Bottom falls out of Lessor’s “mixed bag” argument. Taxpayer (RentCo) was an Indiana business that leased, rented, and maintained trucks, tractors, trailers, and other specialized equipment.  RentCo was one member of a larger group of seven related businesses.  RentCo owned all of the equipment used by related operating companies, leasing the equipment to its “sister entities” as well as to third-party customers.  Reasoning that it was one entity in a larger “controlled group of corporations” (Group) that collectively engaged in a “unitary transportation business,” RentCo asserted that it was entitled to claim the “public transportation” sales tax exemption.  That provision, Ind. Code § 6-2.5-5-27, provides:

Transactions involving tangible personal property and services are exempt from the state gross retail tax, if the person acquiring the property or service directly uses or consumes it in providing public transportation for persons or property.

According to RentCo, it had an “organic” unitary relationship with the Group’s operating entities that entitled them collectively to claim the public transportation exemption.  To support its position, RentCo relied upon “unitary business” principles developed for income tax apportionment purposes.  The Department, however, accused RentCo of “mixing apples and oranges” in “creating a unique blend of sales and income tax law and principles.”  It was irrelevant whether RentCo could establish a unitary relationship with its sister entities, because its “argument rests on a hybrid interpretation of sales and income tax law which finds no support in either statute or common sense.”  The issue was “whether [RentCo] is in the business of providing public transportation.”  It wasn’t, and “there is no authority which allows [an entity to] re-characterize its separate entity status in order to collectively obtain a narrowly defined sales and use tax advantage.”

Lessor fails to “debunk” assessments for rental of accommodations.  RentCo built bunkhouses at its business location that were used by the sister entities’ drivers while the drivers’ trucks were being repaired, cleaned, or while the drivers were on required rest breaks.  RentCo invoiced its sister entities for use of the bunkhouses.  The Department concluded that sales tax should have been collected because “the invoices are for furnishing of accommodations for less than 30 days.”  RentCo disputed the assessments, claiming it was not in the business of furnishing or renting accommodations.  While RentCo’s “core business” may have been leasing trucks, the Department observed:  “[RentCo] constructed accommodations, rented those accommodations, billed its sister entities for the use of the accommodations, and received payments based on those bills.”  And RentCo provided no information showing that purchasers of the accommodations were entitled to the public transportation exemption.

Storage service wasn’t taxable.  The Department concluded that RentCo did not owe sales tax on charges to its sister operating entities for storing damaged merchandise.  The storage service did not involve the transfer of tangible personal property and therefore was not taxable.

The Department’s ruling can viewed here.

Next Thursday, October 10th, I am presenting an update on Indiana sales and use tax at an Aviation Law program, where I will discuss this ruling.

In Letter of Findings No. 04-20120368 (2012 tax year) (posted 2/27/2013), the Taxpayer, a Montana LLC, paid no sales tax when it purchased an aircraft from a Nevada dealership.  Two Indiana residents, a husband and wife, engaged a Montana attorney to set up the LLC (of which they were the sole members) and hold title to the aircraft.  The Department of Revenue issued a use tax assessment on the purchase of the aircraft.  In its protest of the assessment, the LLC argued that the assessment was improper because it was issued for an aircraft purchased and titled out-of-state by a Montana company.  The LLC further asserted that it used the aircraft for legitimate business purposes, i.e. the “business of investing in real and personal property in Montana and in any other lawful business. . . .”  According to the LLC, the aircraft was used mostly outside Indiana, and it was flown to Indiana only during the time the husband was getting his pilot license.

The Department denied the protest.  In so doing, the Department did “not contest that the LLC may have been formed for a purpose other than avoiding the tax.”  But the Department observed that the attorney who established the LLC represents on his web site that taxpayers can “avoid sales tax and licensing fees” by registering in Montana.  And the Department further noted that the LLC’s Montana registration designates the aircraft’s use as “private.”  The LLC could rely upon the attorney’s representations to avoid a fraud penalty, but not to avoid the tax altogether.

The LLC conceded that the aircraft was stored in Dayton, Ohio, for a few months after purchase and then transferred to Indiana.  Invoices showed that the aircraft was stored in hangars both inside and outside Indiana.  Husband and wife were Indiana residents, and the aircraft was stored in Indiana at least part of the time.  Consequently, LLC failed to show that the aircraft was not used or stored in Indiana and that the Department’s assessment was erroneous.  The Department elaborated:

Unfortunately, the Department is unable to accept the proposition that Indiana residents may avoid paying sales and use tax on tangible personal property simply by titling that property outside the state.  In this particular case, the Department is unable to agree that either the law, the facts presented by Taxpayer, or simple common sense compel the conclusion that Taxpayer should not be responsible for paying use tax on this airplane.

In Supplemental Letter of Findings No. 04-20120368 (posted 03/27/2013), the Department allowed the “one-time abatement of the [10%] late payment negligence penalty” because the LLC’s reliance on its attorney’s advice was “reasonable cause” for the LLC to presume that “its arrangement comported with the requirements of the law.”

Letter of Findings No. 04-20120368 can be viewed here.

Supplemental Letter of Findings No. 04-20120368 can be viewed here.

On October 4, 2013, California Governor Jerry Brown approved Assembly Bill 1422 (Chapter 540, Laws 2013).  The legislation clarifies that the sales and use tax exclusion for certain projects approved by the California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA) is available to entities located outside the state of California or overseas.  The amendment is effective January 1, 2014, though a portion of the legislation explains that it is meant to clarify existing law.  Therefore, that portion is functionally effective immediately.

