ADMINISTRATIVE DECISION

Transcription

1 STATE OF ARKANSAS DEPARTMENT OF FINANCE & ADMINISTRATION OFFICE OF HEARINGS & APPEALS ADMINISTRATIVE DECISION IN THE MATTER OF GROSS RECEIPTS TAX & COMPENSATING USE TAX (ACCT. NO.: ) REFUND CLAIMS & ASSESSMENTS DOCKET NOS.: REFUND NO.: PERIOD: 9/01/11 12/31/11 DENIED: REFUND NO.: PERIOD: 7/01/12 12/31/12 DENIED: REFUND NO.: PERIOD: 1/01/12 6/30/12 DENIED: AUDIT NO.: PERIOD: 1/01/13 12/31/14 AMOUNT: ( ) 4 TODD EVANS, ADMINISTRATIVE LAW JUDGE APPEARANCES This case is before the Office of Hearings and Appeals upon written protests dated September 25, 2015 (16-128), November 9, 2015 (16-183), November 9, 2015 (16-184) signed by ( Taxpayer s Representative ) on behalf of, 1 This amount does not reflect concessions made by the Department prior to the administrative hearing that are not addressed in this decision. 2 This amount does not reflect concessions made by the Department prior to the administrative hearing that are not addressed in this decision. 3 This amount does not reflect concessions made by the Department prior to the administrative hearing that are not addressed in this decision. 4 This amount does not reflect concessions made by the Department prior to the administrative hearing that are not addressed in this decision. 1

2 the Taxpayer. The Taxpayer filed an additional protest dated February 25, 2016 (16-410) signed by ( Plant Accountant ) on behalf of the Taxpayer. The Taxpayer protested an assessment and refund claim denials regarding Gross Receipts Tax ( sales tax ) and Compensating Use Tax ( use tax ) issued as a result of an audit and refund claim reviews conducted by Theresa Johnson ( Tax Auditor ) for the Department of Finance and Administration ( Department ). A hearing was held on June 28, 2016, at 10:00 a.m., in Little Rock, Arkansas. A supplemental hearing was held on August 3, 2016, at 10:00 a.m., in Little Rock, Arkansas. The Department was represented by Michelle Baker, Attorney at Law, Office of Revenue Legal Counsel ( Department s Representative ) at the first and second administrative hearing. Present for the Department at the first hearing were the Tax Auditor, Tammy Jones, Tax Auditor, and Clifford Robison ( Audit Supervisor ). Present for the Department at the second hearing were the Tax Auditor and Audit Supervisor. The Taxpayer was represented by the Taxpayer s Representative at the first and second administrative hearing. Present for the Taxpayer at the first hearing were the Plant Accountant, ( Plant Engineer ), and ( Engineering Support ). Present for the Taxpayer at the second hearing were the Plant Accountant, the Plant Engineer, and ( Gauge Tech. ). appeared by telephone. After a general discussion of the burdens of proof in state tax proceedings, the protested transactions shall be addressed in turn with their respective facts, law, and a legal analysis. 2

3 ISSUE Whether the assessment and refund denials issued against the Taxpayer, as adjusted by the agreements and concessions of the parties, should be sustained? Yes, in part. follows: CONCLUSIONS OF FACT AND 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. (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 3

4 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. Further, the burden is upon a taxpayer to prove entitlement to a refund claim. Ark. Code Ann (Repl. 2012). Protested Items I. Tool holder Category (excluding items specifically discussed later in this decision) This category addresses all remaining items listed in the Toolholder & Other Exempt Tooling Items Category contained in the Combined Protested Items dated August 1, 2016 unless the items are otherwise specifically discussed in this decision and the contested portions of. This category also addresses all the Invoices protested in the assessment in this matter that have not been conceded by the Department. The Plant Engineer testified as follows, in pertinent part: (1) tool holders and inserts are a match set that should be viewed as a single item; (2) the tool holders and inserts are typically purchased separately; and (3) the Taxpayer often produces and sells samples with special tool holders. 4

