98-084

Response February 10, 1999

REQUEST LETTER

November 24, 1998

RE: Advisory Opinion Request for COMPANY

COMPANY requests a ruling regarding the taxability of certain "accessories" to equipment that qualify for the manufacturer's expansion exemption or the replacement manufacturer's exemption. When COMPANY buys equipment that qualifies for one of these exemptions, it has taken the applicable exemption on the new asset purchase. However, there are several other items (electric motors, nuts, bolts, and small fixtures) that are needed to get the larger item up and running. These items are taken out of parts inventory on hand. Sales tax on these items is either paid to local vendors at the time of purchase or use tax is self-accrued. The reason tax is paid to the local vendor or self-accrued is that COMPANY is not aware at the time of purchase how the items will be used-whether for normal repairs (which is taxable), for major replacements of equipment (which may be partially or fully exempt, depending on the date of the purchase), or for expansion of a product line. COMPANY takes a conservative approach (in favor of the Tax Commission) in paying or accruing tax at the time of purchase.

Presently, COMPANY is not claiming exemption for these smaller parts. Since these parts make up the total capitalized cost of the manufacturing equipment, we have advised our client that such costs are exempt. Therefore, our inquiry to the Tax Commission is for an advisory opinion as to how the credit can be claimed for past transactions, and how it should be handled in the future.

For illustration purposes, assume the following parts inventory purchases and subsequent use.

SPECIFIC INFORMATION

Assume that tax is self-accrued or paid on the purchase date and that the items used on 09/01/97

properly qualify for the manufacturer's "replacement" exemption.

There are perhaps several approaches that can be taken in determining what should be exempt:

1.

The first approach (and the one which we feel is the fairest and most reasonable) for use taxes is to take a 60% tax credit on 09/01/97. The Tax Commission would receive the tax up front but would not have to pay interest on refunds until 11/01/97 (i.e. the tax return for September 1997 is due on 10/31/97; interest would begin accruing the next day). COMPANY would forgo any interest from the invoice date until the date of use.

This appears to be the best approach for a number of reasons. The information would be easy to document and have a good audit trail, making a review by the Tax Commission simple. The data are on a summary sheet located in each project file, where standard costs could be used and requisition dates show at what point a partial or full (depending on the phase-in date of the replacement exemption) tax credit can be taken. This approach is also consistent with the apparent current Tax Commission practice of assessing tax on goods consumed from resale inventory based on date of conversion to consumption, rather than date of original purchase.

2.

Another approach would be on a LIFO basis. A 30% credit could be claimed for the 100 items purchased on 09/01/96 and no credit could be taken on the remaining 90 items used from the 09/01/95 purchase. The obvious disadvantage to COMPANY is they would only be entitled to 30% of the exemption for on 100 units. The Tax Commission would be unjustly enriched by not only receiving the full tax up front, but also, by the smaller exemption taken by the taxpayer. Bookkeeping by COMPANY would be tedious.

3.

Still another approach would be a FIFO basis. The taxpayer would not be entitled to any exemption for the first 100 items purchased, and only 30% of the next 90 items on 09/01/96. We feel this approach is totally unreasonable since the 60% exemption that COMPANY is entitled to would not be realized. It is extremely tedious to trace these purchases back to the invoices. Also, if there are several concurrent replacement projects and repair projects, the accounting for these items would be virtually impossible and subject to errors.

4.

A final approach for future consideration, is for COMPANY to not pay any use taxes on its purchase and wait until the items are taken out of inventory to decide the use tax status. At that point, a use tax could be accrued on items that are used for normal repairs, or an exemption claimed if the item is used as part of a Areplacement.@ COMPANY would rather pay the tax up-front and file for a credit later since the majority of parts inventory are for taxable purposes. The accounting under this approach would be very tedious and, most likely, the Tax Commission would not receive as much tax because of normal shrinkage due to loss or theft.

COMPANY feels the most reasonable and fair approach to determining use taxes is scenario no. I.

It also seems to be the simplest to apply and for the Tax Commission to audit. The Tax Commission would receive the tax up-front and when the use of the items is determined to be exempt, an audit trail of documented credits would be available for audit. The alternative approaches require tedious accounting resulting in more exposure to errors and would be much more difficult to audit.

If you have questions or would like to discuss other alternatives, please contact NAME at

#####.