An exemption for green energy projects.  CAEATFA was established to provide financial assistance to the developers of certain projects related to sustainable and renewable energy sources, energy efficiency, and advanced transportation alternatives.  The enabling legislation, Section 26000 et seq. of the Public Resources Code, provided a sales and use tax exclusion for certain participating parties and projects.  Under Section 6010.8 of the Revenue and Taxation Code, the terms “sale” and “purchase” as used in the California sales and use tax statutes do not include a lease or transfer of title to tangible personal property constituting a “project.”

Starting next year, “projects” limited to property used in-state.  Before the passage of Assembly Bill 1422, the definition of “project” included all tangible personal property utilized for the design, manufacture, production or assembly of sundry advanced products, components, and systems, including microelectronics and nanoelectronics, semiconductors, advanced materials, nanotechnology, industrial biotechnology, intelligent manufacturing systems, and a host of other technologies.  This language, however, did not qualify the usage, so qualifying entities could purchase property tax-free in California for use anywhere else.  The new legislation restricts the definition of “product” to property utilized in California.  This language, however, is effective January 1, 2014, and is not a clarification of existing law, so tax planning opportunities may be available for the next three months.

Effective now, non-California entities may qualify.  Perhaps more significantly, the new legislation clarifies that a participating entity need not be located in California to qualify for the exclusion.  A participating party can be any person (including corporations and other entities), federal or state agency, college or university, or political entity, whether for-profit or not-for-profit.  The enabling legislation, however, did not specifically include out-of-state or overseas entities, which led some to believe that CAEATFA could not authorize exemptions for non-California entities.  Assembly Bill 1422 specifically states that entities located outside the state, including overseas entities, are eligible to apply for the exemption if the entity commits to opening a manufacturing facility in California.  The legislature further explained that this clause clarifies existing law, rather than expands existing law to new circumstances.  As a result, out-of-state and overseas entities may be eligible to apply for the sales tax exclusion immediately.

On October 16, 2013, the Indiana Tax Court issued an order granting the request by Orbitz, LLC to prohibit public access to contracts that contained trade secrets.  The Court ruled:

Competition is the bedrock of our country’s economic system. The protection afforded to trade secrets under [the Access to Public Records Act or] APRA and Administrative Rule 9 helps to foster a healthy, competitive marketplace.  Here, Orbitz’s contracts contain trade secrets and therefore are protected from public disclosure under both APRA and Administrative Rule 9.

Slip op. at 8-9 (citations omitted).

Contracts govern net rates paid to hotels.  In Orbitz, LLC v. Indiana Department of State Revenue, Cause No. 49T10-0903-TA-10, the online travel company challenges the Department’s assessments of gross retail (sales) and county innkeeper taxes on the bookings at issue.  The Court explains:  “Through its website, . . . Orbitz provides travel related services enabling its customers to search for and make reservations for a broad array of travel products, including airline tickets, lodging, rental cars, cruises and vacation packages.”  Slip op. at 2 (internal quotes and brackets omitted).  The Court describes the company’s business arrangement with hotels and the assessment issue as follows:

Generally speaking, a hotel will contract with Orbitz to make its rooms available for reservation through Orbitz’s website. Pursuant to the contract, the hotel agrees to accept a certain amount for its rooms (“net rate”).  Nevertheless, a customer who books a room through the website sees – and ultimately pays – a different amount, as Orbitz has added a facilitation fee, a service charge, and a tax recovery charge to the net rate.  The tax recovery charge is equal to the amount of state and local taxes due on the room’s rental at the net rate.

After the customer has occupied the room, Orbitz forwards to the hotel the portion of the payment it collected from the customer that constitutes the room’s net rate and tax recovery charge.  The hotel is then responsible for remitting to the taxing authorities the appropriate state and local taxes due on the room’s rental.  Here, as a result of its audit, the Department determined that taxes should have been calculated and remitted based on the total amount Orbitz’s customers paid for the hotel rooms, not merely on the rooms’ net rates.

Slip op. at 2 n.1.

Orbitz sought to protect disclosure of its contracts.  Orbitz filed its original tax appeal on March 3, 2009, and it filed a summary judgment motion on August 2, 2013.  The company designated evidence in support of its motion.  Simultaneously, Orbitz requested an order from the Tax Court prohibiting public access to contracts with three Indiana hotels, claiming the contracts were “proprietary, competitively sensitive, and contain [Orbitz] trade secrets and financial information.”  Slip op. at 3 (citation to record omitted).  The Court conducted a public hearing on the request on September 17, 2013.

In its order, the Court first acknowledges that the “general rule in Indiana is that information submitted to state governmental entities, including the courts, is accessible by the public.”  Slip op. at 3-4 (citation omitted). The Access to Public Records Act, the Court observes, guarantees that “all persons are entitled to full and complete information regarding the affairs of [their] government.”  Slip op. at 4 (quoting Ind. Code § 5-14-3-1, brackets in original).  And Indiana Administrative Rule 9, adopted by the Indiana Supreme Court, “secure[s] the public’s access to court records.” Id.

Defining a “trade secret.”  Trade secrets are an exception to Indiana’s general rule regarding public access.  Slip op. at 4 (citations omitted).  A trade secret is defined by statute as:

information, including a formula, pattern, compilation, program, device, method, technique, or process, that:

(1)   derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(2)   is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

Slip op. at 4-5 (quoting Ind. Code § 24-2-3-2).  The Court next identifies these four general characteristics of a trade secret:

(1) it is information;

(2) that derives independent economic value;

(3) that is not generally known, or readily ascertainable by proper means by others who can obtain economic value from its disclosure or use; and

(4) that is the subject of efforts, reasonable under the circumstances, to maintain its secrecy.

Slip op. at 5 (citation omitted).

