97-1342

SALES TAX

Signed 2/26/99

 

 

BEFORE THE UTAH STATE TAX COMMISSION

____________________________________

 

PETITIONER., ) FINDINGS OF FACT,

) CONCLUSIONS OF LAW,

Petitioner, ) AND FINAL DECISION

)

v. ) Appeal No. 97-1342

) Account No. #####

AUDITING DIVISION OF )

THE UTAH STATE TAX ) Tax Type: Sales Tax

COMMISSION, )

) Presiding: Hendrickson

Respondent. )

_____________________________________

 

Presiding:

Pam Hendrickson, Commissioner

Conducting:

G. Blaine Davis, Administrative Law Judge

 

Appearances:

For Petitioner:

For Respondent: Brian L. Tarbet, Assistant Attorney General

Brad Simpson, Assistant Director, Auditing Division

Scott Smith, Auditing Division

Larry Wursten, Auditing Division

Robbie Levine, Attorney General=s Office

 

 

STATEMENT OF THE CASE

This matter came before the Utah State Tax Commission for a Formal Hearing on May 19, 1998. Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:

FINDINGS OF FACT

1. PETITIONER Petitioner is a Utah corporation doing business at several locations in central Utah. It contains seventeen different divisions, each of which constitutes a separate cost center. Those separate cost centers are not separate legal entities, but they do maintain separate profit and loss statements. PETITIONER is the sole legal entity.

2. PETITIONER maintains one payroll which reflects all the employees in all locations, and it issues W-2's for all of its employees wherever located and files one W-4 with the Internal Revenue Service.

3. Petitioner maintains all accounting and legal functions at its CITY office, and has established a 401-K plan which it maintains on behalf of all employees, wherever located.

4. Petitioner has one contractor=s license which is issued in the name of PETITIONER.

5. For billing purposes, Petitioner bills in the name of PETITIONER.

6. Issuance of bids and execution of contracts are done in the name of PETITIONER.

7. All performance and payment bonds are executed in the name of PETITIONER.

8. All motor vehicles owned by Petitioner which are required to be registered with the state of Utah are registered in the name of PETITIONER.

9. There is no documentation to evidence inter-company transfers of products between accounting cost centers.

10. Petitioner files all workmen=s compensation and employment taxes in the name of PETITIONER.

11. Two of the divisions of Petitioner operate out of CITY, Utah. They are the CITY XXXXX and the CITY XXXXX Plant.

12. The CITY Plant operates in a physical location separate from any other division of Petitioner.

13. Petitioner purchased equipment during the audit period, January 6, 1994, through June 6, 1996, that was used in two of its cost centers: the CITY XXXXX and the CITY XXXXX.

14. During the audit period, Petitioner did not pay sales tax on the purchases at the CITY Plant.

15. On or about August 28, 1997, Petitioner received a Notice of Deficiency (Athe Notice@) from the Auditing Division of the Utah State Tax Commission (Athe Division@). The Notice contained four schedules which set forth, in detail, the tax deficiency, totaling $$$$$. The Notice also contained an assessment of a 10 percent negligence penalty of $$$$$. The total deficiency assessed by the Division was $$$$$. This included interest computed to July 1, 1997, in the amount of $$$$$.

16. Petitioner does not dispute the assessments set forth in Schedules 1, 2, and 3 of the Notice. The total additional tax assessed on Schedules 1, 2, and 3 is $$$$$.

17. Schedule 4 contains a clerical error wherein it double counts the purchase of a XXXXX system from COMPANY ON DATE, for $$$$$. The parties have agreed to delete the first reference reducing the taxable purchases on Schedule 4 by $$$$$.

