STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION (USE TAX) 3

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1 STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION IN THE MATTER OF (ACCT. NO.: ) GROSS RECEIPTS (SALES) & COMPENSATING USE TAX ASSESSMENT AUDIT NO. AUDIT PERIOD: DEC THROUGH SEPT DOCKET NOS.: (SALES TAX) (USE TAX) 3 TODD EVANS, ADMINISTRATIVE LAW JUDGE APPEARANCES This case is before the Office of Hearings and Appeals upon written protest dated March 27, 2017, signed by ( President ) on behalf of the, the Taxpayer. The Taxpayer protested the assessments issued by the Department of Finance and Administration ( Department ). A hearing was held in this matter on September 12, 2017, at 10:30 a.m. in Little Rock, Arkansas. The Department was represented by Lauren Ballard, Attorney at Law, Office of Revenue Legal Counsel ( Department s Representative ). Also present for the Department was Devon Toney, Tax Auditor, ( Auditor ) and Guy Meneley, Audit Supervisor ( Audit Supervisor ). 1 All listed amounts do not represent concessions agreed to by the Department after the assessment. 2 This amount represents (Tax) and (Interest). 3 This amount represents (Tax) and (Interest). 1

2 The Taxpayer was represented by, Attorney at Law ( Taxpayer s Representative ) at the administrative hearing. Also present for the Taxpayer was the President and ( Cost Accountant ). The record was closed and this matter was submitted for a decision on September 12, ISSUE Whether the Department s assessment of certain transactions, after concessions, are correct under Arkansas law. Yes. 4 FACTS AND CONTENTIONS OF THE PARTIES The Department provided a summary of several relevant facts in its Answers to Information Request, stating as follows: ("Taxpayer'') is a printer and located in, Arkansas. The printer uses a method of printing known as is a quick, high capacity form of printing that involves ink being referred to as " The then the paper being printed. The printing plates are often inked and washed clean by separate rollers. A visual diagram of this basic process is attached, along with a copy of the actual schematic of the Taxpayer's machine, as Exhibit l. The rollers and cylinders often wear down with time and must either be repaired or replaced. On November 9, 2015, the Department of Finance and Administration ( Department") conducted an initial audit appointment through its auditor Devon Toney ("auditor"). The auditor reviewed sales invoices, journals, purchase invoices, credit card statements, and fixed asset listings to determine unreported taxable purchases. The auditor worked with the Taxpayer to resolve some items. To continue the audit while allowing time for the Taxpayer to respond, the Taxpayer provided the auditor with a waiver and extension of the statute of limitations through January 31, A copy of the executed waiver is attached as Exhibit 2. After reviewing the relevant invoices, the auditor requested exemption certificates from the purchasers. The auditor was informed that the 4 This decision does not address any concessions agreed to by the parties. 2

3 Taxpayer did not have copies of exemption certificates. Despite the Taxpayer's failure to retain these certificates, the auditor requested that the Taxpayer collect exemption certificates from the purchasers and, if valid, used the exemption certificates to qualify certain invoices for exemption. Of those presented, the auditor disallowed several exemption certificates as invalid. A copy of those exemption certificates is attached as Exhibit 3. The auditor maintained a listing of disallowed exempt sales with both the Taxpayer's and Department's respective positions on the invoices. A copy of the listing is attached as Exhibit 4. The auditor then compiled a final schedule of all sales and use tax assessed against the taxpayer. These final audit schedules are attached as Exhibit 5. Sales Tax. With respect to sales tax, the Department concluded that the Taxpayer should have collected sales tax on many invoices that it categorized as tax exempt. Of those, most exemptions were disallowed because the Taxpayer did not provide a tax exemption certificate from the purchaser claiming that the sales were sale for resale. In most of these sales, the purchaser was distributing the product free of charge. In some invoices, the exemptions were disallowed because the Taxpayer neglected to provide sufficient proof that invoices were written off as bad debt. Use Tax. With respect to use tax, the Department concluded that the Taxpayer should have remitted use tax on many out of state purchases, including rollers, printing and press cleaning supplies. The auditor allowed an exemption for printing and plates. HEARING TESTIMONY The Auditor s Testimony During the administrative hearing, the Auditor testified that she performed the relevant audit of the Taxpayer. She completed the audit by reviewing sales and purchase journals, sales and purchase invoices, and credit card statements. She stated that the Taxpayer is a printing company that produces and for customers. During a plant tour, she reviewed the printing process. The Taxpayer utilizes 5 The Taxpayer later conceded the printing 3