Contracts contained protected trade secrets.  The contracts, which include details of the company’s negotiated room rates, met this standard.  They were “information.”  Slip op. at 6.  And Orbitz “derives independent economic value from this pricing information.”  Slip op. at 7.  The Court observed that the company’s competitors “could possibly gain a competitive advantage by negotiating better rates with hotels” if they possessed the information.  Id.  In addition, the pricing information in the contracts wasn’t “readily ascertainable” by the company’s competitors or the public.  Orbitz had made reasonable efforts to maintain the secrecy of its pricing information.  “Each contract contains its own confidentiality clause that precludes the hotels from disclosing to any third party any information relating to the contracts as well as any information provided by one party to the other in performing the contract.”  Slip op. at 7 (emphasis in original).  Because the contracts constituted trade secrets, they fell within the mandatory exceptions to Indiana’s general rule of public access.  Slip op. at 8.  Therefore, the Court concluded that it “need not determine whether Orbitz’s need for privacy outweighs the policy of providing public access.” Id.

On October 31, 2013, the Indiana Tax Court in Garwood v. Indiana Department of State Revenue, Cause No. 82T10-1208-Ta-46, unmasked the Department’s not-so-scary jurisdictional theories in the latest ruling in the “puppy mill” cases, denying the Department’s motion to dismiss for lack of subject matter jurisdiction.  For background on Garwood’s initial appeal, including the Supreme Court’s reversal of its decision to grant review, see my earlier post (“Department of Revenue barks up the wrong tree”) here.  The relevant facts in this second appeal are:

• June 2, 2009 – The Department serves Garwood and her daughter several jeopardy tax assessments, providing that the two owed over $250,000 in sales tax, interest and penalties on their sales of dogs in 2007 through April 30, 2009.  The Department seized 240 dogs on the taxpayer’s premises pursuant to jeopardy tax warrants. 
• June 3, 2009 – The Department sold all 240 dogs to the U.S. Humane Society for $300, and it applies $175.48 to Garwood’s alleged liability.
• June 29, 2009 – After completing her administrative protest, Garwood files her first appeal with the Tax Court.  The Court denied the Department’s motion to dismiss.
• May 16, 2011 – Garwood files a complaint for damages in circuit court, alleging the Department had violated her due process and equal protection rights in issuing and administering the jeopardy tax assessments and warrants.
• August 19, 2011 – The Tax Court holds that the Department’s jeopardy assessments were void as a matter of law.  But the Court notes the Department could pursue other tax collection methods. 
• August 29, 2011 – Garwood files a one-page document requesting a refund of $122,684.50 (the “Refund”). 
• May – July, 2012 – The Department refunds Garwood the $175.48 and issues several proposed assessments providing that she owed nearly $60,000 in sales tax, interest and penalties for the period 2007 through June 30, 2009.  Garwood files a protest, and the Department conducts a hearing on the protest.  But the Department never issues a final determination.
• August 27, 2012 – Garwood files her second original tax appeal, asserting that the Department failed to rule on the Refund. 
• June 13, 2013 – The Department files its motion to dismiss.

The Tax Court’s jurisdiction.  Subject matter jurisdiction is the “power of a court to hear and determine a particular class of cases.”  Slip op. at 5 (citations omitted).  The Tax Court has exclusive jurisdiction over an “original tax appeal,” which is an appeal that (1) “arises under the tax laws of Indiana” and (2) is an initial appeal of a final determination by the Department.  Id. (citations omitted).

The “arising under” requirement was met.  The Department first claimed that the Refund did not “arise under” Indiana tax law because it was not a “valid” refund.  It wasn’t “valid,” the Department asserted, because it was “based on a purported tax payment derived from the appraised value of her animal inventory.”  Slip op. at 6.   The Department also argued that the Refund didn’t involve the collection of a tax or defenses to that collection; rather, it “seeks to recover monies that allegedly were not paid or credited to her by mistake” – a claim for compensatory damages and not a refund of sales tax.  Slip op. at 6-7.  Here, Garwood filed the Refund on the Department’s official refund form soon after the Court declared that the Department’s jeopardy assessments were void.  She “did everything the Department indicated that she needed to do” to file a refund claim.  Slip op. at 7-8.  The Refund, accordingly, “arises under Indiana’s tax laws.”  Slip op. at 8-9.

In reaching this conclusion, the Court noted that the “arising under” requirement is to be broadly construed.  Slip op. at 9.  To qualify, the taxpayer’s “challenge need not directly involve the collection of a tax – challenges to earlier steps in the taxation or assessment process also arise under the tax laws.  Id.  (citing State ex rel Zoeller v. Aisin USA Mfg., Inc., 946 N.E.2d 1148, 1153 (Ind. 2011) (emphasis in original).)  “Garwood’s case concerns the sale of seized property pursuant to jeopardy tax warrants, a tax matter.”  Id.

The final determination requirement was met.  The Indiana code allows a taxpayer to file an original tax appeal if the Department doesn’t rule on a refund claim within 180 days.  Slip op. at 10 (citing. Ind. Code § 6-8.1-9-1).  Garwood undisputedly filed her second appeal with the Tax Court more than 180 days after filing the Refund with the Department.  Therefore, Garwood satisfied the final determination (or exhaustion of remedies) requirement.  Id.

The Department’s motion to dismiss was denied.  Slip op. at 10-11.

A representative of electronic equipment manufacturers (RepCo) bought equipment that it used to demonstrate the equipment to potential buyers.  In Letter of Findings No. 04-20130346 (2010 and 2011 tax years), RepCo argued that the Indiana Department of Revenue incorrectly assessed sales / use tax on equipment that it either returned to the original vendor or resold to one of its customers.  According to RepCo, its purchase and subsequent use of the equipment was exempt under the purchase-for-resale exemption, see Ind. Code § 6-2.5-5-8 (exempting transactions involving tangible personal property acquired for resale, rental or leasing in the purchaser’s ordinary course of business without changing the property’s form).  The Department short-circuited the argument, explaining that use tax became due once RepCo demonstrated the equipment to potential customers in Indiana (and thus “used” it in-state).   The Department noted:  “The subsequent sale of the items is a secondary consideration and does not relieve Taxpayer of responsibility for the use tax because there is no exemption for items which are ‘used’ and then subsequently resold.”