18. No tax was paid on the following items, listed on Schedule 4, that were purchased by Petitioner during the audit period:

a. a used portable XXXXX, purchased from COMPANY on January 6, 1994, for $$$$$ (Invoice No. #####);

b. a XXXXX, purchased from COMPANY on DATE, for $$$$$ (Invoice No. #####);

c. a XXXXX, purchased from COMPANY on March 1, 1994, for $$$$$ (Invoice No. #####);

d. a used XXXXX, purchased from COMPANY on July 18, 1994, for $$$$$ (Invoice No. #####);

e. a portable XXXXX, purchased from COMPANY . on October 21, 1994, for $$$$$ (Invoice No. #####);

f. a portable XXXXX purchased from COMPANY on April 1, 1996, for $$$$$ (Invoice No. #####);

g. a XXXXX, purchased from COMPANY on April 1, 1996, for $$$$$ (Invoice No. #####); and

h. an XXXXX purchased from COMPANY on January 11, 1995, for $$$$$ (Invoice No. #####).

19. The purchases at issue, as identified above, totaled $$$$$.

20. The XXXXX, portable XXXXX, XXXXX, and XXXXX listed on Schedule 4 of the Notice are used by Petitioner to make aggregate.

21. The remaining items listed in Schedule 4 (XXXXX) are used to mix the aggregate with petroleum products to make asphalt.

22. Facilities which manufacture asphalt for paving are listed under SIC Code 2951 in the 1987 Standard Industrial Classification Manual [SIC] of the Federal Executive Classification Manual of the Federal Executive Office of the President, Office of Management and Budget. General contractors are classified under SIC Code 1611, which includes AGeneral and special trade contractors primarily engaged in the construction of roads, streets, alleys, public sidewalks, guardrails, parkways, and airports . . . @

23. Petitioner is listed in the 1996 American Manufacturer=s Directory, Volume 2 under classification 2951 for Asphalt.

24. Since its creation, the CITY Plant has made asphalt and sells the asphalt either on site or by contract. The contractual sales include agreements with other divisions of PETITIONER, or with other independent subcontractors to perform services such as transporting the asphalt or laying the asphalt. The purchaser under the contract retains the right to inspect and reject each load of asphalt.

25. 75 percent of the aggregate produced at the CITY Plant by the equipment in question is used by Petitioner in its own operations, approximately one-third of which is used by Petitioner=s concrete plants to produce concrete. The remaining 25 percent of the aggregate is sold to private contractors, governmental entities, and individuals.

26. The equipment in question produces all of the aggregate used in the CITY operations.

27. Approximately 20 to 25 percent of the asphalt produced by the CITY Plant is sold directly to third party purchasers such as private contractors, governmental entities, and individuals.

28. The remaining 75 to 80 percent of the asphalt produced by the CITY Plant is installed as real property improvements by Petitioner.

29. The remaining deficiency is based entirely on the dispute regarding whether or not Petitioner was entitled to the manufacturer=s exemption on the machinery and equipment purchased during the Audit Period for the CITY Plant. Those purchases of machinery and equipment totaled $$$$$.

APPLICABLE LAW

Prior to July 1, 1995, Utah Code Ann., '59-12-104(15) was the relevant statute and provided:

The following sales and uses are exempt from the taxes imposed by this chapter:

 

* * *

 

(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...) in any manufacturing facility in Utah. 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. For purposes of this subsection, the commission shall by rule define Anew or expanding operations@ and Aestablishment.@

 

The former Rule R865-19S-85(1B)(14)(E) provided:

 

Machinery or equipment purchased or leased for use in activities that may qualify it for exemption, as well as in other activities, will not lose the exemption if the use in nonqualifying activities is determined to be de minimis. Nonqualifying activities are activities such as maintenance or production of tangible personal property that is not sold in arms-length transactions.

 

Utah Admin.. Rules R865-19-85S(1B)(14)(E) (1991) (recodified as amended Utah Admin. Code R865-19S-85(E) (1994) (emphasis added).