4 The process utilizes rollers and however, the only item that imparts ink onto the paper is the The Auditor testified that the functions as the physical die or mold of the print job. She argued that the rollers function as components of the and distribute ink and water to the The rollers wear out over time. She asserted that the replacement of rollers are taxable as insubstantial replacements of components of the the Taxpayer also utilizes an item referred to as a She stated that are used to during the printing process, function as components of the and wear out over time. The printing were deemed exempt during the audit as the initial die or mold of the print job but the rollers and were deemed taxable as replacement parts of the The Auditor asserted that the rollers are not molds or dies because they do not create or determine the shape of the print jobs. The Auditor next stated that the are component parts of the motors and and constitute taxable replacement parts. During the audit, she did not remember reviewing invoices containing printing plates. The Auditor concluded that chemicals used to cure or set the ink were deemed exempt during the audit. However, she explained that cleaning chemicals (such as autowash, easyclean, globalwash, wipes, and additional chemicals) were used to clean the between jobs and do not become an integral part of the finished process. She concluded that the cleaning chemicals were taxable and not exempt under GR She explained that is used to connect two paper rolls prior to printing to create a 4

5 continuous roll of paper. The Auditor stated that the is eventually cut off, thrown away, and does not become a component part of the product sent to customers. She argued that the should be taxable as tangible personal property. Regarding the sales tax audit and the exemption certificates, the Auditor testified that the Taxpayer did not have any exemption certificates on file at the beginning of the audit. She allowed the Taxpayer to acquire exemption certificates over 120 days from its registered customers. Some of the customers exemption certificates or letters were disallowed by the Auditor because those items lacked a valid sales tax permit number. Either no exemption certificates or invalid certificates were provided by the the and the The Auditor proceeded to discuss the transactions with specific customers. She asserted that the did not possess a sales permit. That customer did provide a signed exemption certificate to the Taxpayer but did not provide an account number. She stated that did not make an exemption claim regarding its purchases. also issued an exemption claim letter to the Taxpayer but lacked a sales tax permit during the audit period. The Auditor further stated that the did not provide an exemption certificate and did not possess a sales tax permit. The Auditor, however, was told that (a customer possessing a Arkansas sales tax permit) was the actual purchaser for those transactions. She 5

6 asserted that the was billed for these transactions and was the purchaser. The Auditor asserted that those transactions were also taxable. provided an exemption claim letter but did not have a sales tax permit during the audit period. She further testified that the did not make an exemption claim for their purchases of, and an Additionally, the Auditor asserted that many of the printed materials that are purchased by the Taxpayer s customers are distributed for free to and not resold. She provided the following examples of that are simply given away to ( and (newspaper inserts or given away), and the She stated that the associated should not qualify as for purposes of Arkansas Gross Receipts Tax Rule GR-48(F) (an exemption for sold by regular The Auditor explained that she did not assess sales of (provided by the to its customers without an additional charge); however, she noted that customer provided a valid exemption certificate to the Taxpayer. The Auditor then explained that the bad debt deductions for the and transactions were denied because the Taxpayer has not shown that these items were deducted as bad debts. Early in the audit, the Auditor was informed that the purchases were donated to the organization as charitable contributions without a collection 6

7 effort. Later in the audit, however, she was told that collection was attempted but the items had not been written off as bad debts. She asserted that the governing rules require that the items be reported and later written off as bad debts to be removed from the assessment. Since the transactions had not been reported or written off, she deemed these transactions to be taxable. The President The President testified that he has worked for the Taxpayer for eleven (11) years, is extremely familiar with its printing process, and is involved in repair decisions. He explained that the uses to create ninety-nine-point-nine percent (99.9%) of the remaining colors during the printing process. After printing, the printed material ultimately goes through an oven to cure the ink. The Taxpayer utilizes : a ( and a ( He testified that the rollers at issue are used to transfer the ink across multiple rollers (referred to as the to an aluminum printing plate that is attached to the plate cylinder. The rollers are cylinders. The rollers contain a steel or hollow core with a rubber (or some other substrate) coating its exterior. The rollers are stored on a consignment basis. When the rubber or nylon coating for a roller is worn off, it is returned to the vendor for recoating and a stored roller is cycled into production. The rollers are thus rotated with the vendor; however, the Taxpayer does not necessarily own any particular roller core. Each roller lasts for an uncertain length of time but are generally not replaced too often. Some rollers are replaced at least once a month. If a core is damaged, the Taxpayer must buy a new replacement core. He explained that the rollers ensure 7

8 that the ink and water mixture is uniformly applied to the printing plate. While the printing plates have to be replaced between jobs, the rollers typically will not need to be replaced at that time. The rollers function is to flatten the ink to create a thin film of ink that is ultimately applied to the upper and lower printing plates. He asserted that the rollers shape or mold the ink to create a uniform print. The rollers, however, do not make contact with the paper. In the rollers absence, the President explained that the printing process would not work. Describing the use of the printing ink, the President testified that the printing ink is purchased in totes and pumped to fountain jets on The ink fountain contains a series of and that are opened and closed by the which controls the amount of each ink type that is dispensed onto the first roller and ultimately onto the printed paper. An opens and closes a The are automatically controlled by the The creates a preset that will be manually adjusted by the pressmen to correct any print issues. The closed loop contains several s that take photos of the printed product to ensure that the printed material meets specifications. The sends its information back to the and pressmen. A had been used for years, but the system was completely replaced with a new system in 2016 (outside the audit period) and several components of the system were also replaced during the audit period. Several items (such as lens trays and a computer system from were replaced in March 2013, September 2013, and March