However, the Department agreed to eliminate tax regarding items acquired from RepCo’s supplier and resold to RepCo’s customer “without Taxpayer making an intervening ‘use’ of the items.”

And the Department removed tax assessed on items acquired from suppliers that were returned to the suppliers for a “credit” or refund.  In these circumstances, the Department observed, “the items were neither used, stored, nor consumed by Taxpayer, and the initial acquisition of the items were not subject to use tax.”

Indiana Residents were managers of a Montana LLC, which they established with the help of a Montana “Service Company.”  As reported by the Department, the “Service Company” invited potential clients to “Register your vehicles in Montana and Pay No Sales Tax.”  The “Service Company” was designated as the LLC’s Montana ”agent.”  Except for the vehicle purchases, Residents provided no “documentation or evidence establishing any business or non-business activity by the LLC in Indiana, Montana, or any other state in the union.”  They made no effort “to acquire, maintain, or dispose of any property other than [the] vehicles in question.”  The Department found that the purchase of the vehicles by the LLC and their registration in Montana served no purpose other than avoidance of sales and use tax.  “The formation of the LLC and the titling of the vehicles in the name of the LLC constituted a ‘sham transaction.’”  Residents owed use tax on the vehicles, which were acquired in a retail transaction and used or stored in Indiana, since no sales tax had been paid “at the point of purchase or anywhere else.”  Letter of Findings No.  04-20130292 (2009, 2012 tax years) (posted Sept. 25, 2013)

An Indiana Farmer raised calves for food consumption, and he produced hay on his property to feed the calves.  Farmer purchased gravel “as a base for round hay bale feeders, which are used in the feeding process for Taxpayer’s calves.”  He claimed that his purchases were exempt under Ind. Code § 6-2.5-5-1 as tangible personal property acquired for “direct use in the direct production of food and food ingredients.”  The Department’s regulation provides:

‘To be directly used by the farmer in the direct production of food or agricultural commodities’ requires that the property in question must have an immediate effect on the article being produced.  Property has an immediate effect on the article being produced if it is an essential and integral part of an integrated process which produces food or an agricultural commodity.

45 IAC 2.2-5-1(a).  Without question, Farmer was “engaged in the direct production of food or agricultural commodities.”  But the issue was whether the gravel was directly used in direct production of the calves.  It wasn’t, because the “gravel does not have an immediate effect on the raising of cattle.”  While the gravel may have been necessary “to protect the hay from moisture and mud and to keep the tractor from getting stuck,” Farmer’s use of the gravel was “merely tangential” to food production.  Accordingly, purchases of the gravel were not exempt from sales tax.  Letter of Findings No. 04-20130316 (2010 tax year) (posted Sept. 25, 2013)

From cement to furniture manufacturers, following is a summary of September final determinations from the Indiana Department of Revenue regarding application of sales and use tax to various items of tangible personal property acquired and used as part of the production process.  The central questions often are (a) whether the items were used during production (as opposed to pre- and post-production) of tangible personal property or (b) whether the items had an “immediate effect” on the property being manufactured.

Concrete rulings:  misc. items acquired by a cement manufacturer – Letter of Findings No. 04-20130070 (2009-2011 tax years) (posted Sept. 25, 2013).  In a lengthy ruling, the Department addressed several issues raised by a cement manufacturer.  The Department explained:  “Taxpayer has two manufacturing locations, one that uses a dry kiln process . . . and one using a wet kiln process . . . .  These locations consist of quarries where stone is mined, delivered to the production areas, and through their kiln process is manufactured into cement.”  The Department observed that in creating the manufacturing exemption, see Ind. Code § 6-2.5-5-3, which applies the “double direct” test, the General Assembly “clearly did not intend to create a global exemption for any and all equipment which a manufacturer purchases for use within its manufacturing facility.”  The exemption “applies to manufacturing machinery, tools, and equipment directly used by the purchaser in direct production.”  (citing 45 IAC 2.2-5-8(a).)  The property must have an “immediate effect” on the item being produced. (citing 45 IAC 2.2-5-8(c).)   And property has an “immediate effect” when it becomes “an essential and integral part of the integrated process which produces tangible personal property.”  Id.  Property acquired for use in pre- and post-production activities is not exempt.  (citing 45 IAC 2.2-5-8(d).)  With this background, the Department concluded:

i.      Waste Fuel System – The waste fuel system didn’t have an “immediate effect on the manufactured cement.”  It may make use of “waste fuel” more efficient, but Taxpayer could manufacture the cement without it.  Processing of “waste fuel” was a pre-production process; thus, purchase of the waste fuel system was taxable.

ii.      Five Gallon Pails – Pails used to collect, store, and transport manufacturing waste that had been removed from production were used in post-production and therefore taxable.

iii.      Fly Ash System; Compressor – Taxpayer’s “fly ash system” feeds fly ash “into the raw mill where it is mixed with other ingredients to form slurry, which is fed into the kiln.”  The “compressor shoots a burst of air into the fly ash before it enters the rotary valve for the raw mill main feed belt.”  But the system, including its compressor, had no “immediate effect” on the cement being manufactured.  While the fly ash is in the storage tank or on the conveyor system, it was “not being mixed, altered, combined, or changed in form.”  Such activity was pre-production, so the compressor used as part of the system was taxable.