 

After July 1, 1995, Utah Code Ann. 59-12-104(15) is still the relevant statute, but was amended to provide:

The following sales and uses are exempt from the taxes imposed by this chapter:

* * *

 

(15) (a) the following purchases or leases by a manufacturer on or after July 1, 1995:

(i) machinery and equipment:

(A) used in the manufacturing process;

(B) having an economic life of three or more years; and

used:

(I) to manufacture an item sold as tangible personal property; and


(II) in new or expanding operations in a manufacturing facility in the state; and

 

(ii) subject to the provisions of Subsection (15)(b), normal operating replacements that:

(A) have an economic life of three or more years;

(B) are used in the manufacturing process in a manufacturing facility in the state;

(C) are used to replace or adapt an existing machine to extend the normal estimated useful life of the machine; and

(D) do not include repairs and maintenance;

 

Utah Administrative Code, Rule R865-19S-85, contains the following definitions:

 

3. a) ANew or expanding operations@ means manufacturing, processing, or assembling activities that:

(1) are substantially different in nature, character, or purpose from prior activities;

(2) are begun in a new physical plant location in Utah; or

(3) increase production or capacity.

b) The definition of new or expanding operations is subject to limitations dealing with normal operating replacements.

4. AManufacturer@ means a person who functions within the activities in SIC codes 2000 - 3999 of the 1987 Standard Industrial Classification Manual, of the federal Executive Office of the President, Office of Management and Budget.

5. AEstablishment@ means an economic unit of operations that is generally at a single physical location in Utah where qualifying manufacturing activities are performed. Where distinct and separate economic activities are performed at a single physical location, each activity should be treated as a separate establishment.

 

The SIC Manual, at 13, contains the following statement:

 

(1)Establishments primarily engaged in producing goods or providing services for other establishments of the same enterprise when such goods or covered by industries in Agriculture (Major Groups 01-07 of Division A); Mining (Division B); Construction (Division C); and Manufacturing (Division D) are classified as operating establishments in such Divisions on the basis of their primary activities.

 

The primary activity should be defined by the value of its production.

 

The SIC Manual, at 53, contains the following statement:

 

If a company has more than one relatively fixed place of business from which it undertakes or manages construction activities and for which separate data on the number of employees, payroll, receipts, and other establishment-type records are maintained, each such place of business is considered a separate construction establishment.

 

ANALYSIS

 

Pre-July 1, 1995 Sales. Because this case involves sales that occurred both before and after the effective date of certain changes in the governing statute, we must address both versions of the statute. Section 59-12-104(15), as in effect prior to July 1, 1995, provided an exemption from sales and use tax for Asales . . . of machinery and equipment purchased . . . by a manufacturer for use in new or expanding operations . . . in any manufacturing facility in Utah.@ AManufacturing facility@ was defined as Aan establishment described in SIC Codes 2000 to 3999 of the 1987 Industrial Classification Manual, of the federal Executive Office of the President, Office of Management and Budget (>the SIC Manual=).@ Ibid. The Commission was granted the authority to define both Anew or expanding operations@ and Aestablishment.@ AEstablishment@ was defined in Rule R865-19-85S (ARule 85") as Aan economic unit of operations that is generally at a single physical location in Utah where qualifying manufacturing activities are performed.@


Pursuant to the statutory and regulatory requirements, these sales are exempt if they are:

1. Sales of machinery or equipment,

2. To a Amanufacturer@,

3. For use in new or expanding operations,

4. In a manufacturing facility,

5. In Utah.

 

Machinery or equipment. There is no dispute that the sales in question are sales of machinery and equipment.

AManufacturer.@ It next must be determined whether PETITIONER is a Amanufacturer@ within the meaning of the statute. In Sanders Brine Shrimp v. Auditing Division, 846 P.2d 1304 (Utah 1993), the Supreme Court invalidated the portion of Rule 85 defining Amanufacturer@ that, inter alia, would have required a taxpayer to Ain the normal course of business produce[] products which are sold as tangible personal property.@ The Court effectively ruled that any person who operates a qualifying manufacturing facility within the meaning of Section 59-12-104(15) is a Amanufacturer@ for purposes of this exemption. Accordingly, whether PETITIONER will qualify as a Amanufacturer@ depends on the analysis of the facility set forth below.

