was represented by Jeffrey Weber, Attorney at Law, Office of Revenue Legal Counsel ( Department s Representative ). The Tax Auditors and Adam Hillis,

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2 was represented by Jeffrey Weber, Attorney at Law, Office of Revenue Legal Counsel ( Department s Representative ). The Tax Auditors and Adam Hillis, Audit Supervisor, appeared for the Department. The Taxpayer was represented by, and ( Taxpayer s Representatives ). Present for the Taxpayer were Tax Director,, and via telephone, Plant Engineer. ISSUE Whether the Taxpayer s purchase of a ( ) was exempt for sales and use taxes under Ark. Code Ann (Supp. 2015) and (Repl. 2014)? 1 Yes. FINDINGS OF FACT/CONTENTIONS OF THE PARTIES The Taxpayer s Opening Brief addressed the functionality of the and stated, in pertinent part, as follows: As a manufacturer of and other goods, must ensure it can meet the supply chain demands during its and the replenishment of by maintaining a level of in-process inventory. manufacturing operations involve complex processes including. employs modern techniques which allow them to perform short runs and, have a quick changeover, and utilize technology, which minimizes time to market. The manufacturing process is quite complex and requires a highly integrated system and rapid communication of inventory needs. The manufacturing process is conducted in batches..... manufacturing plants, including this facility, must produce products throughout the year, creating large quantities of inprocess inventory, which are finalized when shipment destination is determined during the. manufacturing plants have a production layout that allows for the organization of the in- 1 All other issues were resolved by the parties. 2

3 process inventory to be efficiently processed and timely shipped during..... production process is designed so that manufactured inprocess product is separated into batches of 5 or 6 pieces, called wholesale units. Bar codes are placed on the outside of each wholesale unit and then the in-process products are placed in "C boxes". C boxes are totes used to organize in-process inventory until customer orders are received and the manufacturing process can continue[.] Once orders are received, the in-process inventory is retrieved for the final step in the manufacturing process of sorting, packaging, and shipping to customers. refers to multiple orders received in a certain period of time, generally during the course of one day, as an "order wave." Order waves include orders for multiple customers and several different wholesale units. The can package up to different orders at a time. The is used to quickly and effectively sort wholesale units into orders. retrieve the appropriate mix of C boxes to fill an order wave and load them into the. The reads the bar code on each individual in-process product, that was added during the initial manufacturing, and based on the specific order, adds a sequence number which is used at the final store destination. The then distributes the appropriate mix of items into shipping boxes. The shipping boxes are then packed, labeled, and then shipped to customers. [P. 2]. The Department s Response Brief sets forth the basis for the denial of the Taxpayer s exemption claim and stated, in part: The Taxpayer, is a corporation with a manufacturing facility in, Arkansas. It manufactures and distributes, inter alia,. The equipment at issue in this protest is a which is located in the facility's distribution center. After the have been manufactured and put into containers called C-Boxes, they are stored, see Exhibit 2, Slide 3[Footnote omitted], until they are retrieved to fulfill an order from a. According to the Taxpayer, "once orders are received, the in-process inventory is retrieved" to be packaged. Taxpayer's Brief, p. 2. At this point, the that had been stored in the C-Boxes are put into the to be packaged and distributed to the. See Exhibit 1, Slide 5 video. 3

4 Because this machine is used after the manufacturing process it is taxable and the Department assessed the Taxpayer on its purchase of the Once the have been successfully manufactured, they are stored in C Boxes until the time they are retrieved from shelving to fill a. To be exempt, the machinery or equipment must be used "directly" in the manufacturing process. Ark. Code Ann (c)(1)(A) (Supp. 2015). The General Assembly has used the term "directly" to limit the exemption to those items of machinery and equipment that are "used in actual production during processing, fabricating, or assembling raw materials or semifinished materials into the form in which the personal property is to be sold in the commercial market." Id. at 402(c)(1)(B). In the present case, the is not involved during the processing, fabricating or assembling or raw materials or semifinished materials. In fact, it only interacts with completely finished materials that have gone through the manufacturing process and are simply waiting to be sent to customers. In Arkansas Beverage Co. v. Heath, 257 Ark. 991, 521 S.W.2d 835 (1975), the Supreme Court of Arkansas ruled that several pieces of machinery were used in the manufacturing process of Pepsi Cola even though their use occurred after the soft drink had been dispensed into the bottles. In so ruling, the Court noted: the process is a continuous, synchronized operation from the time the empty bottle is taken from the case until the case tilled with the bottled beverage is palletized for storage or delivery, without any human intervention, except for the removal of broken bottles and the intermittent removal of filled bottles for testing the product, and, if any one machine or device in the production line fails to function, the operation stops. In such an integrated process, we must consider each such machine or device as being used directly in producing, assembling. processing and packaging the ultimate product. Arkansas Beverage Co., 257 Ark. at 1004, 521 S.W.2d at 843. In contrast, the Taxpayer's is not part of a continuous, synchronized operation from the time the are manufacturing until they are packaged for delivery. Completely manufactured are placed in the C Boxes for storage until there is human intervention when a worker retrieves the C 4