9 Those transactions involved the replacement of an that said was faulty. At this point, the President described the system as being essentially gutted with replacement of the associated electronics. The President explained that the camera was replaced with the track and motors that move the camera. The computers, software, and other internal components were also replaced along with many of the wires. He asserted that only the camera case was reused. The have been related to the charges from March, May, and August 2015 might replacement, but he does not know for sure. After the rollers, the ink is eventually applied to a printing plate. The President explained that the printing plate contains small indentions to repel or attract ink. The water (containing a chemical called repels the oil-based ink from certain places on the printing plate. A portion of the ink, water, and will be transferred to the finished product. After ink is applied, the printing plate provides a Two types of are utilized by the Taxpayer: on and a on Discussing the cleaning of the presses, the President testified that must be manually cleaned. however, has nozzles that spray cleaning chemicals onto the machine for cleaning between print jobs. A small amount of the cleaning chemicals does remain on the finished product but most of those chemicals are burnt off within the ovens. The cleaning chemicals do not have a purpose in the final product. If all of the cleaning chemicals could be removed from the final product, it would not affect the final product, because it is not a 9

10 necessary component of that product. The cleaning chemicals; however, must be used to clean the printer and ensure a clean print. Without the cleaning chemicals, the press would have to be dismantled and cleaned between jobs. When a job is stopped, the are still set and pouring ink, resulting in a major mess that must be cleaned between jobs. The function of the cleaning chemicals is to remove excess ink from the rollers and before, during, and after a print job. Discussing the the President explained that the is sticky on both sides and is used to combine two rolls of paper to ensure a continuous print. The should be thrown away; however, it has been accidently left on printed materials received by customers. The should not be part of the final product. Discussing the UV lamps, the President testified that the UV lamps contained in the coating system to apply a June 2011 invoice are utilized in the UV or finish to That finish is a chemical coating that becomes a component part of the finished product. The President stated that the UV lamps help to cure that coating. The lamps are installed at between the. He asserted that the UV lamps do not apply the chemical but are a mold or die due to their curing activity. The Cost Accountant The Cost Accountant testified that the becomes involved. She was of the opinion that is also where the replaced every component of the except the box that holds the camera on 10

11 the track. She said that the replacement was accomplished in a piecemeal fashion while tried to repair the existing Discussing the sales tax exemption claims, the Cost Accountant testified that the Taxpayer prints for the which was originally picked up but later removed by the Auditor. The prints a regular that is solely sent to of that For the she stated that the Taxpayer prints a ( that is only received by paying of the organization. The application on the website states that the is included with the payment of The Taxpayer directly mails the to that The Cost Accountant requested an exemption certificate from the that and was informed by that customer should be exempt as a sale which is resold on based on the advice from their accountant. Their accountant also informed the that a sales tax permit was not necessary because it only performed exempt sales. The signed an exemption certificate for the Taxpayer but did not register for a sales tax account. The later applied for a permit but had not received it by the time of the hearing. Discussing other customers, the Cost Accountant testified that provides a for various state Currently, the Taxpayer directly prints the for the The Cost Accountant stated that the cost of the 11

12 is included in each The Taxpayer also prints a which is also included in the She further testified that produces several including and She asserted that the cost of these is included in the for of the Arkansas and The Cost Accountant was not aware of any separately stated charge for the She thinks, at one time, charged for the from its however, she does not have any paperwork to confirm that fact. The Cost Accountant further testified that stated that their attorney instructed them not to register for sales tax because it was selling the items on a this statement. Though the Accountant stated that for the She also spoke with that attorney who confirmed would not provide an exemption certificate. is billed for their purchases, the Cost is the actual customer sales because provides the draft to be printed and makes the order. She does not discuss the transaction with the She stated that possesses a sales tax permit and provided an exemption certificate. She also explained that the does not have a permit and could not provide an exemption certificate. The Taxpayer prints and the newsletter for that customer. The Cost Accountant explained that both of these are only provided to that pay 12