New or expanding operations. There is no dispute that PETITIONER is expanding its operations. Nor is there any dispute that the operations are in Utah. Accordingly, the purchases in question will be exempt if the CITY Plant is a Amanufacturing facility.@

Manufacturing facility. As noted above, the term Amanufacturing facility@ is defined by Section 59-12-104(15) as Aan establishment described in SIC Codes 2000 to 3999 of the 1987 Industrial Classification Manual. . . .@ Thus, the first question presented is whether the CITY Plant is an Aestablishment.@ AEstablishment@ is defined in Rule 85 as Aan economic unit of operations that is generally at a single physical location in Utah where qualifying manufacturing activities are performed.@

The phrase Aeconomic unit@ is undefined, either in statute, rule or the SIC manual. Of course, an undefined phrase should be given its generally accepted meaning. We are aware of no generally accepted meaning for the phrase Aeconomic unit.@ AEconomic@ may be defined in this context as Aof, relating to, or based on the production, distribution, and consumption of goods and services.@ Webster=s Ninth New Collegiate Dictionary. But what is the Aunit.@ Webster=s is less helpful here, defining Aunit@ alternatively as A1. . . . a single quantity regarded as a whole in calculation, . . . 3. . . .a single thing, person, or group that is a constituent of the whole, . . . or a piece or complex of apparatus serving to perform one particular function.@

We believe it is unnecessary to clearly define the outer limits of Aeconomic unit@ in this case. Our task is simpler. The Auditing Division offers various alternatives. First, the Auditing Division argues that we must look at the overall nature of PETITIONER itself, and determine what its primary activity is. The implication of this argument is that an Aeconomic unit@ should be a Aunit@ that is judicially cognizable. In other words, the entity must be separately incorporated. We reject this contention.

Rule 85, as in effect during the years in issue, provides that an Aestablishment@ is generally at a single physical location. Enterprises, like PETITIONER, are frequently located at several locations. Second, the Rule contemplates that more than one Aestablishment@ may exist at a single physical location, clearly implying that one business entity at one location may have more than one Aestablishment.@ These provisions of our own Rule indicate that Aestablishment@ is not necessarily equivalent to a Abusiness,@ Aenterprise,@ or Acompany.@ It may be some smaller unit.

This interpretation is confirmed by the SIC Manual itself[1] which provides that A[a]n establishment is not necessarily identical with the enterprise (company) which may consist of one or more establishments.@ Standard Industrial Classification Manual, p. 12. This conclusion is also consistent with the definition of Aestablishment@ in the current version of Rule 85, adopted subsequent to the purchases in issue. That definition provides, in part: AIf a business operates in more than one location (e.g., branch or satellite offices), each physical location is considered separately from any other locations operated by the same business.@ Thus, the fact that PETITIONER, as a company, is engaged primarily in the construction business, is not dispositive. The CITY Plant may still be a manufacturing establishment.


If we reject the contention that an Aeconomic unit@ must be a separate legal entity, the Auditing Division argues that the unit must at least be engaged in the business of providing goods and services to independent parties, not just other branches of the same enterprise. These sales, in the Division=s view, must equal all but a de minimus amount of the production. The third-party sales in this case (roughly 20 - 25% of production) are insufficient in the Division=s view. The Division cites Rule 85.B.4. in support of this contention:

Machinery or equipment purchased or leased for use in activities which may qualify it for exemption, as well as in other activities, will not lose the exemption if the use in nonqualifying activities is determined to be de minimus. Nonqualifying activities are activities such as maintenance or production of tangible personal property that is not sold in arms-length transactions.

 

We also reject this position.

