indiana’s manufacturing

exemption on purchased computer software, because the software produces a

computer disc which, in turn, programs machinery and equipment that it uses in its

manufacturing process. Computers that are interconnected with and control other

production machinery or are used to make tapes which control computerized

production machinery are exempt from tax. However, the corporation could not

claim the manufacturing exemption on cylinders it uses to contain gas just prior to

the manufacturing process, because even though they serve a crucial function in its

overall process, these tanks are merely used for containment purposes prior to the

manufacturing process.

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Recent Rulings and Cases

Iowa - Electricity Generation/Transmission Equipment Do Not

Fall Under Manufacturing Exemption

Document Reference No. 13300004, Iowa Dept. of Rev. (2/27/13). The department held that a

municipal corporation and political subdivision of the State of Minnesota (an electric company)

was subject to state sales/use tax on items and equipment used in the generation and

transmission of electricity, because Iowa's manufacturing exemption specifically excludes such

property from exempt status as "other property that is primarily and directly used in the

production, generation, transmission, or delivery of electricity." The generation and transmission

equipment here was primarily, if not exclusively, used in the generation or transmission of

electricity. Thus, even if the company's purchased equipment was not "operating property," it

was still directly and primarily used in the generation and transmission of electricity and thus

subject to both property tax and state sales/use tax.

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Recent Rulings and Cases

Iowa - Manufacturing Exemption Does Not Likely Apply to

Live Animals or Certain Lab Supplies

Document Reference No. 12300010, Iowa Dept. of Rev. (4/6/12). Regarding a company that

produces biological medical products for sale at wholesale or eventual retail sale wherein the

biological material that is to be sold at retail is introduced into live animals for cultivation and

development of additional products, the department explains that for purposes of Iowa’s

processing exemption, “it is unlikely that the animals are a part of processing because they are

not part of the product that is sold at retail, nor are they chemicals, solvents, sorbents, or

reagents that are consumed, dissipated or depleted.” The company’s use of beakers, dishes,

and tubing also do not appear to meet the requirements of exempt “processing,” because they

are not integrated with the finished product nor are they chemicals, solvents, sorbents, or

reagents.

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Recent Rulings and Cases

Kansas - Equipment Used to Light and Cool General Plant

Premises Does Not Qualify for Exemption

Private Letter Ruling No. P-2012-005, Kan. Dept. of Rev. (8/16/12). The department held that

a company's purchase and installation of metal halide lights that are used for interior lighting at

its Kansas manufacturing plant and warehouse, as well as its purchase and installation of fans

used in the same facilities to exhaust interior air, are subject to Kansas sales and use tax.

Additionally, the electricity consumed by these lights and fans is subject to Kansas sales/use

tax. The department explained that while machinery and equipment used as an integral or

essential part of an integrated production operation may qualify for Kansas' manufacturing

exemption, such machinery and equipment does not include machinery or equipment used for

general plant lighting, heating or cooling. Moreover, only electricity consumed by machinery and

equipment actually used to produce tangible personal property is exempt as consumed in

production – the exemption for electricity is not allowed when the electricity is used for heating,

cooling and lighting buildings or business premises.

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Recent Rulings and Cases

Kansas - Kansas Supreme Court Affirms Integrated Plant Theory

Applies in Manufacturing Exemption Case

In the Matter of the Appeal of LaFarge Midwest/Martin Tractor Co., Inc., Kan. (3/2/12). The

Kansas Supreme Court affirmed a cement manufacturer’s claim for sales/use tax exemption on

repair/replacement parts for loaders and haulers as exempt machinery and equipment.

Essentially, the department and manufacturer disagreed on where the manufacturer’s limestone

excavation and manufacturing facilities, respectively, began and ended. The department

contended that the excavation operations were not a “manufacturing facility” and that the

loaders/haulers were not used in the manufacturing preparation activity, while the manufacturer

claimed that the loaders/haulers were used in the manufacturing process as part of an

integrated production operation.

