Department of Finance Post Office Box and Administration Phone: (501) November 14, 2017

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1 STATE OF ARKANSAS OFFICE OF THE DIRECTOR 1509 West Seventh Street, Suite 401 Department of Finance Post Office Box 3278 Little Rock, Arkansas and Administration Phone: (501) Fax: (501) Re: In the Matter of Proposed Tax Assessment, Docket , Audit A ; Proposed Refund Claim Denial, Docket , Audit A ; Proposed Refund Claim Denial, Docket , Audit A ; Proposed Refund Claim Denial, Docket , Audit A ; and Proposed Refund Claim Denial, Docket , Audit A : This letter is prepared in response to your August 3, 2017, request for a revision of the administrative decision entered in the above-referenced matters on July 18, Your letter is considered a timely-filed request for revision, and this letter will constitute the final decision of the Arkansas Department of Finance and Administration ( Department ) under Ark. Code Ann (Supp. 2015) in regards to the above-referenced matters. FACTS The taxpayer is a member of the, which designs and manufactures custom metal and wood retail display systems, fixtures, and products. The taxpayer holds a direct pay sales and use tax permit under the provisions of Ark. Code Ann (Repl and Supp. 2015). As a direct pay permit holder, the taxpayer is required to accrue, report, and remit gross receipts and compensating use taxes directly to this agency in lieu of paying such taxes to its vendors. Facts Concerning Assessment Audit A , Docket No In May 2015, the department initiated an audit of the taxpayer s books and records for the reporting periods May 1, 2012, through April 30, During the audit, the department determined that the taxpayer had failed to accrue, report, and remit tax on various purchases from Arkansas and out of state vendors. These transactions included purchases from consisting of preventative maintenance, cleaning, and testing services for plant switchgear and a transformer. These transactions also included purchases from consisting of preventative maintenance services for forklifts. The charges from included charges for

2 Page 2 of 11 replacement air filters, oil filters, hydraulic fluid, and oil for the taxpayer s forklifts. They also included charges for preventative maintenance performed on batteries. A proposed assessment of tax was issued in the total amount of $311, The taxpayer paid the assessment in full, and submitted a protest of the assessment. Eventually only the purchases from and were submitted to the hearing officer for a determination as to the applicability of the tax. The taxpayer claimed that the purchase from was excluded from tax as the alteration, cleaning, refinishing, replacement, or repair of non-mechanical, passive, or manually operated components of a building under Arkansas Gross Receipts Tax Rule GR-21. The taxpayer claimed entitlement to a 1% refund of tax for the purchases from under Ark. Code Ann (Repl and Supp. 2015). 1 The hearing officer upheld the assessment of tax on the purchases from on the basis that the taxpayer purchased taxable services to alter, add, clean, or repair electrical appliances and devices. See Ark. Code Ann (3)(B)(i)(g) (Repl. 2014). The hearing officer upheld the assessment of tax on the purchases from on the basis that the taxpayer failed to demonstrate that the items purchased were machinery or equipment for purposes of the claimed refund. The hearing officer incorrectly attributed preventative maintenance services for batteries in the section of the decision concerning purchases from. 2 Facts Concerning Refund Audit A , Docket No In 2015, the taxpayer submitted a claim for a refund of tax accrued, reported, and paid on various purchases made between July 2012 and April The total amount of the taxpayer s claim was $157, This claim for refund was assigned to a field auditor for review. The claim for refund included tax paid in relation to the purchase or lease of forklift batteries from It also included tax paid to in relation to services to evaluate, troubleshoot, and install a new switch in the taxpayer s switchgear. The auditor denied $40, of the claimed refund. The taxpayer protested the denial of refund. Ultimately, only tax paid to for the rental of forklift batteries, as well as tax paid to to service the taxpayer s switchgear, was submitted to the hearing officer for a determination as to the applicability of tax paid for these purchases. The hearing officer overturned the denial of refund in relation to the purchases from, but sustained the denial of refund in relation to the purchases from. The purchases from are not at issue in your request for revision. Instead, only the purchases from are at issue in your request. Facts Concerning Refund Audit A , Docket No In 2015, the taxpayer submitted a claim for a refund of tax accrued, reported, and paid on various purchases made between January 2013 and December The total amount of the taxpayer s claim was $25, This claim for refund was assigned to a field auditor for review. The 1 A companion refund for compensating use tax can be found in Ark. Code Ann (Repl and Supp. 2017); however, for efficiency, only the provisions of Ark. Code Ann (Repl and Supp. 2017) will be cited in this response. 2 Purchases from were at issue in refund claim audit A