As noted above, the Supreme Court has already invalidated the portion of the rule that would have required PETITIONER to Ain the normal course of business produce[] products which are sold as tangible personal property.@ If that portion of the Rule is invalid, we believe the provision cited by the Division is invalid as well, at least as it relates to third-party sales.[2]

We believe it is also inappropriate to require a preponderance of the CITY Plant=s asphalt and aggregate to be sold as tangible personal property in order to qualify the plant as an Aeconomic unit.@ The SIC Manual (p.12) defines Aauxiliary establishments@ as Aestablishments primarily engaged in performing management or support services for other establishments of the same enterprise. . . . . Auxiliary establishments are distinguished from operating establishments that primarily produce goods . . . for other enterprises.@ A unit that performs auxiliary functions and is located physically separate from the establishment or establishments served is treated as a separate establishment, notwithstanding the fact that it may provide no services or goods to independent third parties.

Moreover, some establishments that meet the general definition of auxiliaries are nevertheless treated as Aoperating@ establishments under the SIC Manual. The first example in the Manual (p. 13) is as follows:

AEstablishments primarily engaged in producing goods or providing services for other establishments of the same enterprise when such goods or services are covered by industries in Agriculture . . ., Mining . . . , Construction . . . , and Manufacturing . . . are classified as operating establishments in such Divisions on the basis of their primary activity.@

 

The CITY Plant is primarily engaged in producing aggregate and asphalt for the construction establishments of PETITIONER. Those goods, aggregate and asphalt, are covered by the Manufacturing industry. Therefore, the CITY Plant is classified as an operating establishment in the Manufacturing Division based on the CITY Plant=s own primary activity. Thus, the CITY Plant qualifies as an economic unit, notwithstanding the fact that the majority of its production is used by other Divisions of the Company and is not sold to third parties.

Because PETITIONER purchased machinery and equipment, for use in expanding operations at the CITY Plant, a manufacturing facility, the pre-July 1, 1995 purchases are exempt from sales tax.

We note that in Salt Lake Brewing Co. v. Auditing Division, 945 P. 2d 691 (1997), the Supreme Court upheld our determination that a restaurant and a brewery were not separate Aeconomic units.@ Those operations were conducted at the same physical location, and are thus clearly distinguishable from the circumstances here.[3] Moreover, the Court specifically noted that operations Asimilar to SLBC=s@ might qualify for the exemption under different facts.

Post June 30, 1995 Statute. Utah Code Ann. Section 59-12-15, as in effect after June 30, 1995, exempts purchases of

A(I) machinery and equipment:

(A) used in the manufacturing process;

(B) having an economic life of three or more years; and

(C) used

(I) to manufacture an item sold as tangible personal property; and

(II) in new or expanding operations in a manufacturing facility. . . .@

The statute also exempts, at a reduced rate, certain replacements.

Thus, pursuant to the revised statutory and regulatory requirements, the post June 30, 1995 sales are exempt if they are:

1. Sales of machinery or equipment,

2. Used in the manufacturing process,

3. Having an economic life of three or more years,

4. Used to manufacture an item sold as tangible personal property,

5. In new or expanding operations,

6. In a manufacturing facility.

7. In Utah.

Machinery or equipment. As noted under the prior statute, there is no dispute that the sales in question are sales of machinery and equipment.

Manufacturing process. We believe that the evidence clearly discloses that the machinery and equipment in question is used in the manufacturing process. The parties agree that all of the machinery and equipment is either used to make aggregate or asphalt, both manufacturing processes. There is no allegation that the equipment is used for research and development, storage, shipping or any other process or purpose.

Useful life. There is no dispute that the property in question had a useful life of three or more years at the time of purchase.

Used to manufacture an item sold as tangible personal property. This requirement is more troublesome. Based on the facts, approximately 20-25% of the items manufactured are Asold as tangible personal property.@ The majority of the items, however, are not sold as Atangible personal property.@ They are incorporated by PETITIONER into real property and sold as real property. Sanders Brine Shrimp, of course, does not invalidate this requirement for post June 30, 1995 sales, because the requirement is now imposed by statute, not rule.