(Continued on next slide)

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Recent Rulings and Cases

In the Matter of the Appeal of LaFarge Midwest/Martin Tractor Co., Inc., (Continued)

The Court explained that, by statutory definition, the tax-exempt integrated production

operations of a manufacturing/processing plant or facility include more than the production line

operations where the actual transformation or processing of tangible personal property occurs,

and that the physical location of a manufacturing/processing plant or facility can encompass

more area than the production line assemblage of machinery and equipment. Integrated

production operations also include preproduction operations to handle, store, and treat raw

materials. In this respect, the manufacturing/processing “plant” or “facility” means the entire

single, fixed location owned by the manufacturing or processing business that can consist of

one or more structures or buildings in a contiguous area where integrated production operations

are conducted to manufacture/process tangible personal property. Accordingly, because the

facts here showed that the quarry and cement manufacturing operations were conducted on

adjacent property owned by the taxpayer, the integrated plant theory applied and the

manufacturer successfully showed that the loaders and haulers were used to fulfill essential

functions of its integrated cement production operation.

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Recent Rulings and Cases

Kansas - Oil & Gas Companies Can’t Claim Manufacturing

Exemption on M&E that Fails to “Extract”

In the Matter of the Appeals of Edmiston Oil Company, Inc., Kan. Ct. App. (1/13/12). The

Kansas Court of Appeals affirmed that certain oil and gas producers could not claim a Kansas

manufacturing exemption on purchased “down-hole” and surface pumping machinery and

equipment because it was not used as an “integral part of integrated production operations by a

processing plant or facility operated by a processing business” where extracted oil or gas was

then treated or prepared before its transmission to a refinery or wholesale distribution. The

Court explained that, in the case of oil and gas wells, this exemption requires “extraction” that

does not stop at the bottom of the well bore as was the case here, but must also include

withdrawing the fluids to the surface. That is, to remove oil and gas from the earth, wells must

be drilled to extract the oil and gas from the rock and then deliver it to the surface where it can

be sold. The taxpayers unsuccessfully argued that the exemption applied because movement

or migration of fluids occurred in the sub-surface rock formation with such equipment; however,

those fluids were not extracted from the earth until they reached the surface.

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Recent Rulings and Cases

Kansas - Manufacturer's Purchased Pallets & Shrink Wrap

Qualify as Exempt Resale/Packaging

Opinion Letter O-2011-011, Kan. Dept. of Rev. (11/17/11). A department opinion letter

explains that a pet food manufacturer is not liable for Kansas sales/use tax on purchased

pallets and shrink wrap because they are considered an ingredient or component of the

manufactured product and therefore qualify for resale exemption. Under the facts, the

wholesale or retail buyer that unwraps the shrink-wrapped pet food bags for sale or distribution

has no obligation whatsoever to return the pallets or shrink wrap to the manufacturer or to

anyone else for reuse. Because of this, the pallets are treated as an ingredient or component of

the manufactured products. Accordingly, the manufacturer can claim a resale exemption when

it buys the shrink wrap and pallets or when it buys wood that it fabricates into the pallets.

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Recent Rulings and Cases

Kansas — Lease of pallets to manufacturers exempt

Kansas Private Letter Ruling P-2013-002, (8/14/2013) The Kansas Department of Revenue

has ruled that leases of pallets to manufacturers are non-taxable, provided that the pallets are

used for exempt purposes for at least 50% of the time, and any associated charges are also

exempt and not viewed as separate receipts from a new retail sale. The taxpayer leases pallets

to manufacturers rather than selling them outright and retains title at all times, charging the

lessee a flat issue fee for each pallet plus daily lease charges, as well as a transfer fee when

pallets are delivered to distributors. Once the pallet is delivered to the distributor, the

manufacturer/lessee has no further contractual duties to the taxpayer, no charges are billed to

the lessee, and the distributor is only billed if the pallet is lost or damaged beyond repair.

Generally, in Kansas, “returnable” pallets are taxable, and “nonreturnable” pallets are exempt,

but Kan. Stat. Ann. § 79-3606(kk)(3)(B) provides a manufacturing and machinery exemption for

a manufacturer's purchases of equipment used to transport or handle property at any point in

the manufacturing process, through warehousing or distribution, which the Department has

adopted to mean that returnable pallets qualify as exempt as long as they are used for exempt

purposes for more than 50% of the time.