13 If had provided an exemption certificate prior to the audit, the Cost Accountant said that she would have relied on that document and not charged sales tax to the customer. The Cost Accountant additionally testified that prints which is sold in grocery stores or by Though the Taxpayer has requested an exemption certificate, that customer has only provided a copy of their sales tax permit. 6 The purchases an and cards from the Taxpayer. The Taxpayer directly mails those items to the Discussing the bad debt deduction, the Cost Accountant explained that the Taxpayer does not expect the to pay its bill. She explained that a disagreement erupted between the Taxpayer s owners over whether the transactions were gifts or should be paid. The Cost Accountant testified that she did invoice the and try to collect the amount owed. During a subsequent telephone call with the customer, she stated that the refused to pay the bill, thinking it was a donation. The owed more than as of August 1, The original invoices were dated from 2013 and The Taxpayer did not report the items as bad debts for sale tax purposes to her knowledge. The Cost Accountant further testified that the Taxpayer has reported these amounts as bad debts for income tax purposes. After a general discussion of the burdens of proof in tax proceedings and a discussion of the applicable law, each contested category of the protested 6 A copy of this permit is not present in the record, Exhibit 3 to the Department s Answers to Information Request does include a letter from this customer, which states that its publication are sold by a That letter, however, does not provide a sales tax account number. 13

14 transactions shall be addressed with a summary of the parties legal arguments, a legal analysis, and associated conclusions. follows: CONCLUSIONS OF LAW Burdens of Proof Ark. Code Ann (c) (Supp. 2017) 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. 2017). 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. 2017). If a well-founded doubt exists with respect to the application of a statute imposing a tax or providing a tax 14

15 exemption, deduction, or credit, the doubt must be resolved against the application of the tax, exemption, deduction, or credit. Ark. Code Ann (f)(2) (Supp. 2017). Tax Assessment I. Sales Tax Issues After a general discussion of the law governing the application of Arkansas sales tax, the protested items shall be addressed in turn. Arkansas Gross Receipts (sales) Tax generally applies to all sales of tangible personal property and certain specifically enumerated services, unless an exemption or credit is shown to apply. Ark. Code Ann (Supp. 2017). Printing services of all kinds are specifically enumerated taxable services. Ark. Code Ann (4) (Supp. 2017). Initially, the Taxpayer s services generally qualify as printing services. Consequently, its services are taxable unless an exemption is shown to apply. Generally, the liability for collection and remittance of sales tax is upon the seller. Ark. Code Ann (Supp. 2017). A seller, however, may be relieved of this liability if the customer makes an exemption claim and the seller obtains certain information from that customer. Ark. Code Ann (a) (Supp. 2017). At that point, the purchaser will become liable for the sales tax liability if the Department ultimately determines that the purchaser improperly claimed an exemption. Ark. Code Ann (e) (Supp. 2017). If a seller fails to obtain sufficient information from a purchaser making an exemption claim, a safe harbor is present. Ark. Code Ann (g)(2)(A) (Supp. 2017). Under that subsection, the seller is granted an additional one hundred and twenty (120) days from the date of the Department s request for 15

16 substantiation to prove by other means that the transaction was not subject to sales or use tax or to obtain in good faith a fully completed exemption certificate from the purchaser. Id. To obtain an exemption certificate in good faith, the exemption must have been available at the time in the jurisdiction where the transaction is sourced, could be applicable to the item being purchased, and must be reasonable for the purchaser s business. Ark. Code Ann (g)(2)(B) (Supp. 2017). Further, the Arkansas Supreme Court has explained that the Arkansas General Assembly is sole arbitrator of policy decisions within Arkansas and it would be inappropriate for an administrative agency or court to refuse to enforce a state law as it reads based on a policy disagreement. Snowden v. JRE Investments, Inc., 2010 Ark. 276, 370 S.W.3d 215. Consequently, any arguments by the Taxpayer s Representative that governing statutes reach a harsh or unfair result and equitable remedies should be granted in the alternative must be rejected. a. Sale for Resale Exemption In his Answer s to Information Request, the Taxpayer s Representative asserted that the Auditor agreed that the Taxpayer s sales were exempt as sales for resale because she exempted any transactions where the customer provided a valid resale certificate. 7 He proceeded to argue that the transactions still qualified 7 Based on the record, it appears that this statement represents a misunderstanding of the Auditor s analysis. Here, it appears that the Auditor excluded these transactions because the customers provided a qualifying exemption claim. As stated above, a qualifying exemption claim shifts the tax burden from the seller to the purchaser even if the exemption claim is later determined to be improper. Consequently, the removal of these transaction from the audit does not necessarily mean that the Auditor concluded that the purchases qualified for the sale for resale exemption. 16