PETITIONER argues that the transfers of asphalt and aggregate to other divisions of the company should be treated as sales. We reject this contention. ASale@ is a term of art in the Sales and Use Tax Act that clearly contemplates more than a transfer without consideration from one division to another division of the same company. See Harper Investments, Inc. v. Auditing Division, 868 P. 2d 813 (1994). There is no indication in the record that PETITIONER paid sales tax on these inter-company transfers or otherwise treated them as sales in any way.

We recognize that sales tax exemptions are to be construed narrowly. We also recognize, however, that we cannot by rule or interpretation place requirements on an exemption that are narrower than those provided by statute. By its plain terms, the statute only requires that the equipment be used to manufacture items sold as tangible personal property--not that it be used to manufacture items all of which are sold as tangible personal property. We need not address the situation where only a de minimus amount of the material is sold to third parties. Nor is there any allegation that the transfers in issue here are shams or otherwise lack bona fide content. We hold that the use of the equipment to manufacture items, 20 - 25% of which items are sold in arm=s length transactions to third parties is sufficient to meet this portion of the statutory test.

New or expanding operations. As noted above, there is no dispute that PETITIONER is expanding its operations. Nor is there any dispute that the operations are in Utah. Accordingly, the purchases in question will be exempt if the CITY plant is a Amanufacturing facility.@

Manufacturing facility. For the reasons outlined above for pre-July 1, 1995 years, we hold that the CITY Plant is a manufacturing facility. We see no change in the statute that would require a different result for post June 30, 1995 periods.

Accordingly, we find that the post June 30, 1995 purchases also qualify for the manufacturing exemption.

DECISION AND ORDER

Based upon the foregoing, the Tax Commission finds the items of machinery and equipment purchased by Petitioner for the CITY location to make aggregate and asphalt were used in manufacturing activities. Those items therefore qualify for the exemption from sales tax based upon Utah Code Annotated '59-12-104(15). The Petition for Redetermination is granted and the audit assessment is set aside as far as it relates to the manufacturing equipment. It is so ordered.

DATED this 26TH day of February, 1998.

 

Richard B. McKeown R. Bruce Johnson

Chairman Commissioner

 

Pam Hendrickson

Commissioner

^^

 

DISSENTING OPINION

I have reviewed this case and I dissent from this decision.

This case is one that is difficult because portions of the operations of Petitioner might legitimately be classified as asphalt manufacturing, (SIC Code 2951), and other portions of the business clearly should be classified as general contracting (SIC Code 1611). Based upon the stipulation of the parties, between twenty (20) and twenty-five percent (25%) of the use of the equipment in dispute was for manufacturing purposes, and between seventy-five (75%) and eighty percent (80%) of the use of such equipment was used for construction purposes and used to make real property improvements.

The position of Petitioner is that all of the equipment used to make aggregate and produce asphalt was purchased by a manufacturer for use in the manufacturing process in a new or expanding manufacturing facility in the state of Utah. Petitioner takes that position because the aggregate and asphalt equipment are in a separate location in CITY, Utah, and also because the company keeps its accounting records for each of its seventeen (17) divisions as separate cost centers. Petitioner further argues the equipment is used exclusively in the manufacturing process to manufacture products, and therefore, according to Petitioner, it is not important whether those manufactured products are sold to others or used by Petitioner in its road construction or asphalt paving business.