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Recent Rulings and Cases

Kentucky - Manufacturer Fails to Qualify for Exemption with a

'Substance Over Form' Analysis

Ohio Valley Aluminum Co. LLC v. Department, Ky. Bd. of Tax. App. (5/22/12). The Kentucky

Board of Tax Appeals denied an aluminum billet manufacturer's request for Kentucky's partial

sales/use tax exemption on the consumption of "energy or energy-producing fuels used in the

course of manufacturing, processing, mining or refining" – holding that the company must

include in its calculation all costs associated with the production of its aluminum billets at its

plant facility, including the cost of scrap aluminum purchased by its wholly owned subsidiary for

use at the plant. The manufacturer unsuccessfully attempted to exclude the cost of the

raw/scrap aluminum in its cost of production calculation, reasoning that it had now restructured

and created a wholly-owned separate subsidiary to purchase this material and upon which it

now merely performs services. The Board concluded that while the manufacturer may have

allocated the cost of the raw materials to the subsidiary on paper, it cannot allocate the cost of

the raw aluminum to the subsidiary for purposes of calculating the cost of production for the

statutory energy exemption when there is only one plant facility and operation.

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Recent Rulings and Cases

Louisiana - State High Ct. Reverses Ruling re: Limestone

Purchases & Manufacturing Exclusion

Department v. Nelson Industrial Steam Co., La. (3/8/13). The Louisiana Supreme Court has

reversed the Louisiana Court of Appeals 2012 ruling, which previously held summary judgment

for the department that an electricity/steam company's limestone purchases were not exempt

from Louisiana sales/use tax under the “further processing exclusion.” The Louisiana Court of

Appeal had reasoned that the purpose of the limestone was to comply with federal regulations

and allow the company to generate electricity for sale, rather than for further processing. The

Louisiana Supreme Court has now vacated this previous summary judgment ruling, explaining

that “genuine issues of material fact exist.” Accordingly, the case has been remanded to the trial

court for further proceedings pursuant to this order.

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Recent Rulings and Cases

Massachusetts - Wind Turbine/Equipment Providing

Electricity to Manufacturing Facility is Exempt

Letter Ruling 12-7, Mass. Dept. of Rev. (7/2/12). The department held that because i) all of a

semiconductor manufacturer's electricity generated by its wind project will be used solely to

provide power to its manufacturing facility, and ii) it will not otherwise sell any of the electricity to

any third party, the manufacturer's purchase of a wind turbine is exempt from Massachusetts

sales/use tax as machinery that is used directly and exclusively in furnishing power to an

industrial manufacturing plant. Additionally, purchases of materials, tools, fuel, and machinery

that become part of the electricity furnishing apparatus (i.e., the wind turbine) fall under this

exemption. Accordingly, the manufacturer's contractor may give "Form ST-12" to its vendor

when purchasing these items in order to claim the exemption. However, purchases of materials,

tools, fuels and machinery that do not become part of the electricity furnishing apparatus, or

that are consumed and used before the wind project is actually generating and furnishing

electricity to the facility are subject to Massachusetts sales/use tax.

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Recent Rulings and Cases

Mississippi - New Law Clarifies Application of Manufacturing

Exemption to Scrap Metal Recyclers

H.B. 1680, signed by gov. 3/27/13. Effective from and after July 1, 2013, new law clarifies that

"to manufacture" and "manufacturing" for purposes of Mississippi's sales/use tax manufacturing

exemption include activities of scrap metal recyclers that primarily convert material into a more

useful product such as a specification-grade commodity, by processing the metal into separate

types, removing waste material, and/or cutting, chipping, sorting, sizing or shaping the material

into a usable product for sale. These terms do not include activities of scrap metal recyclers that

involve the gathering of recycled material and flattening, sorting, bundling or performing some

other similar function solely to allow ease of transportation or storage and not to produce

specification-grade commodities and/or the removal of parts for resale.

