STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION

Transcription

1 STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION IN THE MATTER OF GROSS RECEIPTS (SALES) & COMPENSATING (USE) (ACCT. NO.: ) TAX ASSESSMENT AUDIT NO. AUDIT PERIODS: 4/2010 TO 2/2016 DOCKET NOS.: SALES TAX ( ) USE TAX ( ) 2 TODD EVANS, ADMINISTRATIVE LAW JUDGE APPEARANCES This case is before the Office of Hearings and Appeals upon written protest dated June 18, 2016, signed by (President) on behalf of, the Taxpayer. The Taxpayer protested an assessment issued by the Department of Finance and Administration ( Department ). A hearing was held in this matter on October 5, 2016 at 10:48 a.m. in Arkadelphia, Arkansas. The Department was represented by Greg Ivester, Attorney at Law, Office of Revenue Legal Counsel ( Department s Representative ). Also present for the Department was Gary Webb and Latonya Allen, Tax Auditors, and Melissa Guin, Audit Supervisor. ( Taxpayer s Representative ) appeared at the hearing and represented the Taxpayer. The record remained open after the hearing for the submission of posthearing briefs. The Department submitted its Post-Hearing Brief on October 19, 1 This amount does not include any concessions agreed to by the Department. 2 This amount does not include any concessions agreed to by the Department. 1

2 2016. The Taxpayer did not file a response brief. The matter was submitted for a decision on November 22, ISSUE Whether the Department s assessment, as adjusted, in this matter is correct under Arkansas law. Yes. FINDINGS OF FACT/CONTENTIONS OF THE PARTIES The Department s Representative provided the following summary of relevant facts in his Answers to Information Request: Taxpayer is the corporation, located in, AR, and is operated by, President. The taxpayer produces crushed gravel and sand from blasting the rock from the quarry site and placing the rock in a crusher that crushes the rock to va1ious sizes of gravel. The gravel is then washed and separated into various sizes for sale to customer. The taxpayer reports Gross Receipts Tax on a Monthly basis. Taxpayer was audited in 2016 by Gary Webb, Tax Auditor for the Department. The audit review was conducted based on Ark. Code Ann and Arkansas Gross Receipts Rule GR-55 concerning exemptions from tax for manufacturers and Arkansas Gross Receipts Rule GR-59 concerning exemptions from tax for mining and quarrying operations specifically. Records examined for the audit included sales invoices, scale tickets, bank statements, purchase invoices, exemption certificates and monthly tax return copies. Sales invoices were and examined and total sales were calculated for selected months of the audit period. Monthly taxable sales from sales invoices were compared to gross receipts reported on monthly returns. Review of purchase invoices revealed that the taxpayer was purchasing machinery repair parts tax exempt from two vendors. The vendors were contacted to verify that they had an exemption certificate on file for of, Arkansas. The Vendors, and indicated that an exemption certificate was on file for with a SLS permit number of.... 2

3 Due to the fact that the taxpayer had never reported taxable purchases, the audit review was extended beyond the three year statutory period. The taxpayer was notified that additional records would be reviewed dating back to April 1st, During the audit the Auditor determined that there were discrepancies related to exempted taxable purchases made by the Taxpayer due to misrepresentation of sales and use permit by the Taxpayer. A listing was made of all exempted taxable sales to from and. See Exhibit B attached hereto. The purchases consisted of items including woven wire cloth, complete lower bearing assemblies, and belt fasteners for the Taxpayer's crushing and sifting machinery. Id. In addition, the Auditor determined that there were discrepancies related to taxable purchases of repair parts and safety supplies from out of state suppliers for which the Taxpayer did not pay compensating use tax. A listing was made of all taxable purchases. See Exhibit C attached hereto. These purchases include a paddle blades for the scrubber, toggle plate, seals, 0-rings, and earplugs among other items. Id. The Auditor discussed the findings of the audit with on April 25, 2016, and provided him with a copy of the audit at that time. indicated that he believed that the screens and paddles should be exempt from sales and use tax because the screens sort the gravel into various sizes to be separated and placed into inventory for sale. However, the auditor determined that the screens wear over time and replacing them was a taxable repair to machinery. The second item in disagreement is paddles in the scrubber machine. The scrubber is used to wash dirt and grit from the crushed gravel before it is sorted. There are 176 paddles in the scrubber that tum the gravel over as it is sprayed with water jets. The paddles wear over time and must be replaced. The auditor determined the replacement of the paddles to be taxable repairs. The Department s Representative argued that that the items at issue represent sales of tangible personal property that are generally subject to Arkansas Gross Receipts (sales) Tax (when purchased from in state suppliers) and Arkansas Compensating (use) Tax (when purchased from out of state suppliers). The Department s Representative asserted that the purchase of the screens and paddles constituted insubstantial replacements of the washing and 3