3 Page 3 of 11 claim for refund included tax paid in relation to purchases of conference bridging services (services to facilitate conference calls). For conference bridging services, Arkansas tax was collected by the seller of the services, and the seller charged tax on behalf of Arkansas and other states. The taxpayer paid the seller of the conference bridging services for the invoiced costs associated with the purchased services, and the taxpayer accrued, reported, and remitted tax directly to this agency for the invoiced costs associated with the purchased services. The auditor denied $11, of the claimed refund. The taxpayer protested the denial of refund. Ultimately, only the tax paid in relation to conference bridging services was submitted to the hearing officer for a determination as to the applicability of tax paid for these purchases. The hearing officer sustained the denial of refund on the basis that conference bridging services are subject to tax, and the taxpayer failed to provide sufficient proof that it was entitled to a credit for tax collected by the seller on behalf of other states. Facts Concerning Refund Audit A , Docket No In 2015, the taxpayer submitted a claim for a refund of tax accrued, reported, and paid on various purchases made between July 2012 and December The total amount of the taxpayer s claim was $132, This claim for refund was assigned to a field auditor for review. The claim for refund included tax paid in relation to purchases of conference bridging services. The auditor denied $24, of the claimed refund. The taxpayer protested this denial of refund. Ultimately, only tax paid in relation to conference bridging services was submitted to the hearing officer for a determination as to the applicability of tax paid for these purchases. As stated above in regards to audit A , the hearing officer sustained the denial of refund in relation to these purchases. Facts Concerning Refund Audit A , Docket No In 2015, the taxpayer submitted a claim for a refund of tax accrued, reported, and paid on various purchases made between January 2014 and April The total amount of the taxpayer s claim was $16, This claim for refund was assigned to a field auditor for review. The claim for refund included tax paid in relation to purchases of conference bridging services. The auditor denied $4, of the claimed refund. The taxpayer protested this denial of refund. Ultimately, only tax paid in relation to conference bridging services was submitted to the hearing officer for a determination as to the applicability of tax paid for these purchases. As stated above in regards to audit A , the hearing officer sustained the denial of refund in relation to these purchases. ISSUES Your August 3, 2017, request seeks a revision of the administrative decision as it pertains to: 1. The denial of a refund of tax paid for conference bridging services; 2. The assessment of tax in relation to services provided by, and the denial of a refund of tax paid in relation to services provided by ; and 3. The denial of a refund of 1% of the tax paid on purchases from.

4 Page 4 of 11 A meeting was held in relation to your request for revision on August 16, During that meeting you made the following explanations, statements, and arguments in relation to the purchases at issue in your request for revision: For conference bridging services, you explained that the taxpayer paid tax in relation to services to facilitate conference calls. You further asserted that Rule GR-7 does not clearly explain that conference bridging services are subject to tax. You conceded that conference bridging services are subject to tax. You conceded that you had no proof as to whether tax collected by the vendor on behalf of other states was properly collected for purposes of obtaining a credit against the Arkansas tax paid. When asked what relief you were seeking concerning the issue of a denial of refund for conference bridging services, you stated that you were requesting that any existing statute of limitation that might hinder the taxpayer s ability to obtain a refund of tax paid to the vendor be extended. In addition, you requested that Rule GR-7 be amended to clearly explain that conference bridging services are subject to tax. For purchases from and, you stated that replaced a switch in the taxpayer s plant switchgear, and that cleaned up boxes for the taxpayer s switchgear and transformer. You argued that these services were exempt from tax under Arkansas Gross Receipts Tax Rule GR-21 because the switchgear and the transformer were part of the taxpayer s building. When the case of Arkansas Department of Finance & Administration v. Otis Elevator, 271 Ark. 442, 609 S.W.2d 41 (1980) was referenced in support of the taxability of purchases from and, you argued that House Bill 1472 of 1995 effectively overturned the decision of the court in Otis Elevator. You also argued that switchgear and transformers are not representative of taxable services identified in Rule GR-21(C)(2). Lastly, you also referenced decisions issued by this agency under docket numbers , , , and in regards to the taxpayer s purchases from and. For purchases from, you stated that you had called and been informed that the preventative maintenance services performed on the taxpayer s batteries involved cleaning the batteries (cleaning the battery terminals), and checking the water in the batteries. You argued that the assessment of tax in relation to purchases of preventative maintenance services for batteries should be overturned because the Department did not prove that the batteries were altered. In addition, you argued that the assessment of tax in relation to purchases of filters, lubricants, and preventative maintenance services for the taxpayer s forklifts should be reduced by 1% under the provisions of Ark. Code Ann (Repl and Supp. 2015). Specifically, you argue that the statute should be interpreted to provide a 1% refund of tax paid in relation to the replacement or repair of any component of manufacturing machinery and equipment, which would include filters and lubricants for the taxpayer s forklifts. In addition, you argued that taxpayers should not be required to spend money on accounting and tracking systems to verify that