iv.      Slurry Tank Repair Parts – The slurry tank is used to temporarily hold work-in-process, so it was directly used during production and repair parts purchased for the tank were exempt.  (citing 45 IAC 2.2-5-8(e)(1) and 45 IAC 2.2-5-8(h)(2).).

v.      Maintenance Agreement – An agreement purchased for software for a “CBX x-ray machine” was exempt, because the machine was used for quality control of the production system.  (citing 45 IAC 2.2-5-8(h)(2).)

vi.      Plant Water Tower – Repair parts for the “RIP Plant Water Tower” were taxable, because the tower and associated pipes “store and transport a raw material before it enters into the manufacturing process.”  While stored in the tower and pipes, the water was “not being mixed, altered, combined, or changed.”

vii.      Heat Tape – The tape was used on water pipes to prevent freezing.  Because the tape was purchased for and consumed for maintenance – a post-production activity – it was taxable.  (citing 45 IAC 2.2-5-12(b) and (f).)

viii.      Wells – Materials for well repair were deemed taxable, because the “wells do not have an immediate effect on the manufactured cement.”  Cement could be manufactured without the wells.  And the wells are used to draw and/or transport “well water” before the water enters into the manufacturing process – a pre-production activity.

ix.      Water treatment chemicals – Chemicals used to treat “process water” before the water enters the manufacturing process were used in pre-production and therefore taxable.  Taxpayer could manufacture the cement without using the chemicals; accordingly, adding the chemicals to the “process water” was “a separate process both distinct and removed from the actual manufacturing of the cement.”

x.      Idler roll – Bearings used to repair the idler roll, which is located in the quarry and moves crushed stone to the raw mill, were exempt because the machine was used to transport work-in-process.  (citing 45 IAC 2.2-5-8(f)(3) and 2.2-5-8(h)(2).)

 xi.      Flowmeter – The flowmeter was purchased to measure the amount of bulk cement placed into each individual bag in the automated packaging line.  Because it was used in transporting and measuring the cement to create the packaged product (individual bags of cement), the flowmeter was found to be used during production.  It was exempt.

xii.      Reducer – The reducer was a repair part for a scale that measured work-in-process, so it was exempt.  The scale was used within an “integrated, automated production process that depends on precise measurement of various combinations of materials.”

xiii.      P & H Crane Rail – A replacement rail for a crane rail system used to transport work-in-process was exempt.

xiv.      12 Strand Fiber Optics – Fiber optics used as part of a computer system that “functions as a ‘key to the [finished product] silo’” wasn’t exempt; the computer system did not have an “immediate effect” on the cement being produced.  It performed a post-production activity.

 xv.      Crusher – Fuses used to repair Taxpayer’s secondary crusher, which was manufacturing equipment, were exempt.

xvi.      Petron Gear Shield NC Lubricant – Lubricant that directly affected the kiln, which also was manufacturing equipment, was exempt.

 xvii.      Inline Heater – A heater used to heat oil to be pumped through pipes was taxable, as it was “readying an item consumed in production.”  Pre-heating of the oil was a pre-production activity.

 xviii.      V-Ball Controller Housing – Valves for the housing were exempt repair parts.  (citing 45 IAC 2.2-5-8(h)(2).)  The valve controlled the amount of work-in-process raw feed entering the kiln.  Transporting work-in-process is direct use in direct manufacturing.  (citing 45 IAC 2.2-5-8(f)(3).)

xix.      Quality Control Laboratory:  Electrical System – A transformer purchased to repair the electrical system for a quality control laboratory which tested product during production was exempt.  Here, the laboratory was located immediately next to the kiln burn floor, and Taxpayer analyzed production samples “every minute.”  (citing 45 IAC 2.2-5-8(i).)

xx.      Gypsum Hopper Grate – Sales tax applied to the purchase of the grate, which was used to prevent oversized pieces of gypsum from entering the gypsum storage silo.  The Department concluded that the grate was used to prepare the gypsum for the manufacturing process, i.e. it was used in pre-production.

 xxi.      Environmental Exemption – Three items – a “cooling tower filter,” “85 PPM Propane Nitrogen,” and a “Spool Assembly” for a “Baghouse” – were found exempt by the Department under Ind. Code § 6-2.5.5-30, which exempts property acquired by a manufacturer “for the purpose of complying with any state, local, or federal environmental quality statutes, regulations, or standards.”

Contractor Services – The Department ruled that Taxpayer was not liable for sales tax on two transactions with a contractor for the installation of “heat detection systems,” because the contractor was liable for paying the tax on materials used in the lump sum contracts.  (citing 45 IAC 2.2-4-1, 45 IAC 2.2-3-7, 45 IAC 2.2-4-22(d)-(e), Sales Tax Bulletin 60.)  But Taxpayer was responsible for tax on the cost of materials furnished under a time and materials contract for the installation of smoke/heat detectors. (citing 45 IAC 2.2-4-22(d)(1).)