4 sorting machines that did not qualify for the manufacturing machinery and equipment exemption. In the Taxpayer s Protest, the Taxpayer argued that the screens (used to grade and separate rocks) and the paddles used to wash the rocks should be exempt as machinery and equipment utilized in washing, grading, and separating mined or quarried articles of commerce at the site of a continuous mining operation. The Taxpayer further argued that several screens were purchased for first use to create a new rock size and should be exempt. In its Answers to Information Request, the Taxpayer limited its protest to certain assessed purchases and argued that those purchases should be exempt under manufacturing machinery and equipment exemption located at Ark. Code Ann (Supp. 2015) and Ark. Code Ann (Repl. 2014). Specifically, the Taxpayer protested the following purchases: (1) a toggle plate purchased as part of a new crusher 3, (2) stronger Ni-hard steel paddles that were purchased to replace other metal paddles that had worn out, (3) screens that were purchased for first use to sort a new rock sizes for particular customers, and (4) estimate invoices that was assessed but represented quotes and not actual purchases. 4 In the Department s Post-Hearing Brief, the Department s Representative argued that the screens at issue cannot cause the creation of new or different products since the screens merely filter and separate rocks of various sizes. He asserts that the different sizes of rock were created by the crusher and before screens filtering. He further argues that the screens are used to make custom 3 This purchase was later conceded by the Department. 4 These items were later conceded by the Department. 4

5 orders (rocks of certain sizes for particular customers) that are not readily marketable to the general public and, thus, not articles of commerce. The Department s Representative maintained his position that the screens and paddles are component parts of larger machines and do not represent substantial replacements of those machines. The Department s Representative conceded that the Taxpayer s quarrying operation qualifies as manufacturing 5 and that washing and sorting of rock is part of the manufacturing process. 6 The Department s Representative further stated that the Department has no evidence to contradict the Taxpayer s assertion that the screens purchased in the protested transactions were used to separate new rock sizes. During the administrative hearing, Mr. Webb (one of the Department s Auditors), testified as follows in relevant part: (1) the Taxpayer operates a gravel quarrying and mining operation; (2) the use tax audit was extended to six (6) years due to Taxpayer s failure to report use tax; (3) the sales tax audit was limited to three (3) years because the Taxpayer did not underreport its sales tax liability by twenty five percent (25%) or more; (4) the Taxpayer purchased items from out of state vendors that were not reported for use tax; (5) the Taxpayer also improperly purchased some items tax exempt from in state vendors after providing an exemption claim; (6) the paddles were purchased from an out of state vendor and were taxable since those items replaced worn paddles and did not represent substantial replacement of the washing machine; (7) the screens were taxed as replacement parts since those items replaced existing screens and 5 See Ark. Code Ann (b)(2) (Supp. 2015) and Ark. Code Ann (b)(2). 6 See Arkansas Gross Receipts Tax Rule GR-59. 5

6 did not represent a substantial replacement of the sorting machine; (8) a substantial replacement requires the replacement of a majority of a machine s components; (9) though the screens and paddles are used in the quarrying process by assisting in the washing and sorting of the rock, the items do not meet the requirements of GR-55 since those purchases do not qualify as a physical or economic expansion of the Taxpayer s manufacturing plant or substantial replacements; and (10) the production of different sizes of rock is not a new product for economic expansion analysis since it is still rock before and after sorting. 7 The Audit Supervisor testified as follows: (1) the screens at issue allow the Taxpayer to separate different sizes of rock but the rocks of a particular size were created by the crusher and (2) the screens do not create different sizes of rock. During the administrative hearing, the Taxpayer s Representative testified as follows: (1) after the Department s concessions, the Taxpayer was only protesting the first time use screens and the paddles that were listed in the Taxpayer s Answers to Information Request; (2) the only activity that the Taxpayer does is crush and sort rock; (3) rocks of different sizes represent different products that have different prices and are used in different applications by customers; (4) the addition of the screens at issue allowed the production of two inch and three inch rock, which were new products; (5) the paddles are attached to a flight containing eighty-eight (88) other paddles that turn into each 7 It is uncertain if Mr. Webb meant that the rock sizes were previously determined by the crusher or if he intended to state that different sizes of rock do not represent different products. If the latter statement was intended, it is in error since quarrying is specifically recognized as manufacturing and the end product of that process is rock crushed and sorted into different sizes. Consequently different rock sizes do represent different products from the quarrying operation. 6