5 Page 5 of 11 purchases of repair and replacement parts are entitled to refund under Ark. Code Ann (Repl and Supp. 2017). Issue 1 Conference Bridging Services ANALYSIS The taxpayer purchased conference bridging services, which are services to facilitate conference calls. For conference bridging services, Arkansas tax was collected by the seller of the services, and the seller charged tax on behalf of Arkansas and other states. The taxpayer paid the seller of the conference bridging services for the invoiced costs associated with the purchased services, and the taxpayer accrued, reported, and remitted tax directly to this agency for the invoiced costs associated with the purchased services. You assert that Rule GR-7 does not clearly explain that conference bridging services are subject to tax; however, you concede that conference bridging services are subject to tax under Arkansas law. You further concede that you have no proof that sales tax collected by the vendor on behalf of other states was properly collected for purposes of obtaining a credit against the Arkansas tax paid. You have requested that I extend any existing statute of limitation that might hinder the taxpayer s ability to obtain a refund of the tax it paid to sellers of conference bridging services to permit the taxpayer to now seek a refund of tax from the sellers of those services. In addition, you have requested that Rule GR-7 be amended to clearly explain that conference bridging services are subject to tax. Arkansas sales and use tax is levied upon the sale of telecommunications and other related services, including ancillary services. Ark. Code Ann (a)(2) (Repl and Supp. 2017) and Ark. Code Ann (a) (Repl and Supp. 2017). Conference bridging services are identified as ancillary services in Gross Receipts Tax Rule GR-7. Accordingly, Arkansas sales and use tax is levied upon conference bridging services. As the taxpayer is a direct pay permit holder, the payment of tax that it made directly to this agency for purchases of conference bridging services was the proper method of payment of the tax under state law. Any payment of tax the taxpayer made to the sellers of conference bridging services was improperly made, and was not sufficient to satisfy the taxpayer s tax obligations to this agency. See Administrative Hearing Decision issued under docket number , The provisions of Ark. Code Ann (Repl and Supp. 2017) govern the revision of administrative decisions. Nothing within that statute authorizes the director of this agency to waive statutes of limitation. Therefore, to the extent that you have requested that statutes of limitation be extended to permit the taxpayer to now seek a refund of tax paid to sellers of conference bridging services, that request must be denied. Similarly, making changes to the Gross Receipts Tax Rules is outside the scope of the administrative hearing process, including requests for a revision of an administrative decision. However, as I explained to you in our August meeting, our agency is currently reviewing existing rules for necessary changes. As the provisions of Ark. Code Ann (Repl and Supp. 2017) make it clear that tax is