The relevant statutes and rules do recognize that equipment may still qualify for the manufacturers exemption even if it is not used exclusively for manufacturing purposes. The former rule R865-19-85S provided that equipment would Anot lose the exemption if the use in non-qualifying activities is determined to be de minimis.@ Multiple uses would not seem to violate the provisions of the present or former statute (U.C.A. '59-12-104(15)) or the current rule (R 865-19S-85). The provisions, from the SIC Manual, also anticipate multiple uses and indicate that the classification should be made Aon the basis of their primary activities.@

Based upon the stipulation of facts, and the testimony and evidence presented at the hearing, the primary activity of Petitioner is as a real property contractor, and the equipment at issue is used primarily for making improvements to real property, and not primarily for manufacturing. This is consistent with prior Tax Commission and Court decisions.

In Salt Lake Brewing Company v. Auditing Division of the Utah State Tax Commission, 945 p. 2d 691 (Utah 1997), the Salt Lake Brewing Company had divided its business into two cost centers, a brewery and a restaurant, and was arguing that the brewery was a manufacturer entitled to the same manufacturers exemption that is at issue in this proceeding. The Utah Supreme Court affirmed the decision of the Tax Commission and denied the exemption because the brewery and the restaurant Afunctioned together for the primary objective of selling beer at retail...@ Id. At 694. In the case at hand, the production of aggregate and asphalt, and the other construction activities all function together for the primary objective of building roads, laying asphalt, and making other real property improvements. There is no separate substantial manufacturing activity.

This is also consistent with the decision of the Tax Commission in appeal no. 89-0031, issued by the Commission on November 21, 1991. In that case, a corporation fabricated and later installed steel as real property improvements, and was assessed a sales tax deficiency for failure to pay sales tax on the machinery it purchased to fabricate the steel. The Commission stated that, A[generally], where separate economic activities are being conducted, the activity which constitutes the primary activity is determined by measuring the income produced by each activity.@ The Petitioner argued that the primary activity was fabrication; however, the vast majority of the jobs performed were Afurnish and install contracts.@ The Commission said it would be misleading to try to separate the production and installation income since Athe income received under those contracts [for both production and installation] [was] not independent of one another...@ Therefore, the Commission found that the corporation was not primarily engaged in manufacturing, but was primarily engaged in steel erection, SIC Code 1791.

Similarly, Petitioner in this proceeding is not conducting separate economic activities; i.e., production and installation of asphalt and aggregate as real property improvements. Most of the jobs at the CITY Plant, between 75 and 80 percent, were performed by Petitioner as installation contracts, not as wholesale to third-parties. The income from these jobs is neither production nor installation income, independently. Under the reasoning of the Final Decision of the Tax Commission in appeal no. 89-0031, issued November 21, 1991, supra, the dependence of income on both production and installation disqualifies Petitioner from the manufacturer=s exemption because it is not primarily engaged in manufacturing.

The case at hand is also nearly identical to another decision of the Tax Commission in appeal no. 87-1056, issued March 15, 1991. In that case, the Petitioner was in the business of constructing highways (SIC Code 1611) and purchased an asphalt plant (normally SIC Code 2951). For the first two years the Petitioner used 86% of the asphalt in its own construction projects, and 14% of the asphalt was sold to others. The Tax Commission held that the Aasphalt plant is used predominantly in construction activities which do not qualify for the exemption.@

Petitioner is primarily engaged as a general contractor. AGeneral and special trade contractors primarily engaged in the construction of roads, streets, alleys, public sidewalks, guardrails, parkways, and airports...@ are classified under SIC Code 1611.

During the audit period at issue in this proceeding, both the statute and the rule have been changed.

Under the former rule R865-19S-85, it was clear that the production of tangible personal property that was not sold in an arms-length transaction was a "non-qualifying activity" for purposes of qualifying for the manufacturing exemption. Only a minimum amount of such a nonqualifying activity could occur and have the property still qualify for the manufacturers exemption. Although the statute and rule did not define "de minimus" nonqualifying activities, 75% of the production that is not sold in an arms-length transaction is far greater than "de minimus." Therefore, it is clear that under the former rule, where 75% to 80% of the tangible personal property (aggregate and asphalt) was not sold in an arms-length transaction, the equipment purchased to produce that property did not qualify for the manufacturers exemption.