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Recent Rulings and Cases

Missouri - Compressors Used in Services are Nontaxable;

Gas Compression is "Manufacturing"

Letter Ruling No. LR 7210, Mo. Dept. of Rev. (2/19/13). The department held that an out-of-

state business renting natural gas compressors with an operator to natural gas producers is not

subject to state sales/use tax on these "rentals," because the company is in fact providing the

nontaxable service of removing impurities and compressing the well gas head to discharge

through gas lines for commercial and residential use, rather than merely renting tangible

personal property. This compression service is performed by the company's personnel

operating the compressors for gas producers; the tangible compressors are simply a necessary

part of the service. Additionally, the department held that the company's purchases of natural

gas compressors, parts, and oil filters to perform these nontaxable services falls under

Missouri's sales/use tax manufacturing exemption, because the compressor is used directly in

the production of natural gas – i.e., in removing impurities and compressing the non-marketable

natural gas to discharge through gas lines for marketable commercial and residential use.

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Recent Rulings and Cases

Missouri - DOR Says Software Sold to Manufacturers is Not

Exempt, Unless Delivered Electronically

Letter Ruling No. 7201, Mo. Dept. of Rev. (12/19/12). An out-of-state software developer

making sales to Missouri customers of software programs which assist purchasers in making

their manufacturing and administration processes more efficient do not qualify for Missouri's

manufacturing exemption, because this software is not directly used in the manufacturing

process since the software programs do not operate manufacturing equipment and are not

used in producing any product. The department does note that the company's sales of software

delivered electronically through the Internet are not subject to state sales/use tax, while its sales

of software delivered by tangible medium are subject to state sales/use tax. Additionally, the

company's sales of mandatory software maintenance and support delivered electronically

through the Internet are not subject to state sales/use tax if delivery of the initial software

occurred electronically through the Internet. However, the company's sales of mandatory

software and support delivered electronically through the Internet are subject to state sales/use

tax if delivery of the initial software occurred via tangible medium.

43

Recent Rulings and Cases

Missouri - New/Replacement Two-Way Radios Used in Amino

Acid Production are Exempt

Letter Ruling No. 7158, Mo. Dept. of Rev. (10/1/12). The department held that a

company’s purchases of new and replacement two-way radios used during the

production of amino acids qualified for Missouri’s manufacturing sales/use tax

exemption as machinery, equipment, and materials used/consumed in the

manufacturing, processing, compounding, or producing of any product, or

used/consumed in the processing of recovered materials. Under the facts, the

company had used the two-way radios to immediately transfer information in the

production process of amino acids and during the reclamation of waste materials.

44

Recent Rulings and Cases

New Mexico - Dep't Issues Proposed Changes to Rules

Involving Manufacturing Exemption

Proposed Repeal NMAC 3.2.204.10; Proposed Amended NMAC 3.2.204.13 - 3.2.204.16, 3.2.204.18;

Proposed New NMAC 3.2.204.19 - 3.2.204.22, N.M. Tax. & Rev. Dept. (2/28/13). The department has issued

proposed changes to administrative rules involving manufacturing-related exemptions under New Mexico's

gross receipts and compensating use tax. Among various other changes, the proposals provide that, beginning

January 1, 2013, receipts from selling tangible personal property to a manufacturer are deductible if the

property is consumed in the manufacturing process. Such property would include, but would not be limited to: i)

lubricants; ii) electricity; iii) water; iv) fuel/energy; v) chemicals used to produce reactions in the manufacturing

process, even though the chemicals do not become part of the manufactured product; vi) materials used to

prepare the manufactured product for sale, shipment or use; vii) cleaning solvents and materials used to keep

the manufacturing equipment sanitary and functional; and viii) light bulbs or filaments for the facility's lighting

system; replaceable air filters, seals, gaskets, hoses and similar items for any air purification system or heating

and cooling system; and similar items necessary to keep the manufacturing equipment operational. Tangible

personal property used in administrative, personnel, security, inventory control, record keeping, ordering, billing

or similar functions would not be considered consumed in the manufacturing process and would not be

deductible.

45

Recent Rulings and Cases

Pennsylvania - State High Court Affirms Manufacturer's

Pallets are Exempt Wrapping Supplies

Proctor & Gamble Paper Products Co. v. Commonwealth, Pa. (10/16/12). The Pennsylvania

Supreme Court has affirmed, without opinion, that an in-state manufacturer did not owe state

sales/use tax on its rental and use of wooden pallets, which aid in its transport of finished paper

products to its clients, because the pallets qualified for Pennsylvania's wrapping supply

exemption and did not constitute taxable returnable containers. The earlier commonwealth

court had held that the wooden pallets by themselves – apart from the slip sheet, corner posts

and stretch wrap – were not "containers." Alone, the wooden pallets were only part of the

"containers," i.e., the flooring. Accordingly, the commonwealth court had held that the pallets

qualified for the wrapping supply exemption.