Jamming a printer?  Delivery charges, maintenance agreement, forklift, waste toner cartridges, and dehumidifier – Letter of Findings No. 04-20120284 (2008-2010 tax years) (posted September 25, 2013).  Taxpayer is a commercial printer.  The Department found:

i.      Delivery charges were subject to sales tax, even if they were separately stated.

ii.       An exemption certificate provided to the printer was not fully filled out by the client.  Information such as the client’s name, address, tax identification number (TID) and completion date of the certificate were missing.  Accordingly, “Taxpayer’s protest that it had an exemption certificate from a client” was denied.

iii.      Maintenance agreement – Taxpayer’s protest of sales tax against a maintenance agreement was sustained, because Taxpayer documented that the agreement was for consulting services only and that sales tax was paid on purchases of tangible personal property purchased from the consultant.

 iv.      Forklift – A partial manufacturing exemption was applied to a forklift to the extent it was directly used in direct production.  The Department explained:   “Taxpayer’s exempt process begins with the placement of paper (or other items) into the printers and ends when the printed materials are in their final form. Any other activities are considered to be pre- or post-production.”

v.      Waste toner cartridges – While necessary, use of the cartridges did not meet the “double direct” test required by Ind. Code § 6-2.5-5-3.  “Here the waste toner cartridge is not part of direct production. Once the paper has been printed upon, the leftover/waste toner is no longer part of production. Therefore the cartridges used solely for holding toner waste are not directly used in direct production.”

vi.      Dehumidifier – A dehumidifier wasn’t exempt, because it lacked a direct effect on the product being produced.  “Only clearly demarcated areas in which there is active manufacturing that depends on a controlled environment are entitled to the exemption.”  The dehumidifiers “condition” the facility’s environment “rather than a specific, demarcated area within that facility.”

Not digging the assessment – Letter of Findings No. 04-20130165 (2009-2011 tax years) (posted Sept. 25, 2013).  The Department ruled in part that equipment and machinery “used to construct or prepare a manufacturing site are not used in the actual production process.”  Consequently, Taxpayer’s rental of a digger to prepare a site for the eventual placement of exempt equipment and machinery was taxable.

No evidence, no exemptions – Letter of Findings No. 04-20130289 (2009-2011 tax years) (posted Sept. 25, 2013).  Taxpayer operated an Indiana manufacturing facility.  The Department observed that various protested items such as pallets, a machining/coolant system, propane, and “modular plug-in lighting” may have qualified for the manufacturing exemption.  However, there was “no independent documentation, explanation, or confirmation for Taxpayer’s position.”  Where support was lacking, Taxpayer’s protest was rejected.

Natural gas used for air makeup units by furniture manufacturer taxable –  Letter of Findings No. 04-20120432 (2009-2011 tax years) (posted September 25, 2013).  Taxpayer challenged the assessment of sales tax for purchases of natural gas, which Taxpayer asserted was used for air makeup units (AMUs). A 2011 study showed that 71% of the gas was used to heat the air being brought into the building by the AMUs.  Gas used for that purpose was taxable, the Department’s audit concluded.  Taxpayer responded:

The [AMUs] are responsible for maintaining the finishing room’s positive air pressure, which prevents dust and other particles from entering the rooms and settling on the freshly applied finish. The [AMUs] also control the temperature and humidity in the room, which increases the air’s capacity to absorb excess solvents. Without the temperature and humidity controls a condition called “blushing” would occur where the finish becomes cloudy and the product un-saleable.

Moreover, Taxpayer contended that it must “adhere within the finish manufacturer’s temperature requirements.”  Not exactly, the Department observed; the “Finishing Schedule” provides a temperature recommendation – not a requirement.  And the AMUs were not located in a closed room environment.  Air could travel from the finishing room to other parts of the plant.  Accordingly, “Taxpayer has not established that without the [AMUs] a final marketable product could not be produced.

In a pair of rulings issued last month, the Indiana Department of Revenue concluded that a Distributor’s clients didn’t have income from Indiana sources and had no substantial nexus with Indiana.  Therefore, the clients were not required to file Indiana income tax returns or collect and remit sales tax on transactions sourced to Indiana.  Distributor stores and distributes catalogs for its clients.  It sought guidance on the following question posed to the Department:

Does storage by an out-of-state retailer of catalogs at [Distributor's] facilities in Indiana, prior to the distribution of those catalogs by [Distributor] to recipients throughout the United States, including Indiana, constitute ‘substantial nexus’ for the retailer in the state or otherwise require the out-of-state retailer to collect, remit, or report Indiana sales/use taxes or business activity taxes?

No Indiana sourced income = no income tax filing.   Indiana imposes a tax upon non-residents’ adjusted gross income derived from doing business within the state.  Ind. Code § 6-3-2-1(a) and -2(a)(2).  By regulation, 45 IAC 3.1-1-38, “doing business” includes:

(1) Maintenance of an office or other place of business in the state

(2) Maintenance of an inventory of merchandise or material for sale distribution, or manufacture, or consigned goods

(3) Sale or distribution of merchandise to customers in the state directly from company-owned or operated vehicles where title to the goods passes at the time of sale or distribution

(4) Rendering services to customers in the state

(5) Ownership, rental or operation of a business or of property (real or personal) in the state

(6) Acceptance of orders in the state

(7) Any other act in such state which exceeds mere solicitation of orders so as to give the state nexus under P.L. 86-272 to tax its net income

The Department concluded that “the only semblance of a business activity that [Distributor’s] clients are conducting in the state consists of the presence of the clients’ advertising catalogs.”  That “mere presence” didn’t qualify as “doing business” within the regulatory definition.  According to the Department, Distributor’s “clients do not appear to have adjusted gross income derived from sources within Indiana” and thus don’t “have any Indiana income tax filing requirement derivative of the presence of their advertising catalogs within the state.”  The Department’s ruling can be viewed here.