7 other to push the gravel forward in the flight while water washes over it; (6) the flights are roughly twenty (20) feet in length; (7) the paddles are attached to a single motor; (8) the washed gravel is then dumped onto a belt, goes through initial screening, and is then transported to a sorting machine that contains the screens at issue; (9) the screens are arranged in three decks; (10) rock that can fall through the holes on the top screen go to the next level or deck and rock that can fit through the screen on that deck falls to the bottom screen; (11) the rock on each screen is thus separated and transported by chutes to separate piles; (12) the level below the last screen receives sand that is also separated; (13) any rock that cannot fall through the top screen is sent for further crushing and returned to the sorting machine; (14) the protested transactions only include those screens that were first used to produce a new product size for a customer and replaced screens that were used to make other product sizes; (15) though some of the invoices contained three screens, those screens are butted against each other to make a single deck in the sorting machine; (16) the Ni-hard paddles are harder than the other paddles; (17) the protested paddle purchases involve the replacement of a few existing broken paddles with Ni-hard paddles; and (18) an additional protested transaction involved the replacement of roughly in paddles. 8 After a general discussion of the burdens of proof in tax proceedings, a legal analysis with associated conclusions shall follow regarding the relevant transactions. 8 This invoice represents a replacement of roughly 7 to 8% of the paddles in a flight. This percentage was calculated using the invoice price and the Taxpayer s Representative s assertion that is the cost to replace half of the paddles. 7

8 follows: CONCLUSIONS OF LAW Burdens of Proof Ark. Code Ann (c) (Supp. 2015) provides, in pertinent part, as The burden of proof applied to matters of fact and evidence, whether placed on the taxpayer or the state in controversies regarding the application of a state tax law shall be by preponderance of the evidence. A preponderance of the evidence means the greater weight of the evidence. Chandler v. Baker, 16 Ark. App. 253, 700 S.W.2d 378 (1985). In Edmisten v. Bull Shoals Landing, 2014 Ark. 89, at 12-13, 432 S.W.3d 25, 33, the Arkansas Supreme Court explained: A preponderance of the evidence is not necessarily established by the greater number of witnesses testifying to a fact but by evidence that has the most convincing force; superior evidentiary weight that, though not sufficient to free the mind wholly from all reasonable doubt, is still sufficient to incline a fair and impartial mind to one side of the issue rather than the other. The Department bears the burden of proving that the tax law applies to an item or service sought to be taxed, and a taxpayer bears the burden of proving entitlement to a tax exemption, deduction, or credit. Ark. Code Ann (d) (Supp. 2015). Statutes imposing a tax or providing a tax exemption, deduction, or credit must be reasonably and strictly construed in limitation of their application, giving the words their plain and ordinary meaning. Ark. Code Ann (a), (b), and (e) (Supp. 2015). If a well-founded doubt exists with respect to the application of a statute imposing a tax or providing a tax exemption, deduction, or credit, the doubt must be resolved against the 8