6 Page 6 of 11 levied on ancillary services, I am not altogether convinced that Rule GR-7 requires the changes you seek. We will take your suggestion into consideration when updating the existing rules. In addition, any changes to our rules will require an opportunity for public comment, and you are welcome to suggest changes during that time. See Arkansas Administrative Procedure Act, Ark. Code Ann et seq. (Repl. 2014). Issue 2 Purchases from and Arkansas sales and use tax was assessed on purchases from consisting of preventative maintenance, cleaning, and testing services for plant switchgear and a transformer. A refund of tax was denied for purchases of services from to evaluate, troubleshoot, and install a new switch in the taxpayer s switchgear. Tax was assessed, and a refund was denied, on the basis that the taxpayer purchased services to install, alter, add, clean, refinish, replace, or repair electrical appliances and devices, which are subject to tax under the provisions of Ark. Code Ann (3)(B)(i)(g) (Repl and Supp. 2017). See also Arkansas Gross Receipts Tax Rule GR-9. You assert that these services are excluded from tax under the provisions of Arkansas Gross Receipts Tax Rule GR-21. Rule GR-21 was promulgated to implement and clarify the provisions of Ark. Code Ann (3)(B)(viii)(a) (Repl and Supp. 2017), which provide an exclusion from tax for the initial installation, alteration, addition, cleaning, refinishing, replacement, or repair of non-mechanical, passive, or manually operated components of buildings or other improvements or structures affixed to real estate. There appears to be no dispute that switchgear and transformers are electrical appliances and devices. The issue then becomes whether services to install, alter, add, clean, refinish, or repair switchgear and transformers are excluded from tax under Ark. Code Ann (3)(B)(viii)(a) (Repl and Supp. 2017). In support of your position concerning the purchases from and, you have referenced Act 835 of 1995 (HB 1472 of 1995), Rule GR-21(C), and administrative decisions issued under Docket Numbers , , and In regards to the impact of Act 835 of 1995, it is first important to understand that tax has been levied upon services to alter, add, clean, refinish, replace, and repair electrical appliances and devices and machinery of all kinds (as well as other items of property) since For this reason, the Arkansas Supreme Court determined in 1980 that tax was properly assessed upon the service and maintenance of elevators (machinery), even though elevators were incorporated into real property. See Department of Finance and Administration v. Otis Elevator Co., 271 Ark. 442, 609 S.W.2d 41 (1980). In 1995, with passage of Act 835 of 1995, the Arkansas General Assembly carved out an exclusion from tax for services to alter, add, clean, refinish, replace, or repair non-mechanical, passive, or manually operated components of buildings or other improvements or structures affixed to real estate. In 1995, the General Assembly was expressly aware of the fact that tax was specifically levied on the installation, addition, alteration, cleaning, refinishing, replacement, and repair of machinery of all kinds, as well as upon electrical 3 Act 214 of 1971.

7 Page 7 of 11 appliances and devices and other items of property. This is made clear by the emergency clause incorporated within Act 835 of It would also have been presumed to be aware of the construction of the tax levy given by the court in the Otis Elevator case. If the General Assembly intended to carve out an exclusion from tax for the installation, alteration, addition, cleaning, refinishing, replacement, or repair of electrical appliances and devices and machinery incorporated into real property, it arguably would have done so. Instead, it limited the exclusion to only non-mechanical, passive, and manually operated components of buildings or other structures or improvements to real estate. Your argument that GR-21(C) does not contemplate taxation of the services provided by and represents a misreading of the rule. Rule GR-21(C) explains that: (1) cleaning and janitorial services are taxable; (2) the initial installation, alteration, addition, cleaning, refinishing, replacement, and repair of electrical appliances, machines, and other mechanical items are taxable; (3) for existing buildings, the initial installation, alteration, addition, cleaning, refinishing, replacement, and repair of carpets and rugs is taxable; and (4) the replacement and repair of elevators is taxable. In addition, the caption or heading for Rule GR- 21(C) clearly informs the reader to see Rules GR-9 through GR-9.17 for additional taxable services, and Rule GR-9 informs the reader of the taxability of the initial installation, addition, alteration, refinishing, replacement, and repair of machinery of all kinds, as well as electrical appliances and devices. Lastly, I do not understand your reference to dockets numbers , , , and in regards to your position concerning the purchases from and. The administrative and revision decisions entered in relation to the docket numbers that you have cited concerned a protest filed by another taxpayer with facts that are different than those in this case. Additionally, the decisions both hold that the installation, alteration, addition, cleaning, refinishing, and repair of electrical appliances and devices, including transformers, are subject to tax. For the reasons above, I must sustain the administrative decision as it relates to purchases from and. Issue 3(A) Purchases from Forklift Battery Maintenance Services Arkansas sales and use tax was assessed in relation to purchases of preventative maintenance services for forklift batteries. You stated these services consisted of cleaning the batteries (battery terminals) and checking the water in the batteries. You have asserted that the assessment of tax on these preventative maintenance services should be overturned on the basis that the department failed to prove that the batteries were altered. A battery is an electrical device. The provisions of Ark. Code Ann (3)(B)(i)(g) (Repl and Supp. 2017) provide that tax is levied upon services to install, alter, add, clean, refinish, replace, or repair electrical appliances and devices. See also Arkansas Gross Receipts Tax Rule GR-9. When battery terminals are cleaned, a taxable service to clean an electrical