5 Engineering Support testified as follows, in pertinent part: (1) some tool holders and inserts are sold together as a kit, but the Taxpayer does not buy kits; (2) it normally takes five or six tool holders on the turning side of the lathe to produce a ; (3) tool holders will function for various lengths of time; (4) sometimes a tool holder and insert are purchased to produce a new product for a customer but those transactions cannot be identified in the current records; (5) collets are utilized to hold drill bits; and (6) a shim is a seat that is placed under an insert to ensure that an insert is level and properly fitted inside the tool holder. The Taxpayer s Representative stated as follows with respect to tool holders: (1) tool holders (by themselves) do not determine the shape of the, and tool holders are usually viewed as taxable by the Department; (2) tool holders are essential to the manufacturing process, possess the necessary complexity and continuing utility, and should be exempt; (3) tool holders should not be viewed as a normal repair part for the lathe; and (4) except for items specifically discussed, the items described as tool holders hold an insert or a drill bit. The Department s Representative stated as follows: (1) the tool holders are components of the lathe machines and their replacements are non-substantial and (2) some tool holder-like items have been exempted in past audits with other taxpayers where the tool holder and the insert are permanently connected and form a single item, which is not the case in this proceeding. In summation, the Taxpayer s Representative asserts that tool holders and collets should be considered as component parts of the dies rather than as 5

6 component parts of the lathes or drills. 5 The Department s Representative asserts that the tool holders should be considered component parts of the manufacturing machinery that do not impart a predetermined and distinctive shape. Viewed as component parts of the machinery, the Department s Representative argues that the purchases are taxable as insubstantial replacements of component parts of manufacturing machinery. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. Ark. Code Ann (c)(2)(B)(ii) (Supp. 2015) allows an exemption for: Dies, tools, and devices attached to or a part of a unit of machinery that determine the physical characteristics of the finished product or its packaging material at any stage of the manufacturing process.... Arkansas Gross Receipts Tax Rule GR-56(F)(2) further defines a die, stating as follows: " Die means a tool or device that is attached to, or part of, a unit of machinery and that imparts a predetermined and distinctive shape, pattern, texture, or finish to a material or impresses an object or material, including any replacement tooling that performs the intended function. 5 As stated above during the administrative hearing, the Taxpayer stated that some of the tool holders were likely purchased with new machine purchases but was unable to state which transactions were associated with new machinery purchases rather than replacement purchases. The relevant transactions shall be analyzed as replacement purchases for purposes of this decision. 6

7 Absent qualifying as a die, the tool holders would be component parts of large pieces of machinery and constitute taxable non-substantial replacements of components of manufacturing machinery and equipment. See Ark. Code Ann (a)(2) (Supp. 2015). Arkansas Gross Receipts Tax Rule GR-55(D)(3) defines the components of a piece of machinery, stating: When individual machines or machinery are interconnected in order to accomplish a single function and the function of each such individual machine is not complete before the adjacent machines begin to function, the result is a new single identifiable machine. See also S. H. & J. Drilling Corp. v. Qualls, 268 Ark. 71, 593 S.W.2d 178 (1980); Southern Steel and Wire Co. v. Wooten, 276 Ark. 37, 631 S.W.2d 835 (1982). Here, the evidence preponderates in favor of denying the exemption claim. It was proven that the inserts and drill bits that directly interact with the manufactured parts impart the predetermined and distinctive shape and, thus, qualify as dies. Generally, adapters, collet chucks, shims, and other tool holders, however, are the mounting points where dies are attached to manufacturing machinery and equipment or components of the mounting points. While the adapters, collet chucks, other tool holders, and shims are closely related in proximity to the dies they hold during the manufacturing process, their function is not as a die. The adapters, collet chucks, other tool holders, and shims do not impart a predetermined and distinctive shape, a necessary function of a die. While it is true that the dies in this matter could not function without the tool holders, the dies also could not function without the other components of the manufacturing machine as well. The exemption cannot be interpreted as broadly as the Taxpayer s Representative proposes. A statutory exemption must be considered in light of 7