No Indiana nexus = no sales tax collection.  The Department first notes, “In a typical situation, the retail merchant [in a retail transaction] is statutorily required to collect and remit the tax as an agent for the state.” (citing Ind. Code § 6-2.5-2-1(b).)  But the “United States Constitution places limits upon Indiana’s ability to compel merchants to collect and remit sales tax.” (citing Quill Corp. v. North Dakota, 504 U.S. 298 (1992).)  The Commerce Clause requires, among other things, that a tax imposed by Indiana must be “applied to an activity with a substantial nexus with” the Hoosier State.  The Supreme Court’s decision in Quill “reaffirmed that, at the very least, ‘substantial nexus’ with [Indiana] for Commerce Clause purposes must include some kind of physical presence” in Indiana.  Here, the only presence of Distributor’s clients within Indiana was their advertising catalogs.  “Without more, the Department finds this to fall short of the physical presence requirement contemplated by Quill and its progeny.”  The clients lacked substantial nexus with Indiana, so the Department could not “compel [Distributor’s] clients to collect and remit sales tax on their transactions sourced to Indiana absent more of a physical presence in the state.”  The Department’s ruling can be viewed here.

The Michigan Court of Appeals recently shocked the Michigan Department of Treasury when it held that machinery and equipment used to transmit and distribute electricity was entitled to a use tax exemption available for industrial processing.  In Detroit Edison Co. v. Department of Treasury, the Court found that the electricity was not a finished good ready for sale when it left the generating facility, but instead needed further processing to be usable by the taxpayer’s customers – processing performed by the distribution equipment.  In so finding, the Court specifically invalidated the Michigan regulation that declared taxable the sale of property consumed or used in the transmission or distribution of electricity.

The taxpayer’s charge and the Department’s resistance

Detroit Edison (DTE) is an electric utility that provides electricity to a variety of residential, commercial, and industrial customers.  DTE produces electricity in its generation plants and distributes that power to its customers via a network of substations, transformers, high-voltage towers, and cables.  DTE’s voltage levels at its generation plant range from 15,000 to 25,000 volts, a voltage that is actually stepped-up to as much as 500,000 volts.  The usable voltage for most customers is 120/240 volts.  The voltage must be stepped-down to be usable by customers, but must be stepped-up to an extreme level so that it can reach the customer.  DTE’s expert testified that it would “not [be] practical under the laws of physics” for generation plants to produce electricity at the 120/240 volt level.

There was no dispute that equipment used in the production of electricity in DTE’s plant qualified for a sales tax exemption under the Michigan statutes.  The Department determined that the exemption ended at the wall of the generating plant; as soon as the electricity was released into the grid, it was ready for consumption by the consumer.  The Department relied on its own Rule 205.115, which declared “the sale of tangible personal property consumed or used in the transmission or distribution of electricity” taxable.  The Department’s expert testified that though the voltage was stepped-up and stepped-down, “the nature, composition, and character of the electricity” was not altered.

An ample review of the evidence conducted by the Court

In Michigan, “industrial processing” is an activity entitled to sales tax exemption.  Industrial processing – i.e. the activity of converting or conditioning tangible personal property by changing its form, composition, quality, combination, or character – begins when the property begins movement from raw materials storage into production and ends when the finished goods come to rest in inventory.  Virtually all states imposing sales tax provide a similar exemption for property used in manufacturing or processing activities.

The Court noted that the legislature “seemingly envisioned a simple manufacturing situation in which a company engages in industrial processing at its plant to produce a product, the product is in the form of a finished good and ready for retail sale while awaiting transport at the company’s plant, and then the company ships or distributes the product to a customer.”  But when is electricity a finished good?  The Court found it “indisputable” that electricity is not a finished good ready for sale until it reached the meters of DTE’s customers.

The Court favorably cited the “extremely detailed scientific views espoused by DTE’s experts.”  DTE’s experts provided opinions on and explanations of the nature of electricity, the physics inherent in the transmission of electricity, and the ways that the electricity was continually processed as it passed through the distribution grid.  In contrast, the Department’s expert testified in conclusory fashion that the electricity did not change during transmission and distribution.  The Court noted that the Department’s expert struggled at times to toe the Department’s line – for example, by noting that the “change [in] phase angle” could qualify as conditioning and stating that electricity was unusable “until it’s transformed.”

The Department argued that the industrial processing exemption does not extend to distribution activities, so any processing performed by the equipment was secondary to its taxable distribution purpose.  The Court reiterated that a concurrent taxable use with an exempt use does not remove the protection of an exemption.  The equipment was part of a unified system concurrently used for both distribution and processing, and was accordingly exempt.

Science provides the spark

The case is a helpful reminder that science can be a helpful ally, even in state tax cases.  Many sales tax exemptions turn on when a certain process begins and ends, and whether a change is occurring in the product.  Consider, for example, a recent administrative decision in Indiana (LOF 04-20110458) where the taxpayer prevailed by showing the molecular and pH changes in slag, or Southwest Royalties, Inc. v. Combs, where the 353rd District Court in Texas evaluated the physical changes in petroleum.  As Detroit Edison and other cases show, science can positively charge a taxpayer’s position.

In an uplifting post, the Texas State & Local Tax Law Blog (authored by attorney Alan E. Sherman) on February 12, 2014 wrote:

This morning, the Texas Third Court of Appeals at Austin issued its opinion in Cirrus Exploration Company v. Combs, et al. . . .  In the opinion, the court held that a taxpayer’s helicopter purchases were exempt from sales and use tax by reason of Subsect. (a) of Tex. Tax Code ann. §151.328 and the Texas Comptroller of Public Accounts’ Sales and Use Tax Rule 3.297. . . .  [T]he case stands for the proposition that a court won’t automatically defer to the Comptroller’s “longstanding interpretation” of a Tax Code provision, or of the agency’s own rule, no matter how old the interpretation might be.” (emphasis in original.)

The full post can be viewed here.

On February 6, 2014, Minnesota resident Scott Stevens received an early Valentine he will not soon forget – an Order from the Tax Court relieving him from a $4 plus million liability for petroleum and sales/use taxes for tax periods in 2008, 2009 and 2010.  Stevens was President and COO of a Retailer operating service stations and convenience stores primarily in Minnesota.  He owned less than one percent of Retailer’s parent company.  According to the Court, Stevens “lacked actual authority or control over [Retailer’s] financial affairs.” (Order ¶ 4.)  Rather, he had personnel and human resource responsibilities.  (Order ¶ 5.)

