BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, ) FINDINGS OF FACT,
: CONCLUSIONS OF LAW,
v. ) AND FINAL DECISION
AUDITING DIVISION OF THE ) Appeal No. 91-1797
UTAH STATE TAX COMMISSION, :
) Account No. XXXXX
STATEMENT OF CASE
This matter came before the Utah State Tax Commission ("Tax Commission") for a formal hearing on XXXXX. G. Blaine Davis, Administrative Law Judge, heard the matter for and on behalf of the Tax Commission. XXXXX and XXXXX of XXXXX represented petitioner XXXXX. XXXXX, Assistant Utah Attorney General, represented the Auditing Division of the Utah State Tax Commission ("Auditing Division"). Having considered the evidence presented at the formal hearing, and the memoranda and pleadings on file, the Commission now enters its Findings of Fact, Conclusion of Law and Final Decision.
FINDINGS OF FACT
1. The tax in question is the Utah sales and use tax.
2. The period in question is XXXXX through XXXXX.
3. XXXXX is a XXXXX qualified to do business in the state of Utah.
4. The Auditing Division is a division of the Utah State Tax Commission, which is the state agency charged under Article XIII of the Utah Constitution with the administration and supervision of the state's tax laws.
5. XXXXX manufactures XXXXX and XXXXX at its XXXXX in XXXXX County, Utah.
6. In XXXXX, XXXXX began an expansion of its existing manufacturing operations by developing and constructing XXXXX in XXXXX County. XXXXX purpose in constructing XXXXX was to expand its XXXXX business to include the manufacture of XXXXX and XXXXX. This was a new product line for XXXXX.
7. The expansion continued into XXXXX, thus spanning a period of XXXXX years. Numerous buildings and facilities were constructed and placed in service during the period including XXXXX. The capital expenditures for the XXXXX expansion exceeded $$$$$.
8. When all of the buildings, including XXXXX were constructed, XXXXX purchased machinery and equipment for those buildings without the payment of sales and use tax. The Auditing Division did not challenge the qualification of such purchases for the manufacturer's exemption except for the machinery and equipment purchased for XXXXX.
9. On XXXXX, a XXXXX (explosion) occurred during the mixing of XXXXX in XXXXX at XXXXX. This fire and explosion occurred during the first test use of XXXXX. XXXXX.
10. Following the incident, XXXXX developed and constructed a XXXXX building designated as XXXXX. XXXXX.
11. The construction and equipping of XXXXX was completed during XXXXX of XXXXX, and was part of the XXXXX expansion. The first XXXXX occurred in XXXXX. On the XXXXX was placed in service it was a new facility and contained new machinery and equipment. Neither the building nor any of the machinery and equipment installed therein had previously been used.
12. As constructed and equipped, XXXXX is capable of XXXXX -- XXXXX and XXXXX. Only XXXXX could be made in XXXXX. XXXXX are much more XXXXX, XXXXX than XXXXX. XXXXX cannot be used as XXXXX designed to run on XXXXX and vice versa.
13. Several major pieces of machinery and equipment are contained in XXXXX which were not contained or installed in XXXXX. These include:
a. XXXXX for feeding chemicals and materials (XXXXX) and XXXXX) into the mixing bowl area;
b. A XXXXX to reduce the XXXXX of the feed system handling the XXXXX;
d. XXXXX and faster XXXXX devices;
e. XXXXX and XXXXX; and
f. Enhanced XXXXX.
14. All of the machinery and equipment in XXXXX required "XXXXX." XXXXX checks for and eliminates XXXXX and other parts of the equipment where XXXXX could XXXXX. XXXXX was not required of the machinery and equipment in XXXXX.
15. XXXXX increased XXXXX production capacity for the manufacture and mixing of XXXXX at XXXXX. Both XXXXX and XXXXX XXXXX can be processed therein. Also, XXXXX is located outside of the XXXXX of the other XXXXX providing for less XXXXX both during the period of XXXXX was being constructed and from the standpoint of being able to operate all XXXXX concurrently.