46

Recent Rulings and Cases

Tennessee - Equipment for EPA Water Pollution Control

Qualifies for Manufacturing Exemption

Letter Ruling No. 13-06, Tenn. Dept. of Rev. (2/25/13).The department held that a

company partnering with municipalities to design, construct, and manage solid

waste landfills in Tennessee qualified for Tennessee's industrial machinery

exemption on purchased materials and/or equipment to construct and/or operate a

solid waste disposal landfill that were used primarily for water pollution control as

required by the United States Environmental Protection Agency's rules and

regulations promulgated under the Clean Water Act. However, no other materials

or equipment purchased by the company to construct and/or operate a solid waste

disposal landfill would qualify as exempt industrial machinery.

47

Recent Rulings and Cases

Tennessee - Purchased & Installed Freezer Rack System

Qualifies for Manufacturing Exemption

Letter Ruling No. 13-02, Tenn. Dept. of Rev. (1/9/13). A food products producer qualified for

Tennessee's industrial machinery exemption on its freezer rack system because the freezing

and maintenance of its manufactured food products in a frozen state was deemed part of the

"fabrication or processing" of those products. The rack system was installed in the freezer area

of the company's facility, bolted to the freezer area floor, and was not used in any other part of

the facility. The department reasoned that the facts showed that these freezer racks: i) were

properly considered "machinery, apparatus, and/or equipment, or their associated parts,

appurtenances or accessories," ii) were necessary to the fabrication or processing of the

products sold by the manufacturer, and iii) were primarily for the fabrication of the products sold

by the manufacturer. The maintenance of the food products in a frozen state – and thus the

manufacturing process – continued until the products were removed from the freezer racks. In

this respect, use of the freezer racks could not be characterized as being for storage, as the

racks were used at least 90% of the time during the manufacturing process.

48

Recent Rulings and Cases

Tennessee - Reusable Specialty Containers Qualify for

Machinery/Manufacturing Exemption

Letter Ruling No. 12-16, Tenn. Dept. of Rev. (8/2/12). The department

held that a manufacturer could claim Tennessee’s industrial machinery

exemption on certain reusable specialty containers, because the

containers were never used for storing raw materials or for moving raw

materials around the storage facility but solely to protect parts from

damage during transportation from storage to the manufacturer’s

production and assembly line. Under the facts, each assembly part was

transported in a container that had been specifically designed for that part.

49

Recent Rulings and Cases

Texas - Refinery Qualifies for Manufacturing Exemption on

Purchased Component Parts/Valves

Hearing No. 103,679, Tex. Comptroller of Public Accounts. (12/1/12). Regarding a refinery’s

purchase of various component parts of pumps used at its alumina refinery and valves for its

rod mill, the department agreed with an administrative law judge that such purchases qualified

as exempt parts for manufacturing equipment. More specifically, the department held that

purchased digester feed pumps and lime injection pumps were exempt because they directly

supplied the digester vessels, which are qualified exempt manufacturing equipment under

statute. Additionally, purchased calciner feed pumps were exempt because they supplied the

gas suspension calciner, which is exempt manufacturing equipment under statute. Lastly, the

purchased valves were exempt, because they were not part of a non-manufacturing pump but

instead were part of the computerized system for controlling the density of the product stream in

the rod mill.

50

Recent Rulings and Cases

Texas - Oil & Gas Company Fails to Show Purchases

Qualified for Manufacturing Exemption

Hearing No. 100,249, Tex. Comptroller of Public Accounts. (10/26/12). Regarding certain

purchases related to compressor equipment made by an Oklahoma-based oil and gas company

with operations in Texas, the department held that these purchases failed to qualify for Texas‘

manufacturing exemption because the company did not provide adequate documentation to

show how the compressors were used in its operations – i.e., whether they dehydrated the

natural gas or increased its pressure. The company claimed that its purchases related to the

compressors qualified for the exemption on the grounds that i) they directly caused a physical

change to the natural gas by dehydrating it, and ii) they directly caused a physical change to the

natural gas by increasing the pressure to improve its marketability.