Under the current statute, UCA 59-12-104(15) is very specific that the machinery only qualifies for the exemption if it is used "to manufacture an item sold as tangible personal property . . . ." That is not the primary use of Petitioner's equipment and the purchase of that equipment therefore does not qualify for the exemption.

The majority opinion says, AWe believe it is also inappropriate to require a preponderance of the CITY Plant=s asphalt and aggregate to be sold as tangible personal property in order to qualify the plant as an >economic unit.=@ I strongly disagree. According to the SIC manual, establishments are classified "on the basis of their primary activities." Since the majority of the product of the CITY plant is not "sold as tangible personal property", the primary activity of the establishment is not manufacturing, but is construction. This is true regardless of whether the "establishment" is viewed as the Elsinore plant or the whole company of PETITIONER. In addition, according to the SIC manual:

"Establishments primarily engaged in producing goods or providing services for other establishments of the same enterprise when such goods or services are covered by industries in . . . Construction . . .are classified as operating establishments in such Divisions on the basis of their primary activities. (Emphasis added)

Therefore, even if the CITY plant is its own establishment, it is "primarily engaged in producing goods . . . for other establishments of the same enterprise "and should be classified as an operating establishment on the basis of the primary activities of the Division. That classification is construction and not manufacturing. The CITY plant is part of a construction establishment and is not its own manufacturing establishment.


Petitioner has argued, and the Commission has agreed, that the CITY Plant was a separate establishment. However, in my opinion, the CITY plant was not a separate establishment, even though it does have a separate profit and loss statement prepared by the company. The CITY plant is not a separate legal entity, and does not function as a separate establishment because it does have:

a. a separate payroll

b. separate employees

c. separate payroll tax returns

d. separate employee insurance

e. separate workman's compensation insurance

f. separate accounting functions

g. separate legal functions

h. separate business license

i. separate retirement plan

j. separate billing systems for accounts receivable

k. separate bidding process

l. separate performance bonds

m. separate documentation for inter-company transfers of products

n. separate motor vehicle registration

Therefore, the CITY plant is not a separate establishment because it is not its own Aeconomic unit of operations.@


The majority opinion asserts that the position of the Auditing Division is that the CITY plant is only an Aeconomic unit A if it is a separate legal entity. I do not interpret that to be the position of the Auditing Division, and it certainly would not be my position. Instead, I would view the CITY plant to be a separate Aeconomic unit@ if it truly functioned as a separate division. It does not. The CITY plant just functions as a part of the construction business. If it functioned as its own Aeconomic unit of operations@ then you could look just at the functioning of the CITY plant. However, since it does not function in that manner, it is just part of the construction business. It is therefore the whole business of PETITIONER that should be viewed to determine if the Aeconomic unit@ if it is a manufacturer. Since more than a preponderance (50%) of the product of PETITIONER is used by it in its road construction business, I believe it is not a manufacturer, but is in the construction business.

The decision of the majority of the Commission overturns a long line of prior decisions by the Tax Commission, and I would not do so unless it was clear that those prior decisions were erroneous. There is no evidence that those prior decisions were erroneous.

I would vote to sustain the audit assessment made by the Auditing Division.

DATED this 26th day of February, 1999.

 

____________________________________________

Joe B. Pacheco

Commissioner

^^


[1] Indeed, the Rule=s definition of Aestablishment@ clearly originates in and is virtually identical with the SIC manual, except that the Rule is limited to manufacturing facilities. Thus, the explanatory material in the SIC Manual is more than usually helpful in interpreting the rule.

[2] More than a de minimus use of the equipment for research and development, storage or shipping might still invalidate the exemption. That issue is not presented in this case.

[3] Cox notes in its brief that the parties in Salt Lake Brewing Co. stipulated at the Commission level that the machinery and equipment in question would have been exempt if the brewing activities were conducted at a separate physical location from the retail activities.