16. XXXXX did not pay sales or use taxes on any of the machinery and equipment it purchased and installed in XXXXX, claiming the purchases were exempt from the sales and use tax under Utah Code Ann '59-12-104(16).1 At the time of such purchases XXXXX gave its vendors an exemption certificate number.
17. The equipment contained in the audit is tangible personal property which was purchased, stored, used or consumed by XXXXX in the state of Utah and is therefore subject to the tax imposed by Utah Code Ann. '59-1-103, unless it meets the exemption criteria set forth in Utah Code Ann. '59-12-104(15).
1For the tax years in controversy, XXXXX through XXXXX, the statutory exemption relied upon by XXXXX was codified at U.C.A. '59-12-104(16). Because of changes and renumbering of certain statutory exemptions, the exemption is now codified at U.C.A. '59-12-104(15) (XXXXX). For convenience, all references hereinafter to the Utah Sales and Use Tax Act shall be to U.C.A. '59-12-104 (15). The renumbering did not affect the substance of the provision.
18. On XXXXX, the Auditing Division issued a Statutory Notice of Deficiency assessing XXXXX additional sales and use taxes of $$$$$, a penalty of $$$$$ and interest at the statutory rate. On XXXXX, the Auditing Division issued a Second Statutory Notice which amended the original assessment by reducing the amount of the tax to $$$$$, the penalty to $$$$$, and recomputing interest accordingly. On XXXXX, the Auditing Division issued a Third Statutory Notice which further amended its assessment by reducing the amount of the tax to $$$$$, the penalty to $$$$$ and recomputing the interest.
19. Of the $$$$$ in tax imposed by the Third Statutory Notice, $$$$$ arose from XXXXX purchase of machinery and equipment installed in XXXXX. The remaining $$$$$ of assessed taxes related to several other sales and use tax issues which are not in dispute in this proceeding.
20. All issues except tax on the machinery and equipment purchased for XXXXX have been resolved and XXXXX has paid the uncontested amounts.
Two issues are presented for resolution:
1. Does the construction and equipping of XXXXX qualify under Utah Code Ann. '59-12-104(15) as a "new or expanding operation?"
2. Is the machinery and equipment XXXXX purchased and installed in XXXXX a "normal operating replacement" of the machinery and equipment destroyed in the XXXXX mishap, within the meaning of Utah Code Ann. '59-12-104(15)?
CONCLUSIONS OF LAW
The Sales and Use Tax Act (Utah Code Ann. '59-12-101 et seq.) levies a tax on tangible personal property purchased within Utah or on tangible personal property stored, used or consumed in Utah. Utah code Ann. '59-12-103. It is agreed that XXXXX purchased and installed machinery and equipment (tangible personal property) in connection with the construction of XXXXX. Unless the Sales and Use Tax Act provides an exemption, the purchases and use of the machinery and equipment in XXXXX would be subject to the sales and use tax.
Utah code Ann '59-12-104(15)(1993)1 provides a relevant exemption. In pertinent part, it states:
1For the tax years in controversy, XXXXX through XXXXX, the statutory exemption relied upon by XXXXX was codified at U.C.A. '59-12-104(16). For convenience all references hereinafter to the Utah Sales and Use Tax Act are to U.C.A. '59-12-104(15)(XXXXX). The renumbering did not affect the substance of the provision.
(15) sales or leases of machinery and equipment purchased or leased by a manufacturer for use in new or expanding operations (excluding normal operating replacements, which includes replacement machinery and equipment even though they may increase plant production or capacity, as determined by the commission) in any manufacturing facility in Utah;
(a) manufacturing facility means an establishment described in SIC Codes 2000 to 3999 of the 1987 Standard Industrial Classification Manual of the federal Executive Office of the President, Office of Management and Budget;
(b) for purposes of this subsection, the commission shall by rule define "new or expanding operations" and "establishment".
The Statute sets forth certain conditions for procuring the exemption from the sales tax which are: 1) the items purchased or leased must be machinery or equipment; 2) the purchaser must be a manufacturer, as described within SIC Codes 2000-3999; 3) the equipment or machinery must be used in a manufacturing facility in Utah; 4) the items must be for use in a new or expanding operation; and 5) the items must not be normal operating replacements.
