Sales and Use Tax Water used during the manufacturing process Opinion No

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1 May 7, 2018 STATE OF ARKANSAS REVENUE LEGAL COUNSEL Department of Finance Post Office Box 1272, Room 2380 Little Rock, Arkansas and Administration Phone: (501) Fax: (501) RE: Sales and Use Tax Water used during the manufacturing process Opinion No Dear, This is in response to your letter dated December 14, 2017, which seeks a legal opinion regarding whether water used during the manufacturing process is exempt from sales and use tax. Specifically, your letter states: During the Arkansas Tax Conference held in November 2017, I discussed with you the topic of water used directly in the manufacturing line. I am requesting a legal opinion regarding the ambiguity of the Law verses the Rule. The law states the following regarding catalysts, chemicals, reagents and solutions of which water is a chemical H2O: Various products and services. [Applicable to tax years 2017 and before.] There is specifically exempted from the tax imposed by this chapter the following: (35) (A) Gross receipts or gross proceeds derived from the sale of catalysts, chemicals, reagents, and solutions which are consumed or used: (i) In producing, manufacturing, fabricating, processing, or finishing articles of commerce at manufacturing or processing plants or facilities in the State of Arkansas; and (ii) By manufacturing or processing plants or facilities in the state to prevent or reduce air or water pollution or contamination which might otherwise result from the operation of the plant or facility. (B) As used in this subdivision (35), manufacturing and processing mean the same as set forth in (b); The law provides a specific exemption for catalysts, chemicals, reagents and solutions consumed or used in manufacturing. However, the Arkansas Rule: GR EXEMPTIONS FROM TAX CHEMICALS USED IN MANUFACTURING: C. MANUFACTURING OPERATIONS.

2 2. For purposes of this section, the term substance means only chemicals, catalysts, reagents, or solutions as defined in GR-55.1(B). A substance may be in the form of liquid, solid, or gas. e. Water used during the manufacturing process is not exempt. I have many clients who use water directly in the manufacturing process to make their products. The water (H2O) is a chemical consumed and used directly in the manufacturing process to clean or cool the product being manufactured. Example #1: A paper manufacturer uses water in the manufacturing of paper. The water is directly used with the raw materials to make slurry of water, wood chips, sawdust, etc. to achieve the consistency known as pulp, which is basically a water solution of wood fiber cellulose. The pulp is laid on a belt to form the product and then sent to a press to press out the water and then to a dryer to become paper. The water is critical to the manufacturing of paper, because it is the solvent used to make the pulp solution. It comes in direct contact with the product. This H2O is a chemical consumed and used in the manufacturing process and should be exempt by law. Example #2: In the manufacturing of aircraft parts, my client places a maskant chemical on the metal for which no change in product will occur (the maskant acts as a preventative measure), the aircraft part is then dipped into a caustic soda tank in order to change the molecular structure of the metal as well as reduce the weight of the aircraft part. From the caustic soda tank, the aircraft part is dipped into a chemical quench tank. From the chemical quench tank, the aircraft part is dipped into a rinse tank (water only). Once the aircraft part leaves the rinse tank the maskant is removed and the aircraft part continues in the manufacturing process. The water is critical to the preparation of the aircraft part for further manufacturing, because the quench water stops the other chemicals from furthering eroding the metal once the metal is chemically milled to the required specifications. This H2O is a chemical consumed and used in the manufacturing process and should be exempt by law. The Department of Finance and Administration s (DFA) agents have denied this chemical used in the manufacturing process because of the RULE and not the LAW. My clients wish to have the law applied to the chemical H2O (aka water). The law is the law and the rules are interpretations of the law. With that said, the law clearly exempts H2O (water) since it meets the statutory requirement regarding the manufacturing chemical exemption.

3 Please provide a written response to my request for legal opinion regarding Arkansas law. Your inquiry states there is an ambiguity between the law and the rule, stating that the law provides a specific exemption for catalysts, chemicals, reagents and solutions consumed or used in manufacturing. Your inquiry seeks to clarify whether water is a chemical under Rule 55.1(C)(1). Your request does not describe what sales transactions, if any, are involved in the examples given. RESPONSE: Water used in the manufacturing process is not exempt from sales and use tax. There is no conflict between Ark. Code Ann and Arkansas Gross Receipts Rule GR GENERALLY APPLICABLE LAW Before addressing your specific question, it is necessary to discuss several points applicable to the opinion as a whole. Arkansas law provides that sales tax must be paid on purchases of tangible personal property unless the item or purchaser qualifies for an exemption. Ark. Code Ann (1) (Supp. 2017); Gross Receipts Tax Rule GR-5. Tangible personal property is defined as personal property that can be seen, weighed, measured, felt, or touched or that is in any other manner perceptible to the senses. Ark. Code Ann (21)(A) (Supp. 2017). Water is tangible personal property, therefore sales tax must be paid on purchases of water. Next, it is necessary to state the full statutory text concerning your request. Arkansas Code Annotated (35) provides: (a) There is specifically exempted from the tax imposed by this chapter the following:.... (35)(A) Gross receipts or gross proceeds derived from the sale of catalysts, chemicals, reagents, and solutions which are consumed or used: (i) In producing, manufacturing, fabricating, processing, or finishing articles of commerce at manufacturing or processing plants or facilities in the State of Arkansas; and (ii) By manufacturing or processing plants or facilities in the state to prevent or reduce air or water pollution or contamination which might otherwise result from the operation of the plant or facility. (B) As used in this subdivision (35), manufacturing and processing mean the same as set forth in (b); Ark. Code Ann (35) (Supp. 2017). The statute does not provide a definition for the terms catalysts, chemicals, reagents, or solutions. GR-55.1, however, provides clarifying definitions of what those mean. Chemicals