Sincerely,

RESPONSE LETTER

February 10, 1999

RE: Advisory Opinion - Manufacturing Equipment Exemption for COMPANY

Dear COMPANY,

We have received your request for an advisory opinion concerning the manufacturing equipment exemption and its application to COMPANY use of parts taken out of inventory on hand. You have asked how to claim a sales tax credit on past transactions by which this inventory was obtained and how to administer this issue prospectively. We shall address these questions below.

First, however, arises the question as to whether these parts can qualify for the manufacturing equipment exemption for normal operating replacements. Utah Code Ann. '59-12-104(14) provides an exemption for machinery and equipment. Utah Admin. Code R865-19S-85(A)(6) provides that normal operating replacements also includes parts. Accordingly, the word Aparts@ as used in subsection (A)(6) of the rule may include the electric motors, nuts, bolts, and small fixtures used to install machinery or equipment that is itself a normal operating replacement or parts that themselves meet the normal operating replacement requirements of the statute and the rule.

Assuming that the parts you describe do qualify as normal operating replacement equipment as set forth in Section 59-12-104(14)(a)(ii), the exemption must be reported and administered in accordance with other statutory guidelines. Utah Code Ann. '59-12-106(2) states that it is presumed that an item is taxable unless the person selling the item takes from the purchaser an exemption certificate. Utah Admin. Code R865-19S-23(E) places the burden of proving that an item is exempt upon the vendor. Lastly, as you ask about refunds, we note that Utah Code Ann. '59-12-110(2)(b) requires that a taxpayer request a refund or credit of sales tax within three years from the day on which the taxpayer overpaid the tax.

Given these guidelines, how should COMPANY recoup sales tax already paid on tax-exempt parts? It depends upon the way the sales tax was paid. If COMPANY paid the sales tax to a vendor, then COMPANY should issue the vendor an exemption certificate for the tax-exempt parts and request a refund from the vendor. The vendor will then receive a credit for the amount it refunds COMPANY on its next tax return to the Commission. This procedure ensures that the taxes refunded to MagCorp ultimately comes from the same taxing entities which originally received the sales tax. On the other hand, should COMPANY have paid the sales tax to the Commission directly, it should take a credit on its next sales tax return. This too ensures that the original taxing entities that received the sales tax are the same ones that will be affected by the credit.

What exemption percentage on normal operating replacements will COMPANY be entitled to? The exemption percentage for normal operating replacements is dependent upon the date of the replacement purchase. Let us use your example and assume that COMPANY purchased 100 units on 9/1/95 and another 100 units on 9/1/96, then used 190 of these parts on 9/1/97 as normal operating replacement parts. The question of the exemption percentage arises because purchases made on 9/1/95 receive a 0% exemption, purchases made on 9/1/96 receive a 30% exemption, and purchases made on 9/1/97 receive a 60% exemption. Sales tax and exemptions apply to transactions and the date of these transactions, not to the date the items are actually put into use. Therefore, the 60% exemption percentage in effect on the Ause@ date of 9/1/97 is not applicable. The transactions were made on 9/1/95 and 9/1/96, so the exemption percentages in effect on those dates are applicable.

COMPANY should already have in place an accounting system (LIFO, FIFO, or some other procedure) to account for changes in inventory. This same system should be used to determine whether the parts purchased on 9/1/95 or 9/1/96 are the ones first used when parts were taken out of inventory on 9/1/97. For example, should COMPANY have a LIFO accounting system in place, the 190 units used on 9/1/97 would consist of the 100 units purchased on 9/1/96 and 90 of the 100 units purchased on 9/1/95. In this case, COMPANY could request a 30% exemption for the 100 units purchased on 9/1/96, but no refund for the other 90 units purchased on 9/1/95. Also relevant when making any refund or credit request is the existence of the three-year statute of limitation.

As to prospective purchases that combine both repair and normal operating replacement parts where COMPANY is unable to segregate the repair parts from the normal operating replacement parts, COMPANY should pay tax on all parts at the time of purchase. Then, COMPANY should request a refund or credit of the sales tax as set forth above when a portion of these parts are actually used as normal operating replacements. If, instead, COMPANY knows at the time of purchase that all parts will be used as normal operating replacements, then COMPANY should purchase the parts tax-free and issue an exemption certificate to the vendor.

Please contact us if you have any other questions.

For the Commission,

Joe B. Pacheco, CPA

^^ Commissioner