5 Boxes and places their contents in the. The does not satisfy the requirements for the exemption. [P. 1-3]. The Taxpayer submitted a Reply Brief at the hearing, Taxpayer Exhibit 1, which provided, in pertinent part, as follows: In the Department's Response Brief, the Department states the in question is located in the facility's distribution center. The, Arkansas facility is a manufacturing and distribution facility. The facility produces large volumes of etc. The performs the final steps in the manufacturing process by reading the in-process bar code, initiating for the addition of the sequence number, sorts, and then packages the articles of commerce into shipping boxes. The Department argues the is used after the manufacturing process and does not qualify for the manufacturing exemption.... In the instant case, is not arguing that its manufacturing operation is a continuous, synchronized operation, lacking human intervention since the statute does not require an operation to be continuous, synchronized operation, or lacking human intervention to qualify for the exemption. In fact, points out that the statute allows machinery and equipment used at any time to qualify. The statute states that "machinery and equipment as shall be used directly in the actual manufacturing or processing operation at any time from the initial stage when actual manufacturing or processing begins through the completion of the finished article of commerce and the packaging of the finished end product qualifies for the exemption." (emphasis added) argues that the qualifies as packaging equipment used directly in packaging of articles of commerce. The Department's regulation GR-55.H. provides an example that a "shrink wrap machine and palletizer used for packing articles of commerce for shipping to its customers qualifies for the exemption from tax." In the instant case, the is performing a function prior to shrink wrapping and palletizing, by placing product into cases prior to shipment to customers. [P. 1-2]. The Plant Engineer testified that: (1) the Taxpayer primarily manufactures and related products; (2) the Taxpayer s 5

6 business is ; (3) the Taxpayer receives a digital order which goes through the converting process of ; (4) after the converting process, the operation suspends 2 until more are available to do the final assembly; (5) the final assembly happens in the ; (6) the different are brought to the with an order for a specific sequence; (7) the reads the, decides the correct sequence, and identifies the sequence with a number on the so the Taxpayer s customers will know specifically which will go into; (8) the are assigned where they need to go in a customer s ; (9) when certain are produced, the are bundled into groups of five [5] or six [6], the have a and so they are in and the go into a corrugated box until the Taxpayer receives a product offering then are selected and assembled on the ; (10) are stored in C-boxes; (11) orders do not come in for, an order will include certain numbers of certain so the Taxpayer makes an assembly and identifies on the what sequence the go in; (12) if an order includes five [5] or six [6] different kinds of, five [5] or six [6] different C- boxes are retrieved and placed in the ; (13) the in C-boxes are not sequenced the same by the, so the number on the may indicate different for different customers; (14) the individual number, on the of the same type of, is unique to one [1] of 2 Because there are so many and the of the business. 3 A at a. Each has a unique identifier. 4 For example,. 6

7 possibly forty thousand [40,000] orders; (15) the length of time may be in C-boxes varies from days to weeks; 5 (16) once the are in C-boxes, an is not altered but the on a bundled group of five [5] or six [6] has an individual sequence number printed on the ; 6 (17) the demographics of different areas of the country influence the placement of the in ; (18) after the leave the C-boxes, the sequence number is ink-jetted onto the while inside the ; (19) from the each bundled group of five [5] or six [6] goes into a shipper box that goes to customers; and (20) in each shipper box, the must be loaded in a specific sequence and that is a function of the. The Tax Director testified that: (1) the Taxpayer is engaged in a very competitive business; (2) the Taxpayer creates annually and the are introduced into the market in a test environment or by specific demographic areas; (3) that are not selling are taken off and some that are selling may be refreshed; (4) are always manufactured ahead of time to stay in a competitive position; (5) business intelligence is used to get orders to the Taxpayer s numerous customers; (6) the Taxpayer is always trying to get the right mix of products to the right areas; (7) the Taxpayer manufactures and then ships the ; (8) business intelligence is built into the so certain can be sold to customers ; and (9) business intelligence drives the Taxpayer s supply chain. 5 The average length of time was estimated to be 4 6 weeks. 6 The sequence number tells a customer to place the in. 7