51

Recent Rulings and Cases

Virginia - Execution System/Software and Wireless Gun Fail

to Qualify for Manufacturing Exemption

Public Document No. 12-118, Va. Dept. of Tax. (7/23/12). The department held

that a paper towel/tissue products manufacturer could not claim Virginia's

manufacturing exemption on its manufacturing execution system (MES) software

because the equipment/software did not ensure the integrity of the products being

produced and thus was not directly used in production line quality control, or in a

production process. A wireless gun system used in internal tracking and inventory

control was also deemed taxable because it was not an immediate part of the

company's production process but merely used in a taxable administrative activity.

52

Recent Rulings and Cases

Washington - Prototypes & Related Materials Don't Qualify for

Manufacturing Exemption

Tax Determination No. 11-0052, Wash. Dept. of Rev. (2/27/13). The department held that a

Washington company developing a complex medical device did not qualify for the state

sales/use tax manufacturing machinery & equipment (M&E) exemption on the materials it used

to build the prototypes it had used for product development, because even though the

prototypes may have been "integral" in the development of a new product, the ingredients and

components of prototypes do not qualify as M&E under the exemption statute and/or its

underlying legislative intent. The department also held that the prototypes that the company had

developed and used for testing did not qualify for the M&E exemption, as the system did not

qualify as a tool that produced another item of tangible property. That is, merely testing and

improving one or more of the prototype components using the rest of the system did not qualify

as "testing another item of tangible personal property" for exemption purposes.

53

Audits

54

Audit Preparation

Initial Contact and Scheduling

– Appointments usually should be 3 to 6 months out

from first contact.

– Request from the auditor an audit plan and

summary, preferably with a timeline as well.

– Request all contact information of the auditor

including his supervisor and manager.

– Make sure a taxpayer bill of rights is delivered

and discussed

55

Audit Preparation

Points of discussion with the auditor – Clearly define the scope of the audit! - No fishing

expeditions.

– Audit period – End date should allow time for data

preparation.

– Waivers – Be strict on signing waivers when it is obvious

that delays are the result of auditor lack of preparation and

diligence.

– Keep detailed audit and email logs to track the audit

timeline in case you need to push back on signing waivers.

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Audit Preparation

Points of discussion (continued)

– Consider the benefits and drawbacks of a

managed audit arrangement.

– Discuss plant visits - sometimes it is beneficial to

do before the audit if the auditor is unfamiliar with

your processes, otherwise it may be better to wait

until there are specific items to look at.

Prepare the plant tour guide for what to say or not…..

57

Audit Preparation

Points of discussion (continued)

– Audit methodology – Sample/No Sample, Block,

detail…If you know your data (and you should),

you will have the upper hand in these choices. Go

to the audit sampling class.

– Chart of Accounts – discuss with auditor, only

provide after the data is pulled and reconciled.

– Systems – if you have multiple systems and are

sampling, be careful to pull to samples if needed.

58

Audit Preparation

Data Preparation

– This will be specific to your system.

– Check for reversed documents.

– Remove documents with credit/debit offsets.

– Be careful only to pull that particular state’s data.

– If you are working the audit with an electronic file,

try to make sure you and the auditor work in the

same file.

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Auditor Fieldwork

Discuss your tax auditor policy with the

auditor

– If you don’t have one, develop one

– Work hours

– Dress code

– Entry and exit from the building

– Do not allow the auditor to wander through the

department asking questions, strictly control who

disseminates information to the auditor

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Audit Preliminary Listings

Establish whether or not the auditor will be

including overpayments, if not prepare any

overpayments to net into the audit.

For any listings that need to be looked at in

the plant, prepare a schedule of questions for

the plant as soon as possible and if possible

rehearse with plant before auditor gets there.

61

Final Assessment

Clearly communicate disagreed items.

Verify the final audit work papers agree with

the assessment summary.

For sample audits, review projection

methodology again.

Make sure you understand the appeal

process.

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Post Audit

Make sure you make needed changes to

your system based on the audit results

– System updates refinements, and enhancements

– Process improvement

– Training

63