In Administrative Rule R865-19-85s(A) (now R865-19S-85A.6., the Commission has defined normal operating replacements as follows:
6. "Normal operating replacements" means machinery or equipment which replaces existing machinery or equipment of a similar nature, even if the use results in increased plant production or capacity.
a) If new machinery or equipment is purchased or leased which has the same or similar purpose as machinery or equipment retired from service within twelve months before or after the purchase date, such machinery or equipment is considered as replacement and is not exempt.
b) If machinery or equipment is kept for backup or infrequent use; new, similar machinery or equipment purchased would be considered as replacement and is not exempt.
In Administrative Rule R865-19-85S.A.3. (now R865-19S-85.A.3.) the Commission has defined new or expanding operations as follows:
3. "New or expanding operations" means manufacturing, processing or assembling activities which:
a) are substantially different in nature, character or purpose from prior activities;
b) are begun in a new physical plant location in Utah; or
c) increase production or capacity. This definition is subject to limitations dealing with normal operating replacements.
A statute containing a tax exemption should be narrowly construed. Parson Asphalt Products, Inc. v. Utah State Tax Commission, 617 P.2d 397, 398 (Utah 1980); Nucor Corp. v. Utah State Tax Commission, 832 P.2d 1294, 1297 (Utah 1993).
The parties have agreed that the items purchased or leased for XXXXX were machinery or equipment; that the purchaser was a manufacturer as described in SIC Codes 2000-3999; and that the machinery and equipment is used in a manufacturing facility in Utah. XXXXX asserts that the machinery and equipment purchased for XXXXX qualifies as "new or expanding operations" which are not "normal operating replacements," as contemplated by Utah Code Ann. '59-12-104(15) (XXXXX). It was on that basis that XXXXX did not pay sales and use taxes on the machinery and equipment purchased and installed in XXXXX. Contrawise, the Auditing Division claims that the XXXXX facility does not constitute "new or expanding operations" and the machinery and equipment installed therein are "normal operating replacements" within the meaning of the statute.
XXXXX claims entitlement to the exemption from sales and use taxes under Section 59-12-104(15) under either of two alternative theories.
The first theory of XXXXX is that XXXXX is a new manufacturing facility integral to and built as a continuation of the XXXXX expansion, and as part of the expansion, the machinery and equipment purchased for use in XXXXX was a step towards achieving the production capacity intended at the outset of the XXXXX expansion. Without XXXXX, XXXXX contends, production capacity would not have been achieved. Therefore, XXXXX claims, XXXXX did not replace anything. XXXXX termed this analysis the "XXXXX" theory.
The second theory of XXXXX is that even assuming that XXXXX is not a continuation of the XXXXX expansion, XXXXX is a new or expanding operation as compared to XXXXX and that the machinery and equipment purchased for use in XXXXX are not normal operating replacements of the equipment destroyed in the XXXXX explosion. XXXXX termed this analysis the "XXXXX" theory.
Both parties spent substantial time debating the interpretation to be given to the words "normal operating replacements" and "replacement machinery and equipment" within the meaning of Section 59-12-104(15).
The Auditing Division argues that the phrase "normal operating replacements" means "replacements." According to the Auditing Division all "replacements" are "normal operating replacements." The Auditing Division bases its argument on language in Section 59-12-104(15), which states "excluding normal
operating replacements, which includes replacement machinery and equipment even though they may increase plant production or capacity." The Auditing Division maintains that the words "which includes replacement machinery and equipment supersede the words "normal operating replacements" in the statute. Therefore, it concludes that "replacements" are a subset of "normal operating replacements." The Auditing Division would conclude that the machinery and equipment for XXXXX would constitute "replacements" and would therefore be "normal operating replacement" for the machinery and equipment from XXXXX which were XXXXX.