8 the narrow construction that must be applied to all tax exemption cases. Walther v. Carrothers Construction Company of Arkansas, LLC, 2016 Ark. 209, at 6, S.W.3d (stating: There is a strong presumption in favor of the taxing power of the state, and all tax-exemption provisions must be strictly construed against the exemption. ); see also Ark. Code Ann (f)(2) (Supp. 2015). Consequently, the Taxpayer has not proven entitlement to the manufacturing machinery and equipment exemption and the Department correctly determined that the relevant tool holder and shim purchases were not dies, represented insubstantial replacements of manufacturing machinery, and, consequently, are taxable. II. Taxation of Adjustments to Machine Software by Various Vendors This category addresses all remaining items listed in the Exempt Services Category contained in the Combined Protested Items dated August 1, 2016 unless the items are otherwise specifically discussed in this decision. Generally, the Taxpayer purchased services from various vendors that provide adjustments or alterations to machine software. Some of these services were performed in conjunction with certification/calibrations 6 of various pieces of machinery and equipment and other services were correcting other errors in existing machine software. The taxability of these items turns on the same issue of whether alterations to a machine s software qualifies as taxable machine 6 The Taxpayer s witnesses consistently stated that the Taxpayer could not guarantee that a certification did not involve some adjustment to the software of a machine or device. Consequently, this decision will assume that all certifications involved some software adjustment and the transactions shall be analyzed accordingly. 8

9 repairs or nontaxable software programming services under Arkansas Gross Receipts Tax Rule GR-25(H)(2). The Plant Engineer testified as follows, in pertinent part: (1) a certification of a piece of machinery means that a piece of equipment or machinery met its specifications at the time the vendor left the factory; however, it does not indicate whether adjustments to software occurred as part of the certification; (2) the sensor adjustments are accomplished by altering the readings on a machine s software to match the readings on a calibrated instrument; (3) the Taxpayer also adjusts its own machinery so it is unlikely that a certifying vendor would need to adjust software readings at every certification; (4) is a probe head sensor calibration, which is sent out to be certified; (5) the probe head sensor measures parts in production and it has the ability to move itself; and (6) the Invoice involved the debugging of new or existing control software on the. The Plant Accountant testified as follows: (1) vendor explained that a certification (costing $250 to $260) only involves a certification, any repairs would cost another $300, and repair was not defined by the vendor; (2) adjustments to the home or zero position in the involved software; and (3) involved the installation of new positioning software to correct the home positioning issues on the but 9

10 these machines were previously in operation and ran for some time before going down. 7 The Gauge Tech. testified as follows regarding these items: (1) is a probe tip (an electrical device) on the for the machine; (2) is a certification of a digital thermometer that checks ambient temperature and the invoice description sounds like the thermometer was adjusted; (3) are hardness testers (electronic devices) that are likely adjusted for certification; and (4) involved the reprogramming of machine settings. The Taxpayer s Representative stated as follows: (1) vendor provided an explanation of its calibration services for the heat treat furnaces which explained that it verified the correct temperatures were reflected on machine readings, would adjust the machine software when necessary to reflect accurate readings, and did not consider its services to be repairs; (2) adjustments to the software are nontaxable under GR-25; and (3) services are also exempt as software services. The Department s Representative stated as follows: (1) all calibrations (even those done by adjusting software) are taxable under the prior hearing with this Taxpayer (Docket No. ) and (2) services are taxable as repairs. 7 Based on the invoice description, it appears that a was replaced in this transaction, which the Department correctly identified as a non-substantial replacement of a component of the machine. This decision follows the Taxpayer s description of the transaction as merely involving replacement of software since the transaction is taxable regardless of whether a part was replaced or the machine software was repaired. 10