17 as sales for resale even if the Taxpayer s customers did not possess sales tax permits so long as the subsequent resale of the items qualified as exempt sales under Arkansas Gross Receipts Tax Rule GR-48(F). He argued that requiring the Taxpayer s customers to obtain a sales tax permit to purchase items for resale (when he concluded that the subsequent resales were exempt) was too burdensome and improperly taxed transactions that were otherwise exempt. During the administrative hearing, the Department s Representative argued that the provided sales tax exemption certificates were invalid due to the absence of sales tax permit numbers. Even if the certificates were valid, she argued that the exemption certificates could not be applied to relieve the Taxpayer of liability because the and were given away to of their and not resold. Consequently, she argued that sale for resale exemption could not be applicable to the items purchased as required by Ark. Code Ann (g)(2)(B) (Supp. 2017). During the administrative hearing, the Taxpayer s Representative noted that, if the customers failing to provide an exemption certificate had provided one, the Auditor would not have assessed the transactions (like the invoices). Consequently, he reasoned that it was irrelevant whether the transactions actually qualified for the sale for resale exemption. He again asserted that it was unfair to require the Taxpayer s customers to obtain sales tax permits since he concluded that their sales should qualify as exempt under Arkansas Gross Receipts Tax Rule GR-48. He acknowledged that the Taxpayer must collect Arkansas sales tax in the absence of an exemption 17

18 certificate under the law; however, he argued that application of the law in this matter was improper because it resulted in taxation of transactions that were otherwise exempt. He explained that the Taxpayer s position could be characterized as a plea for equitable relief. One narrow exemption is implicated by the arguments raised by the parties with respect to these transactions: the sale for resale exemption. Ark. Code Ann (12)(A) (Supp. 2017) grants a narrow exemption for sales for resale, stating as follows: Gross receipts or gross proceeds derived from sales for resale to persons regularly engaged in the business of reselling the articles purchased, whether within or without the state if the sales within the state are made to persons to whom gross receipts tax permits have been issued as provided in [Emphasis supplied]. Under the governing statute, a customer may not claim the sale for resale exemption unless that customer has attained a sales tax permit. Consequently, in the absence of a sales tax permit, the transaction cannot qualify as a sale for resale and the Taxpayer s exemption claim cannot satisfy the requirement contained at Ark. Code Ann (g)(2)(B)(ii) (Supp. 2017) (stating that the exemption must be potentially applicable to the items being purchased). Though the Taxpayer s Representative asserted that this seems unfair or burdensome for customers, those arguments do not allow this Office to overlook the express statutory requirement that customers must possess a sales tax permit 8 The requirement that the purchaser must possess a sales tax permit is repeated in Arkansas Gross Receipts Tax Rule GR-53(A), a subsection of the governing regulation. 18

19 to qualify for the sale for resale exemption. 9 The analysis of the relevant transactions shall proceed with the understanding. i. In his protest, the Taxpayer s Representative asserted that this transaction should be exempted as a sale for resale. In his Answers to Information Request, the Taxpayer s Representative explained that the fee for the monthly at issue is included in the for the. He asserted that no exemption certificate should be required based on his analysis stated above. In her Answers to Information Request, the Department s Representative asserted that, though this customer made an exemption claim by letter, this ( was not resold but given away to of the and did not qualify as a regular under Arkansas Gross Receipts Tax Rule GR-48. Consequently, she reasoned that the Taxpayer cannot demonstrate that the sale for resale exemption could be available for the purchased item, under Ark. Code Ann (g)(2)(B) (Supp. 2017). No sales tax account number was contained in the provided exemption certificate. 10 Here, the Auditor has explained that the did not possess a sales tax permit during the audit period. 11 The Taxpayer has not shown that the sale for resale exemption could apply to these transactions by a 9 The issue of whether or not the Taxpayer s customers transactions qualify as exempt under Arkansas Gross Receipts Tax Rule GR-48(F) even though the are not separately billed to the shall not be addressed in this decision as it is rendered moot. 10 See Exhibit 3 to the Department s Answers to Information Request. 11 The Cost Accountant s testimony also supported this statement. 19

20 preponderance of the evidence. Thus, the transaction does not qualify as a sale for resale and the Taxpayer s exemption claim cannot satisfy the requirement contained at Ark. Code Ann (g)(2)(B)(ii) (Supp. 2017). Consequently, the Department s assessment of these transactions is sustained. ii. In his protest, the Taxpayer s Representative asserted that this transaction should be exempted as a sale for resale or as services not subject to tax. In his Answers to Information Request, the Taxpayer s Representative explained that the fee for the for the at issue is included in the He asserted that no exemption certificate should be required based on his analysis stated above. In her Answers to Information Request, the Department s Representative asserted that the Taxpayer cannot be relieved of its tax liability for these transactions because the Taxpayer has not shown that this customer made a sales tax exemption claim at the time of the transaction or during the audit. Here, the Auditor has testified that this customer did not make an exemption claim regarding its purchases. Additionally, it is not shown that the customer possessed a sales tax permit during the Audit Period. The Taxpayer has not shown that the sale for resale exemption applies to these transactions by a preponderance of the evidence. Consequently, the Department s assessment of these transactions is sustained. iii. In his protest, the Taxpayer s Representative asserted that this transaction should be exempted as a sale for resale. In his Answers to Information Request, 20