9 application of the tax, exemption, deduction, or credit. Ark. Code Ann (f)(2) (Supp. 2015). Assessed Transactions Arkansas Gross Receipts (sales) Tax generally applies to all sales of tangible personal property within the State of Arkansas. Ark. Code Ann (Repl. 2014). Arkansas Compensating (use) Tax generally applies to the storage, use, distribution, or consumption of tangible personal property within the state of tangible personal property that purchased outside the state. Ark. Code Ann (Repl. 2014). The purchases at issue are tangible personal property and, thus, are generally taxable unless the Taxpayer can demonstrate entitlement to an exemption by a preponderance of the evidence. This matter turns on whether the transactions at issue qualify for the manufacturing machinery and equipment exemption under Ark. Code Ann (Repl. 2014) and (Repl. 2014). Ark. Code Ann (Repl. 2014) is largely mirrored in the use tax exemption for manufacturing machinery and equipment codified at Ark. Code Ann (a) (Repl. 2014). Sales tax exemptions are applied uniformly with use tax exemptions. Ark. Code Ann (Repl. 2014). The Arkansas Gross Receipts Tax Rules governing the manufacturing exemption control the application of the manufacturing use tax exemption as well. Arkansas Use Tax Rule UT-2. 9 Boiled down to its simplest terms, the provisions of Ark. Code Ann (Repl. 2014) provide an exemption from tax on purchases of machinery 9 For the remainder of this decision, the manufacturing machinery and equipment exemption shall be referenced by solely citing the sales tax exemption located at Ark. Code Ann (Repl. 2014). 9

10 and equipment purchased by a manufacturer for direct use in manufacturing an article of commerce. The statute actually creates three separate exemptions. The provisions of Ark. Code Ann (a)(1) (Supp. 2015) provide an exemption for the purchase of machinery and equipment necessary to create a new manufacturing facility or to expand an existing facility. The provisions of Ark. Code Ann (a)(2) (Supp. 2015) provide an exemption for the purchase of machinery and equipment that replace substantially all of an existing unit of machinery and equipment that is necessary to perform an essential function in the manufacturing process. The provisions of Ark. Code Ann (a)(3) (Supp. 2015) provide an exemption for the purchase of machinery and equipment used to prevent or reduce pollution or contamination that might otherwise result from manufacturing operations. An analysis of Ark. Code Ann (a)(1) (Supp. 2015) and the governing case law shows that the exemption found in section (a)(1) is reserved for a manufacturer s purchase of machinery and equipment that results in a new manufacturing or expands existing manufacturing within the State of Arkansas. In Holbrook v. Healthport, Inc., 2014 Ark. 146, at 5-6, 432 S.W.3d 593, , the Arkansas Supreme Court explained the method for analyzing a statute and stated as follows: The basic rule of statutory construction is to give effect to the intent of the legislature. Calaway v. Practice Mgmt. Servs., Inc., 2010 Ark. 432, 2010 WL Where the language of a statute is plain and unambiguous, this court determines legislative intent from the ordinary meaning of the language used. Id. In considering the meaning of a statute, this court construes it just as it reads, giving the words their ordinary and usually accepted meaning in common language. Id. This court construes the statute so that no word is left void, superfluous, or insignificant, and this court gives meaning and effect to every word in the statute, if possible. Id. 10

11 If the language of a statute is clear and unambiguous and conveys a clear and definite meaning, it is unnecessary to resort to the rules of statutory interpretation. Brown v. State, 375 Ark. 499, 292 S.W.3d 288 (2009). However, this court will not give statutes a literal interpretation if it leads to absurd consequences that are contrary to legislative intent. Brock, supra. A statute is considered ambiguous if it is open to more than one construction. Pulaski Cnty. v. Ark. Democrat Gazette, Inc., 370 Ark. 435, 260 S.W.3d 718 (2007). When a statute is ambiguous, this court must interpret it according to legislative intent and our review becomes an examination of the whole act. Helena W. Helena Sch. Dist. v. Fluker, 371 Ark. 574, 580, 268 S.W.3d 879, 884 (2007). In reviewing the act in its entirety, this court will reconcile provisions to make them consistent, harmonious, and sensible in an effort to give effect to every part. Williams v. Little Rock Sch. Dist., 347 Ark. 637, 66 S.W.3d 590 (2002). In addition, this court must look at the legislative history, the language, and the subject matter involved. Id. However, when a statute is clear, it is given its plain meaning and this court will not search for legislative intent. Cave City Nursing Home, Inc. v. Ark. Dep't of Human Servs., 351 Ark. 13, 89 S.W.3d 884 (2002). This court is very hesitant to interpret a legislative act in a manner that is contrary to its express language, unless it is clear that a drafting error or omission has circumvented legislative intent. Id. In applying the rules of statutory construction set forth by the Arkansas Supreme Court, the provisions of Ark. Code Ann (a)(1) and (a)(2) must be interpreted in such a way as to make them consistent, harmonious, and sensible in an effort to give effect to every part of the statute. Here, the legislature created an exemption for machinery that expands manufacturing in Arkansas and a separate exemption for the replacement of existing machinery and equipment, requiring a substantial replacement. A harmonious interpretation requires that the exemption located (a)(2) be exclusively utilized in determining whether a replacement part qualifies for the manufacturing machinery and equipment exemption. As a result of the above conclusions, the screens and paddles (which replace existing components) must be analyzed as replacement 11

