Putting it Together:  Sales and Use tax rulings impacting Indiana manufacturers (September 2013)

Putting it Together: Sales and Use tax rulings impacting Indiana manufacturers (September 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.

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