21 the Taxpayer s Representative explained that the fees for the annual at issue are included in the for the relevant 12 He asserted that no exemption certificate should be required based on his analysis stated above. In her Answers to Information Request, the Department s Representative explained that this customer stated that it is a company responsible for producing ( and clients. She asserted that, since without cost to their for its customers provide the the items do not qualify as sales for resale, and the items do not qualify as regular under Arkansas Gross Receipts Tax Rule GR-48. Consequently, she reasoned that the Taxpayer cannot demonstrate that the sale for resale exemption could be available for the purchased item, under Ark. Code Ann (g)(2)(B) (Supp. 2017). No sales tax account number was contained in the exemption claim letter. 13 Here, the Auditor testified that this customer did not possess a sale tax registration during the Audit Period. 14 The Taxpayer has not shown that the sale for resale exemption could apply to these transactions by a preponderance of the evidence. Thus, the transaction cannot qualify as a sale for resale and the Taxpayer s exemption claim cannot satisfy the requirement contained at Ark. 12 These transactions are dissimilar from the other discussed in this opinion in that the do not pay for these The printing costs are paid by in exchange for the This transaction structure would appear to undercut the statement that the purchase and resell these to their 13 See Exhibit 3 to the Department s Answers to Information Request. 14 The Cost Accountant s testimony also supported this statement. 21

22 Code Ann (g)(2)(B)(ii) (Supp. 2017). Consequently, the Department s assessment of these transactions is sustained. iv. In his protest, the Taxpayer s Representative asserted that this transaction should be exempted as a sale for resale. In his Answers to Information Request, the Taxpayer s Representative asserts is the actual customer for this transaction, is registered for the Arkansas sales tax, and provided a qualifying exemption claim. If the be the actual customer, he argued that the fee for the annual is deemed to at issue is included in the annual for the organization. He asserted that no exemption certificate should be required based on his analysis stated above. In her Answers to Information Request, the Department s Representative asserted that, though customer, all invoices are addressed to the actual customer. Further, she asserted that the claims to be the actual and that is the is distributed free of charge, does not qualify as a sale for resale, and, thus, remains taxable. Here, the Auditor testified that the was billed for the relevant transaction and was listed as the customer on the related invoices. 15 Based on this evidence, the was the customer for these transactions even though the Cost Accountant felt that transactions. should be considered the real purchaser due to its control over the 15 The Cost Accountant s testimony also supported this statement. 22

23 The Auditor further testified that the did not possess a sales tax permit during the Audit Period. 16 The Taxpayer has not shown that the sale for resale exemption could apply to these transactions by a preponderance of the evidence. Thus, the transaction cannot qualify as a sale for resale and the Taxpayer s exemption claim cannot satisfy the requirement contained at Ark. Code Ann (g)(2)(B)(ii) (Supp. 2017). Consequently, the Department s assessment of these transactions is sustained. v. In his protest, the Taxpayer s Representative asserted that this transaction should be exempted as a sale for resale. In his Answers to Information Request, the Taxpayer s Representative asserted that this relevant publication is resold at retail and the Taxpayer would attempt to obtain a qualifying exemption claim prior to the administrative hearing. In her Answers to Information Request, the Department s Representative asserted that, though the customer claimed its ( and are sold on by a third party ( that statement is incorrect and the are actually distributed free of charge. Consequently, she reasoned that the Taxpayer cannot demonstrate that the sale for resale exemption could be available for the purchased item, under Ark. Code Ann (g)(2)(B) (Supp. 2017). No sales tax account number was contained in the exemption claim letter. 17 Here, the Auditor testified that did not possess a sales tax permit during the Audit Period. The Taxpayer has not shown this assertion to be 16 The Cost Accountant s testimony also supported this statement. 17 See Exhibit 3 to the Department s Answers to Information Request. 23

24 incorrect. The Taxpayer has not shown that the sale for resale exemption could apply to these transactions by a preponderance of the evidence. Thus, the transaction cannot qualify as a sale for resale and the Taxpayer s exemption claim cannot satisfy the requirement contained at Ark. Code Ann (g)(2)(B)(ii) (Supp. 2017). Consequently, the Department s assessment of these transactions is sustained. vi. In his Answers to Information Request, the Taxpayer s Representative explained that the fee for the at issue is included in the annual for the organization. He asserted that no exemption certificate should be required based on his analysis stated above. In her Answers to Information Request, the Department s Representative asserted that the Taxpayer cannot be relieved of its tax liability for these transactions because the Taxpayer has not shown that this customer made a sales tax exemption claim at the time of the transaction or during the audit. Here, the Auditor has testified that this customer did not make an exemption claim regarding its purchases. Additionally, it is not shown that the customer possessed a sales tax permit during the Audit Period. The Taxpayer has not shown that the sale for resale exemption applies to these transactions by a preponderance of the evidence. Consequently, the Department s assessment of these transactions is sustained. b. Bad Debt Deduction In his protest, the Taxpayer s Representative asserted that no tax should be due on these transactions since the customers did not pay the assessed 24