8 Page 8 of 11 device has occurred. Similarly, if water is added to a battery, the water level of the battery, and the battery itself, would be altered. In some instances, adding water to a battery is done to restore the battery to proper working order, which would be considered a taxable repair of the battery. For these reasons, I find that tax was properly assessed in relation to the preventative maintenance services purchased from, but not for the reasons given by the hearing officer on page 17 of the administrative decision. Issue 3(B) Purchases from Forklift Fluid and Filter Replacements Arkansas sales and use tax was assessed in relation to the taxpayer s purchase of replacement air filters, oil filters, hydraulic fluid, and oil for the taxpayer s forklifts. Tax was also assessed in relation to the taxpayer s purchase of labor to service the taxpayer s forklifts (labor to change the filters and the lubricants in the forklifts). The tax auditor conceded that the taxpayer s forklifts are machinery and equipment used directly in the taxpayer s manufacturing process. 4 In regards to these purchases, you argue that the taxpayer is entitled to a one percent (1%) refund of the tax paid in relation to these purchases pursuant to Ark. Code Ann (Repl and Supp. 2017). You argue that you believe the refund is available for the purchase of any replacement components parts for machines that are used directly in manufacturing and are entitled to exemption under Ark. Code Ann (Repl and Supp. 2017). Lastly, you have argued that, for the purchase of routine maintenance items such as fluids and filters, a taxpayer should not be required to maintain and provide documentation in support of claims for refund under Ark. Code Ann (Repl and Supp. 2017). As a threshold matter, it is important to note, as clarified by Act 465 of 2017, that the refund authorized under Ark. Code Ann (Repl and Supp. 2017) can currently only be claimed by direct pay (or limited direct pay) permit holders, and only by self-refunding on the sales and use tax returns filed with this agency. 5 A direct pay permit holder cannot currently obtain the benefit of the refund by filing a verified claim for refund. For this reason, and because the taxpayer had paid the assessment in full and was therefore pursuing a verified claim for refund, the department originally argued that the taxpayer could not obtain the benefit of the refund through adjustment to the audit. This argument was later withdrawn because it was determined that the audit staff had already provided credit in the audit for purchases they determined would have qualified for the refund authorized by Ark. Code Ann (Repl and Supp. 2017). Though the argument concerning the method for claiming the refund was withdrawn in this case, it must be stressed that, for any other reporting periods, the taxpayer can only claim the benefits of the refund by self-refunding on its returns. It cannot obtain the benefit of the refund by filing a verified claim for refund. In researching the file of this matter, it does not appear that the audit staff disputed that the fluids and filters purchased from, as well as the labor services purchased from, were purchased to service the taxpayer s forklifts. Further, the audit staff conceded that these forklifts 4 Administrative Decision, page 8. 5 This will change in 2018.