11 In summation, the Taxpayer s Representative argues that any adjustments made to a machinery through alteration of a machine s or device s software should be treated as nontaxable programming and not as a taxable repair to machinery. The Department s Representative argues that any adjustment to machinery to make a piece of machinery or an electric device function properly (whether through mechanical adjustments or software changes) should be treated as taxable repair services. To adjust machinery that is not functioning properly in order to return it to its original working order is a repair. Ark. Code Ann (3)(B) (Repl. 2014) provides that the repair or alteration of machinery of all kinds and electrical appliances and devices is subject to Arkansas sales tax. Arkansas Gross Receipts Tax Rule GR-9.18(D) provides that the service of repair of exempt machinery is taxable. Arkansas Gross Receipts Tax Rule GR-55(E) also treats software that is necessary to a manufacturing machine s operation as a component part of the machine. In Cowan v. Thompson, 178 Ark. 44, 49, 9 S.W.2d 790 (1923), the opinion of the Arkansas Supreme Court stated that definitions of the word repair includes: (1) to restore to a sound or good state ; and (2) to restore or reinstate as in former standing. 8 The restoration of the Taxpayer s machinery to its original state is a repair of the machinery. Here, the relevant transactions involved adjustments or alteration to the software of electrical devices and machinery when those items were not functioning properly and those adjustments return the machinery or devices to 8 The Taxpayer s Representative attempted to distinguish Cowan on the basis that it was not a sales tax case and involved repairs to roads; however, the definition of what constitutes a repair is still persuasive. 11

12 proper working order. 9 To adjust or alter machinery or device that is not functioning properly in order to return it to its original correct working order (through software or manual changes) is a taxable repair. The Taxpayer s Representative s assertions that calibration or repairs to machine software are analogous to and should be similar to development of custom software or other software programming services is not persuasive. Consequently, the Department correctly determined that the items in this category are taxable. III. Certifications of Mechanically Adjusted Pieces of Machinery The Gauge Tech testified as follows regarding these items: (1) involved a repair to a gauss meter; (2) typically gauges are sent out to vendors to be certified and the Taxpayer is contacted if additional repairs are necessary; (3) the invoice involves the calibration of an adjustable torque wrench; and (4) to calibrate an adjustable torque wrench, the hand tool is sent out to ensure that the wrench reads correctly and is adjusted if necessary. The Plant Engineer testified as follows, in pertinent part: (1) a certification of a piece of machinery means that a piece of equipment or machinery met its specifications at the time the vendor left the factory; however, it does not indicate whether adjustments occurred as part of the certification; 10 (2) and the 9 As stated previously, the Taxpayer alleged that some transactions may have been limited to simple inspections and certification of items that involved no adjustment to the items or software but was unable to separate such invoices from the taxable calibrations. Further, testimony stated that calibrations, certifications, and inspections could involve adjustment to an item s software. Consequently, all transactions are treated as the performance of taxable repair services. 10 All items in this category shall also be analyzed as if adjustments or alteration of the items occurred since the Taxpayer cannot guarantee that certifications of mechanical instruments did not involve adjustments. 12

13 invoice at issue are mechanical gauges that are sent out to be calibrated; and (3) Invoices involve bench testers that are mechanical and are repaired. The alteration or repair of electrical appliance and devices and mechanical tools is subject to Arkansas Sales Tax. Ark. Code Ann (3)(B) (Repl. 2014). As stated previously, adjustments (even for purposes of calibration or certification) are considered taxable repairs. Consequently, the Department correctly determined that the items in this category are taxable as alteration or repair services. IV. Replacements of Carbonseers The Plant Engineer testified as follows, in pertinent part: (1) the carbonseer probe is threaded into a furnace, reads the oxygen concentrations inside the furnace, and is connected to the furnace controller; (2) the furnace controller increases or decreases natural gas concentrations in the furnace based on the carbonseer readings; (3) the carbonseer probes are regularly replaced; and (4) the sensors, controller, and other furnace components are interconnected and function together. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. Arkansas Gross Receipts Tax Rule GR- 55(D)(3) provides as follows: 13