25 invoices. In his Answers to Information Request, the Taxpayer s Representative asserted that several invoices were not paid, were not donated, and were written off as bad debts. Additionally, he asserted that collection was attempted regarding these debts. He concluded that these transactions qualified for the bad debt deduction. In her Answers to the Information Request, the Department s Representative asserted that the Taxpayer has not shown that these items are eligible for the bad debt deduction under Ark. Code Ann (Repl. 2014). During the administrative hearing, the Taxpayer s Representative explained that the Taxpayer had to pay sales tax on accrued transactions that were not paid. He argued that, even though the law requires the Taxpayer to report bad debts before the deduction is allowed, the Taxpayer s failure to complete this requirement was a technical violation and requested the removal of the assessment of these transactions as equitable relief. Ark. Code Ann (Repl. 2014) allows a deduction for bad debts, stating as follows, in relevant part: (a) (1) A taxpayer is allowed a deduction from taxable sales for a bad debt. (2) Any deduction taken under this section that is attributed to a bad debt shall not include interest. (b) The federal definition of bad debt in 26 U.S.C. 166, as in effect on January 1, 2007, is the basis for calculating a bad debt deduction under this section except that the amount calculated pursuant to 26 U.S.C. 166 shall be adjusted to exclude:.... (c) (1) A bad debt may be deducted on the sales and use tax return of a taxpayer for the tax period during which: (A) The bad debt is written off as uncollectible in the taxpayer's books and records; and (B) The taxpayer is eligible to deduct the bad debt for federal income tax purposes if the taxpayer or seller kept accounts on a cash basis or could be eligible to be claimed if the taxpayer or seller kept accounts on an accrual basis. 25

26 (2) For purposes of this subsection, a taxpayer who is not required to file a federal income tax return may deduct a bad debt on a sales and use tax return filed for the period in which the bad debt is written off as uncollectible in the taxpayer's books and records if the taxpayer would be eligible for a bad debt deduction for federal income tax purposes if the taxpayer were required to file a federal income tax return. During the administrative hearing, the Taxpayer s Representative presented a three-page exhibit regarding the transactions. The first page totals the customer s invoice balance as of August 1, 2016, providing a balance of The second page lists the account as a Doubtful Acc. Finally, the third page totals the customer s outstanding invoices as of July 31, 2016, providing a balance of Here, the Auditor testified that the Taxpayer has not shown that the relevant transactions were deducted as bad debts. Additionally, the Cost Accountant has explained that there exists a disagreement between the Taxpayer s controlling families whether the transactions are properly characterized as bad debts or charitable donations. She also testified that the and the transactions were reported as bad debt for income tax purposes. Based on the record, the Taxpayer has not proven that it qualifies for the bad debt deduction with regard to these transactions. Initially, significant doubt is present whether the were actually bad debts. The Cost Accountant explained that the Taxpayer s controlling families disagreed on whether the transactions are properly characterized as bad debts or charitable donations. The Cost Accountant s description of the 26

27 collection activities was limited to a billing and a phone call, after which the matter appears to have been dropped. The collection activities seem minimal and undercut the assertion the invoices were seriously treated as bad debts by the Taxpayer. Additionally, though the Cost Accountant asserted that the and transactions were deducted as bad debts for income tax purposes, no documentation from the actual income tax returns has been presented to verify this statement. 18 The Taxpayer simply has not shown that the bad debt deduction should apply to these transactions by a preponderance of the evidence. Though the Taxpayer s Representative has proposed that certain requirements should be waived for this deduction, the deduction s requirements cannot be waived for the reasons stated within the sale for resale discussion above. Consequently, the Department s assessment of these transactions is sustained. II. Use Tax Issues Arkansas Compensating (Use) Tax generally applies to the privilege of storing, using, distributing, or consuming tangible personal property and taxable services within the State of Arkansas that were purchased outside this state. Ark. Code Ann (Supp. 2017). A purchaser is generally liable for Arkansas Use Tax unless a seller pays the tax on the purchaser s behalf. Ark. Code. Ann (Supp. 2017). Generally, the protested items represent tangible personal property and are subject to Arkansas use tax unless the Taxpayer demonstrates that an exemption applies. 18 It is uncertain how the three-page hearing exhibit supports a finding that the transactions were actually deducted for income tax purposes. 27