9 Page 9 of 11 were used directly in manufacturing. However, the audit staff determined that the purchases did not qualify for the refund authorized under Ark. Code Ann (Repl and Supp. 2017) for the following reasons: (1) the vendor performed preventative maintenance services as opposed to repair services; and (2) the fluids and filters purchased from the vendor were consumable supplies. For this reason, the audit staff did not allow a credit in the assessment audit for these purchases from. Sales eligible for the refund you are claiming are identified in Ark. Code Ann (a) (Repl and Supp. 2017), which provides as follows: (a) The taxes levied under and on the gross receipts or gross proceeds from the sale of the following are subject to a refund as provided in this section: (1) Machinery and equipment purchased to modify, replace, or repair, either in whole or in part, existing machinery or equipment used directly in producing, manufacturing, fabricating, assembling, processing, finishing, or packaging articles of commerce at a manufacturing or processing plant or facility in this state; and (2) Service relating to the initial installation, alteration, addition, cleaning, refinishing, replacement, or repair of machinery or equipment described in subdivision (a)(1) of this section. The refund was first authorized under Act 1404 of The act title explains that the purpose of the act is to reduce sales and use tax relating to the partial replacement and repair of machinery and equipment used directly in manufacturing, as well as to provide a refund mechanism for sales and use tax paid in relation to the partial replacement and repair of machinery and equipment used directly in manufacturing. Fiscal Impact Statements filed by this agency in relation to the act indicate that the agency contemplated that a manufacturer would pay the state sales and use tax rate of 6.5 % when purchasing repair and replacement parts and services, and would then claim a refund of a percentage of the tax paid on the manufacturer s monthly returns. In 2015, through Act 1107 of 2015, the mechanism of claiming the refund was amended. The act title explains that the purpose of the act was to amend the laws concerning the sales and use tax applicable to the partial replacement and repair of certain machinery. Further, the act contained an emergency clause that explained that the act was necessary because the state was not competitive with other states because it was taxing manufacturing machinery and equipment modifications, partial replacements, and repairs. Fiscal Impact Statements filed by this agency indicated that the act concerned purchases of repair and replacement parts and labor. In 2017, through Act 465 of 2017, the law was amended again to establish an annual increase in the amount of the available refund through 2022, at which point purchases associated with the partial replacement or repair of manufacturing machinery would become exempt from sales and use tax. In addition, the method of claiming the refund was clarified and amended to provide a future alternate method for claiming the benefit of the refund. The act title explains that the

10 Page 10 of 11 purpose of the act was, in part, to increase the refund available for taxes paid on purchases related to the repair and partial replacement of manufacturing machinery and equipment. In addition, the act also contained an emergency clause that explained that the act was necessary because the state was not competitive with other states because it was taxing manufacturing machinery and equipment modifications, partial replacements, and repairs. The Fiscal Impact Statement filed by this agency indicated that the act concerned purchases of repair and replacement parts and labor. Based upon the foregoing, it is the interpretation of this agency that the refund is available for the sale or purchase of machinery and equipment component parts necessary to modify, partially replace, or repair original component parts of existing manufacturing machinery and equipment eligible for exemption under the provisions of Ark. Code Ann (Repl and Supp. 2017), as well as services to initially install, alter, add, clean, refinish, replace, or repair machinery and equipment eligible for exemption under the provisions of Ark. Code Ann (Repl and Supp. 2017). Ordinarily, a forklift would not be sold without incorporated air filters, oil filters, hydraulic fluid, engine or motor oil, and batteries. For this reason, I am reversing the decision of the hearing officer in regards to the taxpayer s purchases from of forklift filters, fluids, and preventative maintenance services. In regards to your argument concerning documentation necessary to support claims for refund under the provisions of Ark. Code Ann (Repl and Supp. 2017), it is important to note that taxpayers bear the burden of proving entitlement to refunds, credits, deductions, and exemptions by a preponderance of the evidence, and that claims of entitlement to credits, deductions, and exemptions are strictly construed against same. Ark. Code Ann (Supp. 2017) and (Repl. 2014). Furthermore, Ark. Code Ann (Repl. 2012) requires a taxpayer to maintain suitable records as are necessary to determine the amount of tax due or prove the accuracy of any return. Id. at (a). The amount of the refund requested by the taxpayer under Ark. Code Ann is an example wherein the taxpayer is responsible for maintaining suitable records to determine the amount of tax due or to prove the accuracy of the return. To claim the benefits of the refund, a taxpayer must currently hold a form of direct pay permit and must claim the refund on its sales tax returns. Beginning July 1, 2018, taxpayers who do not hold a direct pay permit can claim the refund by filing a claim for credit or rebate with the department, and by offsetting the amount claimed against reported tax due. In light of the requirements for claiming the refund, it is imperative that a taxpayer keep and maintain sufficient records to verify entitlement to the refund to avoid the possibility of an assessment for unpaid tax.

11 Page 11 of 11 CONCLUSION This concludes your administrative remedies under the Arkansas Tax Procedure Act. Judicial relief from this decision may be sought according to the procedure set forth in Ark. Code Ann (Repl and Supp. 2015). Sincerely, Walter Anger Deputy Director and Commissioner of Revenue