12 machinery under (a)(2) and cannot be considered as expansion machinery under (a)(1). Under (a)(2), a taxpayer must prove that it replaced substantially all of the existing machinery and equipment necessary to perform an essential manufacturing function in order to qualify for exemption. In addition to meeting all other requirements of the statute. Additionally, the Arkansas Supreme Court has explained that all of the machines and devices that are interconnected to accomplish a single purpose must be analyzed as a single machine. Arkansas Gross Receipts Tax Rule GR-3(I), S H & J Drilling Corp. v Qualls, 268 Ark. 71, 593 S.W.2d 178 (1980), and Southern Steel & Wire Co. v. Wooten, 276 Ark. 37, 631 S.W.2d 835 (1982). Arkansas Gross Receipts Tax Rule GR-55 addresses the tax exemption for manufacturing machinery and equipment and provides, in pertinent part, as follows: D. REPLACEMENT MACHINERY. Machinery and equipment purchased to replace existing machinery and equipment and used directly in producing, manufacturing, fabricating, assembling, processing, finishing or packaging of articles of commerce at manufacturing or processing plants or facilities in this state will be exempt from the tax if: 1. The machinery and equipment satisfies the requirements of GR-55(B)(1), (B)(2), and (B)(3); and 2. The "machinery and equipment purchased to replace existing machinery" means that substantially all of the machinery and equipment required to perform an essential function is physically replaced with new machinery. The term "substantially" is intended to exclude routine repairs and maintenance and partial replacements - but is not intended to mean that foundations and minor components that can be economically adapted, rebuilt, or refurbished must be substantially replaced when such replacement would be more expensive or impractical than adapting, rebuilding or refurbishing the old foundation or minor components. 3. When individual machines or machinery are interconnected in order to accomplish a single function and the function of each such 12

13 individual machine is not complete before the adjacent machines begin to function, the result is a new single identifiable machine. The machinery purchased to replace this resulting existing machine must satisfy the requirements of GR-55(D)(2) above and the exemption is not available for the replacement of only some of the individual machines that now form component parts of the aforementioned machine.... Here, both the paddles and screens are components of larger machines and were not associated with replacements of a substantial amount of those machines. At this point the Taxpayer has not demonstrated that the replacement of several of the paddles constituted a substantial replacement of the washing machine or that the replacement of the screens constituted a substantial replacement of the sorting machine. 10 Consequently, the Taxpayer has not proven entitlement to the manufacturing machinery and equipment exemption by a preponderance of the evidence and the Department correctly assessed the Taxpayer on the protested purchases of the paddles and screens in this matter. Interest must be assessed upon tax deficiencies for the use of the State s tax dollars. See Ark. Code Ann (Repl. 2012). DECISION AND ORDER The assessment, after the adjustments agreed to by the Department, is sustained in full. The file is to be returned to the appropriate section of the Department for further proceedings in accordance with this Administrative Decision and applicable law. Pursuant to Ark. Code Ann (Supp. 2015), unless the Taxpayer requests in writing within twenty (20) days of the mailing of this decision that the Commissioner of Revenues revise the decision of 10 The Department s additional argument that the screens did not produce a new product because the rock sizes are determined by the crusher is rendered moot by this determination and, thus, that argument shall not be addressed. 13

14 the Administrative Law Judge, this decision shall be effective and become the action of the agency. The revision request may be mailed to the Assistant Commissioner of Revenues, P.O. Box 1272, Rm. 2440, Little Rock, Arkansas The Commissioner of Revenues, within twenty (20) days of the mailing of this Administrative Decision, may revise the decision regardless of whether the Taxpayer has requested a revision. The Taxpayer may seek relief from the final decision of the Administrative Law Judge or the Commissioner of Revenues on a final assessment by following the procedure set forth in Ark. Code Ann (Supp. 2015). DATED: November 29,