14 When individual machines or machinery are interconnected in order to accomplish a single function and the function of each such 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. An individual machine that performs a separate distinct function in the manufacturing operation as part of a production line, constitutes a single machine for purposes of this exemption and may be replaced tax exempt. See also Southern Steel & Wire Co. v. Wooten, 276 Ark. 37, 631 S.W.2d 835 (1982). Here, the carbonseers (in conjunction with the other components of the furnace) enable the furnace to perform its function. These items, consequently, must be analyzed as component parts of the furnace and the replacement of these sensors does not represent substantial replacement of the furnace components. Non-substantial replacements of component parts of manufacturing machinery and equipment do not qualify for the manufacturing machinery and equipment exemption. Ark. Code Ann (a)(2) (Supp. 2015). Consequently, the Taxpayer has not proven entitlement to the manufacturing machinery and equipment exemption and the Department correctly determined that the relevant purchases were taxable. V. Transformer Purchase with New The Plant Engineer testified as follows regarding this item: (1) the new transformer at issue is wired and affixed to a new 11 and alters the voltage from the building s electrical system to allow the new piece of machinery to operate; (2) the transformer solely powers the ; and (3) 11 This statement was supported by photos provided during the Administrative Hearing. 14

15 transformers are unlikely to break and are typically purchased with a new piece of machinery. Generally, the installation of a transformer is taxable as the installation of an electrical device. Arkansas Gross Receipts Tax Rule GR-9.17(B)(2), see also Ragland v. Allen Transformer Co., 293 Ark. 601, 740 S.W.2d 133 (1987). The Taxpayer s Representative, however, argues that transformer should be treated as a component part of a new Representative conceded that the new. The Department s was exempt under the manufacturing machinery and equipment exemption but argued that the transformer was not a component part of that lathe but a part of the building s electrical system and, thus, not directly used in the manufacturing process. Arkansas Gross Receipts Tax Rule GR-55(B) requires that exempt manufacturing machinery and equipment be utilized directly in the manufacturing process. See also Ark. Code Ann (Supp. 2015). Here, the Taxpayer has not proven that the transformer should be analyzed as a component part of the new lathe. The transformer is attached to the building s electrical circuit and modifies the structure s electrical voltage to allow machines to be essentially plugged into the transformer. Whatever effect the transformer produces in the manufacturing process is secondary and indirect. The transformer is part of the building s electrical system rather than the machine for which the transformer alters power. Had the General Assembly intended to exempt transformers as machinery and equipment, it should have said so. Consequently, the Department correctly determined that this transaction is taxable. 15

16 VI. Process Control Panel Replacement The Plant Engineer testified as follows, in pertinent part: (1) the process controller processes information from the oxygen sensors and controls the furnace gas valves to regulate carbon levels inside the furnace; (2) the Taxpayer eventually upgraded all of its process controllers for its furnaces due to obsolescence; (3) the new controller simplifies the furnace controls; and (4) the sensors, controller, and other furnace components are connected and function together. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. In Southern Steel & Wire Co. v. Wooten, 276 Ark. 37, 631 S.W.2d 835 (1982), the Arkansas Supreme Court discussed the proper treatment of control panels for machinery and stated, as follows: The control panels are designed from scratch and plugged into a welding machine to control the welding process. Appellant urges that each is a separate piece of machinery and that since these control panels can be utilized with different welding machine and are physically plugged into a welder to achieve the desired results, they are distinguishable from the component parts of a drilling rig which we considered in S. H. & J. Drilling Corp. v. Qualls, supra. There we held that where the appellant purchased certain items to replace existing items of a drilling rig, even if the individual item was considered a machine within the definition of Heath v. Research-Cottrell, Inc., 258 Ark. 813, 529 S.W.2d 336 (1975), once they were assembled into a rig and are designed to accomplish a single purpose, they become a single unit and are not exempt from taxation. We find that reasoning controlling here. It appears undisputed that the control panels, air cylinders and transformers are physically combined with other existing components in order to construct a welding machine which has a single 16

