95-0130

Sales & Use

Signed 12/22/95

BEFORE THE UTAH STATE TAX COMMISSION

____________________________________

XXXXX, )

Petitioner, : ORDER

v. : Appeal No. 95-0130

AUDITING DIVISION OF THE : Account No. XXXXX

UTAH STATE TAX COMMISSION, :

Respondent. : Tax Type: Sales & Use

_____________________________________

STATEMENT OF CASE

This matter came before the Utah State Tax Commission for an Initial Hearing pursuant to the provisions of Utah Code Ann. §59-1-502.5, on XXXXX. Jane Phan, Administrative Law Judge, heard the matter for and on behalf of the Commission. Present and representing Petitioner were XXXXX, Esq., XXXXX and XXXXX. Present and representing Respondent were XXXXX, Assistant Attorney General, XXXXX and XXXXX of the Auditing Division.

Petitioner is appealing the assessment of additional tax and interest resulting from a sales and use tax audit for the period of XXXXX through XXXXX. No penalty was assessed. The only remaining tax and interest assessment in dispute and subject to this appeal arises from Petitioner's purchases of a unique, confidential item used in the manufacturing of the drill bits and blades produced by Petitioner.

APPLICABLE LAW

Property purchased for resale in this State, in the regular course of business, either in its original form or as an ingredient or component part of a manufactured or compounded product is exempt from sales and use tax. (Utah Code Ann. § 59-12-104(27).)

All sales of tangible personal property or services which enter into and become an integral or component part of tangible personal property or products which is further manufactured or compounded for personal sale are wholesale sales which are not subject to Utah sales or use tax. (Utah Administrative Rule 865-19-29S(A)(1).)

ANALYSIS

The issue in this appeal is whether Petitioner's purchases of the item at issue qualify as purchases for resale that are exempt from sales and use tax Pursuant to Utah Code Ann. § 59-12-104(27). Petitioner maintains that the item provides an essential ingredient to Petitioner's products and is exempt from tax. Respondent's position is that the item is subject to the tax and the assessment of tax and interest should be affirmed.

Petitioner has developed a unique process for manufacturing diamond drill bits and blades in various sized segments which significantly enhances the stability and performance of the segments during use. Petitioner's representatives state that this process is superior to other processes and it allows the Petitioner to remain competitive. For this reason Petitioner asked that all information provided to the Commission during the hearing concerning the unique process remain confidential. To comply with Petitioner's request, in this Order discussion of Petitioner's unique process and the item at issue has been eliminated, although the process and item at issue were considered and made an integral part of this decision.

At the hearing and in memoranda Petitioner's representatives offered the following arguments in support of their position that because a primary purpose of using the item at issue is to provide an essential ingredient it was purchased by Petitioner for resale and is tax exempt under Utah Code Ann. § 59-12-104(27). Petitioner asserts that, although only a minute amount of material is transferred from the item at issue to the segments produced, it is still an essential ingredient. Pointing out that the ingredients which were found not to be tax exempt in Nucor Corp. v. Utah State Tax Comm'n, 832 P.2d 1294 (Utah 1992), did not affect the quality of the steel Nucor produced and were an incidental part of the end product. The item at issue affects the quality, superiority and function of Petitioner's product.

Petitioner disagrees with Respondent's assertion, which was that since Petitioner is the end user, and it would be wholly impractical for the Auditing Division to impose tax for the purchase of the item at issue on the purchasers of the segments, the assessment should be made against Petitioner. Petitioner represents that this is double taxation.

Respondent offers the following arguments in support of its position that the item at issue is not exempt from sales and use tax. Respondent asserts that the primary purpose for the purchase of the item is its use as a tool for producing the segments, not for resale. Respondent asserts that the minute portion of the item at issue which becomes part of the segments is only incidental and the Utah Supreme Court in Nucor held that incidental ingredients which enter a product during the manufacturing process are not exempt from sales and use taxes. Nucor, at 1296 citing Union Portland Cement Co. v. State Tax Commission, 170 P.2d 164 (Utah 1946).

Respondent states that the item at issue is designed strictly as a tool and not as an ingredient. Pointing out that the item at issue is not consumed in the process and is reused 2 to 10 times until it loses it effectiveness as a tool, after which it is discarded. Respondent pointed to the Nucor decision in which the court held certain items were not essential ingredients and therefore not component parts even though these items were actually entirely melted into and became part of the product made for resale.

Lastly, Respondent points out that the Utah Supreme Court has held that purchasers of materials must pay sales and use taxes when they are the last party upon which Utah could impose the taxes.[i]¹

In Nucor the Utah Supreme Court upheld the Tax Commission's use of the primary purpose test for determining the applicability of the exemption set out in Utah Code Ann. § 59-12-104(27). The exemption set out in Utah Code Ann. §59-12-104(27) is for property purchased for resale in its original form or as an ingredient or component part. The Court stated the Tax Commission's narrow construction of the statute, by requiring that items be primarily purchased for resale, follows the general rule that tax statutes are to be strictly construed against one seeking the exemption. Nucor at 1297. In applying the test affirmed by the Court in Nucor the Commission needs to consider whether the primary purpose for the purchases of the item at issue was for resale. Although Petitioner has shown that the minute amount of material that is transferred from the item at issue to the segments significantly contributes to the quality of the product, Petitioner has not shown that the item at issue was purchased for resale. The fact that only a minute amount of material is transferred from the item at issue to the segments produced and that the item is then discarded when it can no longer function as a tool indicates that the item at issue's primary purpose is not resale for the application of Utah Code Ann. §59-12-104(27).

DECISION AND ORDER

Based upon the information presented at the hearing, and the records of the Tax Commission, the Commission finds the item at issue is not exempt from sales or use tax. The assessment of tax and interest made against Petitioner relating to the purchases of this item for the audit period of XXXXX through XXXXX is affirmed.

This decision does not limit a party's right to a Formal Hearing. However, this Decision and Order will become the Final Decision and Order of the Commission unless any party to this case files a written request within thirty (30) days of the date of this decision to proceed to a Formal Hearing. Such a request shall be mailed to the address listed below and must include the Petitioner's name, address, and appeal number:

Utah State Tax Commission

Appeals Division

210 North 1950 West

Salt Lake City, Utah 84134

Failure to request a Formal Hearing will preclude any further administrative action or appeal rights in this matter.

DATED this 22nd day of December, 1995.

BY ORDER OF THE UTAH STATE TAX COMMISSION.

W. Val Oveson Roger O. Tew

Chairman Commissioner

Joe B. Pacheco Alice Shearer

Commissioner Commissioner