XXXXX argues that "normal operating replacements" are "replacements" which come about as a result of the normal wear and tear (depreciation) of machinery and equipment engaged in the uses for which it was intended. It is also the position of XXXXX that "Normal Operating replacements" do not better, improve or substantially extend the useful life of the original machinery and equipment. Instead they are substituted for the original machinery and equipment when their useful lives have expired. XXXXX claims this interpretation comes from the plain and common meaning of the words "normal operating replacements" as used in the statute.
Logic convinces us that "normal operating replacements" are a subset of the universe of "replacements," not vice versa. Therefore, the words "which includes replacement machinery and equipment", as used in the statute, must be limited by and read in the context of the phrase "normal operating replacements," which grammatically is the phrase it modifies. Otherwise, the statutory words are circular and lead to the illogical conclusion that the words "replacements" and "normal operating replacements" are synonymous. "Replacement machinery and equipment" is greater than the subcategory "normal operating replacements".
Based upon our interpretation of Section 59-12-104(15), we agree with XXXXX "XXXXX" theory, and hold that its purchases of machinery and equipment for XXXXX are exempt from sales and use taxes.
Under the "XXXXX" theory, XXXXX purchases of machinery and equipment for XXXXX were part of the XXXXX new and expanding manufacturing operations. The XXXXX expansion, which began in approximately XXXXX and ended in XXXXX, involved a new and substantially different line of business for XXXXX, i.e. the XXXXX industry. The expansion was at a different plant location in Utah, and contemplated the purchase of new machinery and equipment. XXXXX constructed a number of buildings and facilities at XXXXX including XXXXX, XXXXX, XXXXX and XXXXX as a part of its expansion effort. XXXXX, of which XXXXX was a part, was not a normal operating replacement. Instead it involved XXXXX in a "new or expanding operation" in Utah. All machinery and equipment that had been purchased for XXXXX, including XXXXX, and XXXXX was exempt from sales and use taxes.
Since we have determined that XXXXX was a part of the expansion of the XXXXX manufacturing facility, and that the machinery and equipment purchased for that building were therefore exempt from sales and use taxes, it is not necessary to determine whether or not the "XXXXX" theory of XXXXX is correct.
XXXXX has also attacked Administrative Rule R865-19-85S and urges us to overrule the rule. However, since we have decided that XXXXX is part of a "new or expanding operation" under the "macro" theory, as explained above, we need not reach or decide the points made by XXXXX regarding the validity of the rule. In addition, such an action would normally only be taken through a rule-making proceeding.
We also note that there have been at least two prior formal hearings relating to the exemption provided by Utah Code
Ann. '59-12-104(15). The first matter is styled Newspaper Agency
Corp. v. Auditing Division and the second matter is styled Eaton-Kenway v. Auditing Division. Neither of these prior cases involved the construction of new manufacturing facilities in Utah, as is the case with XXXXX construction of XXXXX. Rather they involved the modernization of existing operations. Moreover, unlike the taxpayer purchases in Newspaper Agency Corp. and Eaton-Kenway, XXXXX purchases of machinery and equipment for XXXXX did not replace existing machinery and equipment. Therefore the decision here is distinguishable from and consistent with our prior rulings.
DECISION AND ORDER
Based upon the foregoing, the Tax Commission finds that Petitioner qualified for the manufacturer's exemption from sales and use tax as provided by Utah Code Ann. '59-12-104(15) for the machinery and equipment placed in XXXXX. The Statutory Notice issued by the Auditing Division is reversed to the extent of the tax on the machinery and equipment purchased for XXXXX, and the exemption claimed by Petitioner is affirmed. In view of our decision on the tax, we need not decide the issue relating to any penalty on the tax. It is so ordered.
DATED this 13 day of January, 1995.
BY ORDER OF THE UTAH STATE TAX COMMISSION.
W. Val Oveson Roger O. Tew
Joe B. Pacheco Alice Shearer
NOTICE: You have twenty (20) days after the date of the final order to file a request for reconsideration or thirty (30) days after the date of final order to file in Supreme Court a petition for judicial review. Utah Code Ann. ''63-46b-13(1), 63-46b-14(3)(a).