8 The Audit Supervisor testified that: (1) he participated in the sales and use tax audit of the Taxpayer; (2) the Department has consistently taxed distribution centers in the past and the fact that the is under the same roof as the Taxpayer s manufacturing facility does not change the Department s position that it is distribution and not manufacturing; (3) the Taxpayer is contending that the C-boxes are pulled when customer orders are received and the manufacturing process continues, the Department s position is that distribution begins at that point; (4) when the Plant Engineer testified that the manufacturing process was suspended when are placed in the C-boxes, we consider the in the C- boxes to be finished goods; 7 (5) the is custom-filling specific orders for ; and (6) the is unique for every order so the is used in distribution and not in manufacturing. follows: CONCLUSIONS OF LAW Standard of Proof Ark. Code Ann (Supp. 2015) provides, in pertinent part, as (a) When the state seeks to impose a tax under the terms of a state tax law, then the statute imposing the tax shall be strictly construed in limitation of the imposition of the tax. (b) When a taxpayer claims to be entitled to a tax exemption, deduction, or credit under the terms of a state tax law, then the statute providing the tax exemption, deduction, or credit shall be strictly construed in limitation of the exemption, deduction, or credit. (c) 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. 7 The Audit Supervisor also stated that the Taxpayer placed the. 8

9 (d) When the meaning of a state tax law is in controversy, the burden of establishing the proper construction of the statute shall be on the party claiming application of the tax or benefit of the tax exemption, deduction, or credit. (e) Words used in statutes imposing a tax and in statutes providing for a tax exemption, deduction, or credit shall be given their plain and ordinary meaning, not their narrowest possible meaning. (f)(1) Statutes imposing a tax and statutes providing a tax exemption, deduction, or credit shall be fairly and reasonably construed, taking into consideration the purpose and spirit of the tax, exemption, deduction, or credit and the public policy at the time the statute was passed. (2) If after taking this section and other applicable rules of statutory construction into account, a well-founded doubt exists with respect to the meaning of a statute imposing a tax or providing a tax exemption, deduction, or credit, the rule of strict construction shall require that the doubt be resolved against the tax, exemption, deduction, or credit. [Emphasis added]. A preponderance of the evidence means the greater weight of the evidence. See 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 that: [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. Manufacturing Exemption Ark. Code Ann (Supp. 2015), Ark. Code Ann (Repl. 2014), and Arkansas Gross Receipts Tax Rule GR-55 provide an exemption from sales and use taxes for machinery and equipment used directly in manufacturing. Machinery and equipment is used directly in manufacturing when used at any time from the initial stage when actual manufacturing or 9

10 processing begins through the completion of the finished article of commerce and the packaging of the finished end product. See Ark. Code Ann (c)(1)(A) (Supp. 2015) and Ark. Code Ann (c)(1) (Repl. 2014). The tax exemption for packaging machinery is addressed in Arkansas Gross Receipts Tax Rule GR-55(H), which states: PACKAGING AND LABELING MACHINERY AND EQUIPMENT. Machinery and equipment that generally meets the requirements for exemption as machinery and equipment used in manufacturing and that is used in the packaging of articles of commerce may be purchased by the manufacturer exempt from tax. Machinery and equipment that is used for the manufacturer's own convenience to palletize or otherwise package items for warehousing or shipping purposes other than to ship the product to the purchaser does not qualify for the exemption from tax. Example: Manufacturer sells a product which is shrinkwrapped and palletized for shipping to its customers. The shrinkwrapping machine and the palletizer used for these functions may be purchased exempt from tax. Manufacturer purchased a second palletizer which is located in the warehouse and is used to palletize items for efficient storage in the warehouse. The purchase of this palletizer is taxable. The Taxpayer s Representatives argued that: (1) the is moving the Taxpayer s finished end products into shipping boxes; 8 and (2) through the end of shipping to customers, the machinery and equipment qualifies for the exemption. The Department s Representative argued that the shrink-wrapping analogy happens when the are wrapped in the and put in the C-boxes, not the individual whole cartons which are shrink-wrapped with other whole cartons, it is the that are wrapped and stamped with a sequence number. 8 The Plant Engineer stated that the shipping boxes ride a conveyor to an area where they are hand-loaded and floor-stacked on a UPS trailer for delivery to customers. UPS does not handle pallets, their drivers unload cartons. 10

11 Applying the law to the facts of this case, the is used in the packaging of the Taxpayer s finished end products for shipping to the Taxpayer s customers. Consequently, the Taxpayer established that the was exempt from tax as packaging machinery and equipment under Arkansas Gross Receipts Tax Rule GR-55(H). With respect to the, the Department incorrectly concluded that the Taxpayer was not entitled to claim the exemption on purchases of machinery and equipment under Ark. Code Ann (Supp. 2015) or (Repl. 2014). DECISION AND ORDER After the removal of the from the audit, the proposed assessments are sustained. 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 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 of a tax 11

12 deficiency by following the procedure set forth in Ark. Code Ann (Supp. 2015). OFFICE OF HEARINGS & APPEALS DATED: December 27,