Lack of control over financial decisions.  The Tax Court’s decision outlines the extensive controls exercised by the Majority Owner over Retailer’s finances — and Stevens’ lack of influence over financial decisions – including:

• Majority Owner “regularly provided detailed directions for making payments to vendors” and his “control only tightened as time went on.”
• Majority Owner directed Stevens to retain a Consultant to “advise on financial matters” for Retailer.  Consultant acted as the “CFO.”  Majority Owner and Consultant controlled Retailer’s finances.
• Consultant prepared a weekly forecast identifying proposed payments to be made, including taxes and utilities.  Stevens was “involved” in financial discussions, but Majority Owner made the decisions.
• “Stevens had no independent authority to make purchasing decisions, and he arranged, directed, or approved inventory purchases only with [Majority Owner’s] prior approval.”
• Although “Stevens discussed with [Retailer's] suppliers the amounts owed by [Retailer] and tried to get them paid, only [Consultant] or [Majority Owner] could authorize actual payments.”
• Stevens engaged in discussions to sell some of Retailer’s stores, but he “had no say in the outcome.”

Taxpayer lacked “meaningful control” over Retailer’s finances.  Minnesota law provides in part that a “person who, either singly or jointly with others, has the control of, supervision of, or responsibility for filing returns or reports, paying taxes, or collecting or withholding and remitting taxes and who fails to do so . . . is liable for the payment of taxes.”  (citing Minnesota Statute Sec. 270C.56, subd. 1) (emphasis added).  The issue, the Tax Court observed, was whether Stevens had “influence over the disbursement of [Retailer’s] funds and priority of payments to creditors.”  (Memorandum, at 10.)  The Court held that Stevens carried his burden to show that he “did not have the requisite financial control over [Retailer] to be held personally liable for the failure to pay taxes as required by Minn. Stat. § 270C.56.”  Id.  In reaching this decision, the Court concluded:  “[T]he record shows [Majority Owner] delegated Stevens only limited powers and Stevens had no actual control of, supervision over, or responsibility for seeing that [Retailer’s] sales and petroleum tax liabilities were paid. . . .  [H]e effectively had no financial control.”  Id.  Moreover, Stevens “had no actual authority to make any payment of the unpaid taxes, was not involved with tax return preparation, and never signed a tax return for [Retailer].”  (Memorandum, at 13.)  He lacked any “meaningful control” over Retailer’s finances, having only operational responsibilities.  (Memorandum, at 13-14.)  Neither being aware of Retailer’s financial affairs nor holding himself out to third parties as having financial control was sufficient to assign liability to Stevens; the statute requires actual “control, supervision or responsibility” to ensure the taxes are paid – “attributes Stevens did not possess.” (Memorandum, at 14.)

Court need only analyze one of five Benoit factors.  The Tax Court considered this case on remand from the Minnesota Supreme Court.  The Supreme Court historically has considered five factors to determine whether a person is personally responsible for payment of a corporation’s tax liability.  Those factors, drawn from the Court’s decision in Benoit v. Comm’r of Revenue, 453 N.W.2d 336, 344 (Minn. 1990), are:

(1) The identity of the officers, directors and stockholders of the corporation and their duties;

(2) The ability to sign checks on behalf of the corporation;

(3) The identity of the individuals who hired and fired employees;

(4) The identity of the individuals who were in control of the financial affairs of the corporation; and

(5) The identity of those who had an entrepreneurial stake in the corporation.

In effect, the Supreme Court in its 2012 decision had applied the Benoit analysis.  It concluded that, if Stevens was president of Retailer in name only as it related to the financial control of Retailer, “then Benoit factor four (control of the financial affairs of the corporation) was determinative of Stevens’ liability.”  (Memorandum, at 19.)  The Tax Court did not have to analyze the other Benoit factors.  (In a footnote, the Court noted that the Benoit factors were “informative” but the “statutory standard controls.”)  The Court described this decision as a “close case” in holding “based solely on the particularized facts of this case” that “Stevens did not have the requisite financial control over [Retailer] to hold him personally liable for the failure to pay taxes as required by Minn. Stat. § 270C.56.” (Memorandum, at 20.)

Was this case really close?  The facts as described strongly support the Tax Court’s holding.  Regardless of the margin of victory, however, it’s clear the record favored the taxpayer’s position.

The Tax Court’s decision can be viewed here.

The Supreme Court’s 2012 ruling can be viewed here.

An Illinois resident taxpayer purchased a boat from an individual who lives in Kentucky in 2011.  The taxpayer completed the Aircraft/Watercraft Use Tax Transaction Report (IL Form RUT-75) and filed it with the Department of Revenue, claiming that the boat was exempt from watercraft use tax.  But the Department determined that tax was owed and assessed tax, penalties, and interest on the boat purchase.  The taxpayer protested, and in a recent decision that can be accessed here, the Illinois Department of Revenue Office of Administrative Hearings sided with the taxpayer.

The Watercraft Use Tax does not apply if the transaction fits within certain exceptions to the Illinois Use Tax Act.  See 35 Ill. Comp. Stat. 158/15-10.  Under Illinois use tax law, tax does not apply if property is acquired outside the state, brought into the state and stored temporarily, and then used solely outside the state.  35 Ill. Comp. Stat. 105/3-55(e).  In this case, after purchasing the boat in Kentucky, the taxpayer brought it into Illinois only to perform maintenance on it, clean it, and title it, and then the taxpayer took the boat back into Kentucky, where it was kept permanently.