4 used in manufacturing are only exempt if one of the following occurs: (1) the chemicals become a recognizable, integral part of the manufactured goods; (2) the chemicals are equipment ; or (3) the provisions of GR-55.1 are met. Chemical is defined by Arkansas Gross Receipts Tax Rules as an element, combination of elements, or a compound obtained by a chemical process. Arkansas Gross Receipts Rule GR 55.1(B)(2). The gross receipts or gross proceeds derived from the sale of catalysts, chemicals, reagents, and solutions which are consumed or used directly in manufacturing or processing articles of commerce at manufacturing or processing plants or facilities in the State of Arkansas are exempt from gross receipts tax. Arkansas Gross Receipts Rule GR-55.1(C)(1). Pursuant to Arkansas Gross Receipts Tax Rule GR-55.1(C)(2)(e), water used during the manufacturing process is not exempt from sales and use tax. GR-55.1(C)(2)(e). Those definitions were promulgated pursuant to DFA s rulemaking authority to implement and clarify the Gross Receipts Act, and in this case, Section (35) of the Arkansas Code. Section (d) provides further that the Director of DFA may promulgate rules and regulations for the orderly and efficient administration of this section. Ark. Code Ann (d) (Supp. 2017). A taxpayer bears the burden of proving entitlement to a tax exemption, deduction, or credit. Ark. Code Ann (d) (Repl. 2012), as amended by Act 896. 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) (Repl. 2012), as amended by Act 896. The basic rule of statutory construction is to give effect to the intent of the Arkansas General Assembly by giving words their usual and ordinary meaning. Searcy Farm Supply, LLC v. Merchants & Planters Bank, 369 Ark. 487, 256 S.W.3d 496 (2007). Arkansas Code Annotated et seq. provides the Director of DFA with the authority to promulgate rules and regulations for the proper enforcement of the Gross Receipts Act. See Weiss v. Bryce Co., LLC, 2009 Ark. 412, 330 S.W.3d 756 (2009). The Arkansas Gross Receipt Tax Rules are promulgated under Ark. Code Ann and to facilitate administration, enforcement, and collection of the sales tax. The purpose of the Rules is to clarify Title 26, Chapter 52 of the Arkansas Code. GR-2. Those rules and regulations encompass Arkansas Gross Receipts Rule GR The Arkansas Supreme Court has held that it does not engage in interpretations that defy common sense and produce absurd results. Green v. Mills, 339 Ark. 200, 205, 4 S.W.3d 493, 496 (1999); see also Alcoa World Alumina, LLC v. Weiss, 2010 Ark. 94, at 3. 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. Ark. Code Ann (b) (Supp. 2017). 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 application of the tax, exemption, deduction, or credit. Ark. Code Ann (f)(2) (Supp. 2017). As the agency charged with the interpretation of the statute, the Department is entitled to deference unless its interpretation is clearly erroneous. The Arkansas Supreme Court has recognized that administrative agencies are often required to interpret statutes and rules, and that the agency s construction is highly persuasive. Walnut Grove School Distr. No. 6 of Boone County v. County Board of Education, 204 Ark. 354, 359, 162 S.W.2d 64, 66 (1942).

5 You state that because water is a chemical H2O it is exempt from sales tax under GR In certain circumstances, chemicals used in manufacturing may be exempt from gross receipts or use tax. GR-55.1(A). As stated above, however, water used during the manufacturing process is not exempt from sales and use tax. GR-55.1(C)(2)(e). The Director promulgated this rule in furtherance of clarifying and enforcing the Gross Receipts Act. There is nothing contained within the Gross Receipts Act that contradicts this Rule. The Arkansas Supreme Court construes these rules as highly persuasive, giving deference to DFA s interpretations. Because your client is claiming an exemption, any doubt as to providing that exemption is resolved against the application of the exemption. Consequently, the statute is strictly construed in limitation of the exemption. There is a clear intent to clarify the exemption of chemicals by expressly stating that water used during the manufacturing process is not exempt. Therefore, there is no conflict between the statute and the promulgated rule, and water used during the manufacturing process is not exempt from sales tax. Because the rule s and DFA s interpretation are not contrary to the plain and ordinary language of the statute, and DFA s rules were properly promulgated, water is not considered a chemical for the purpose of manufacturing sales and use tax exemptions. Furthermore, a court would not uphold any interpretation of a statute that would lead to absurd results. See Green, 339 Ark. at 205, 4 S.W.3d at 496. An exception may not be interpreted in such a way as to invalidate the whole levy. Please note that you have not identified the exact taxpayer in your opinion request, therefore, Arkansas Gross Receipts Tax Rule GR-75 provides that a letter opinion may only be relied on by a taxpayer if it is addressed to him or her or is tendered by a customer to whom it is addressed. Requests for letter opinions must specifically describe the person claiming an exemption and set forth all material facts relevant to the questioned sale or transaction. To receive a binding opinion, you must submit a request specifically identifying the person or entity requesting the binding opinion. This opinion is based on my understanding of the facts as set out in your inquiry as those facts are governed by current Arkansas laws, rules, and regulations. Any change in the facts or law could result in a different opinion. Sincerely, Amanda Land, Attorney Revenue Legal Counsel