28 a. Dies The Taxpayer has argued that several items qualify as dies under Ark. Code Ann (c)(3)(B)(ii) (Repl. 2014). To qualify as an exempt die, tool, or device, a piece of equipment must be attached to or a part of a unit of machinery that determine the physical characteristics of the finished product.... Ark. Code Ann (c)(3)(B)(ii) (Repl. 2014). Specifically, a Taxpayer must demonstrate that an item is attached to, or part of, a unit of machinery and... imparts a predetermined and distinctive shape, pattern, texture, or finish to a material or impresses an object or material.... Arkansas Gross Receipts Tax Rule GR-56(F)(2). Under the governing regulation and statute, an exempt die need not be attached to a piece of machinery so long as the item still constitutes a part of a unit of machinery. Further, the term distinctive has been interpreted as a word of limitation. This Office has previously determined that characteristics such as flat, smooth, or shiny are descriptive of conditions of the surface of a product and do not qualify as distinctive textures or finishes. Additionally, while purchases of dies and their component parts qualify for the exemption under Arkansas Gross Receipts Tax Rule GR-56, the repairing of a die remains taxable under GR-56(D). With this background in the governing law, the protested transactions shall be analyzed. i. Rollers In his Answers to Information Request, the Taxpayer s Representative asserted that, if printing plates qualify as dies 19, the rollers should also qualify as dies because they perform essentially the same function as printing plates by 19 Printing plates are expressly listed as an example of a die under Arkansas Gross Receipts Tax Rule GR-56(G)(5). 28

29 transferring the ink directly to the printing plates. In her Answers to Information Request, the Department s Representative asserted that the rollers only directly act on other parts of manufacturing machinery and equipment and are used to either roll ink or water onto the printing plate. Consequently, she reasoned that the rollers do not qualify as dies because the rollers do not impart a predetermined or distinctive shape, pattern, texture, or finish to the finished product. During the administrative hearing, the Department s Representative additionally argued that, even if the rollers qualified as dies, the resurfacing of the rollers would remain taxable as die repairs. During the administrative hearing, the Taxpayer s Representative argued that the rollers qualify as dies by imparting a physical characteristic to the ink (a component part of the finished product). 20 He explained that the vast majority of the protested invoices involved the refinishing of rollers, but some transactions do involve the replacement of roller cores. Addressing the recovering of the rollers, he stated that the rollers are actually completely redone by stripping and replacing the outside covering (not simply repaired in house). He asserted that the roller transactions are more analogous to an inventoried replacement of the rollers. Here, the record demonstrates that the rollers function is more akin to an ink delivery system. Additionally, the rollers do not impart a predetermined and distinctive pattern to the printed material since those items do not make contact with printed material. To the extent that the rollers assist in the flattening of the ink, this Office has previously determined that flat does not qualify as a 20 This argument was also asserted in the Taxpayer s Protest. 29

30 distinctive shape, pattern, texture, or finish. Further, the vast majority of the transactions at issue involve the resurfacing of rollers whose current surface is worn out, which is properly characterized as a taxable repair to a roller s surface. Repairs to the rollers surfaces would remain taxable regardless of whether the rollers qualified as dies. Based on the record, the Taxpayer has not shown that the transactions at issue qualify for the exemption contained in Arkansas Gross Receipts Tax Rule GR-56 by a preponderance of the evidence. Consequently, the Department s assessment of these transactions is sustained. ii. In his Answers to Information Request, the Taxpayer s Representative asserted that the controls the transfer of ink through the rollers. He reasoned that this system should likewise qualify as a die since it functions as a component part of the that ultimately imparts a predetermined pattern or finish to the printed paper. In her Supplemental Answers to Information Request, the Department s Representative argued that this system does not function as a die because it does not impart a predetermined and distinctive shape, pattern, texture, or finish to the product but directly acts on other components of manufacturing machinery and equipment. During the administrative hearing, the Taxpayer s Representative asserted that, even though the components of this system were replaced in separate transactions over a six to eight-month period, the whole system was eventually replaced. If the transaction is not exempt as a substantial replacement of exempt 30

31 manufacturing machinery, he asserted, in the alternative, that the system should be exempt as a die because the system controls the. An exemption does exist for substantial replacement of certain manufacturing machinery and equipment, which includes quality control equipment that tests the quality of the manufactured product during manufacturing. See Arkansas Gross Receipts Tax Rule GR-55(I). Though the Cost Accountant testified that the major components of the relevant were replaced. She stated that this replacement was completed in a piecemeal fashion while a vendor attempted to troubleshoot problems with the existing The record shows that the was replaced through a series of separate transactions and not as a single transaction that initially intended to replace that system. Each transaction, when viewed separately, does not represent a substantial replacement of the Consequently, the Taxpayer has not demonstrated that the replacement of the qualified as a substantial replacement of manufacturing machinery and equipment under Ark. Code Ann (a)(2) (Repl. 2014). 21 In the alternative, the Taxpayer s Representative argued that the should qualify as a die if it is not a substantial replacement of a manufacturing machinery and equipment. The function is to measure the quality of the finished product and to create a preset for the 21 It should be noted that, based on the President s testimony, it is still uncertain whether the transactions from March, May, and August 2015 were related to this replacement. Since those transactions are otherwise taxable and no exemption claim is demonstrated, the Department correctly assessed those transactions as well even if they are not related to the replacement. 31