17 purpose and function. The control panels and welding machines are interconnected or component parts of welding machines and designed to accomplish a single purpose - welding wire to form shelves. They must function simultaneously as a single unit. Id. at 40-41, 631 S.W.2d at 837. Here, the Taxpayer explained that a furnace carburizer control panel was replaced due to obsolescence. This panel takes data from sensors (like the sensors) to open and close valves in the furnace. The upgraded panel allowed the quantity of furnace control panels to be reduced from three panels to a single panel. The Taxpayer described the controller upgrade as a major upgrade to the furnace but stated that other components of the furnace were not replaced in this transaction. The Taxpayer s Representative argued that the manufacturing machinery and equipment exemption should be interpreted in a way that supports modernization (citing Ark. Code Ann (a)(2)(C) (Supp. 2015)). The Department s Representative argued that similar modernization claims were rejected in Weiss v. Chem-Fab Corp., 336 Ark. 21, 28, 984 S.W.2d 395, 399 (1999). In the cited portion of that case, the Court in Chem-Fab determined that, for a piece of replacement machinery to improve efficiency (as required by the relevant exemption), it must be analyzed by comparing the replacement piece of machinery or equipment at the time it was new with the new equipment being purchased. That decision also explains that exempt replacement manufacturing machinery or equipment must: (1) be a substantial replacement; and (2) must either be more efficient or have a longer useful life than the equipment replaced. Id. at 28, 984 S.W.2d at

18 Ark. Code Ann (a)(2) (Supp. 2015) expressly requires that any replacement machinery must replace substantially all of the machinery and equipment required to perform an essential function.... A court must construe a statute so that no word is left void, superfluous, or insignificant, and meaning and effect are given to every word in the statute if possible. Nolan v. Little, 359 Ark. 161, 196 S.W.3d 1 (2004). Under the rules of statutory construction, the expression of intent contained in subdivision (2)(C) cannot be used to overcome the express exemption requirements in subdivision (2)(B). Since the control panel in this matter is properly analyzed as a component part of the furnace under the analysis in the Southern Steel case, the Process Control Panel Replacement does not represent a substantial replacement of the furnace components and the exemption claim must be denied. 12 The Taxpayer has not proven entitlement to the manufacturing machinery and equipment exemption and the Department correctly determined that the purchase was taxable. VII. Purchases of Chip Conveyer Components The Plant Engineer testified as follows, in pertinent part: (1) the chip conveyer is purchased with every new lathe to avoid the time that would otherwise be spent manually removing metal shavings or chips from an operating lathe; (2) the chip conveyer collects the metal shavings that fall from the lathe and transports that waste to a hopper for disposal; (3) it is not feasible to operate a lathe for a long period of time without a chip conveyer; (4) the chip conveyer is placed under a lathe and is considered a major component of a lathe; and (5) the chip conveyer may or may not be purchased from the same vendor as the lathe. 12 The remaining issue of whether the control panel was more efficient or had a longer useful life shall not be addressed as that determination is rendered moot. 18

19 Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. Ark. Code Ann (a) (Supp. 2013) and Arkansas Gross Receipts Tax Rule GR-55(A) require that machinery and equipment be used directly in manufacturing in order to be exempt from taxation. In Pledger v. Baldor International, Inc., 309 Ark. 30, 827 S.W.2d 646 (1992), the Arkansas Supreme Court considered whether an environmental control system was exempt manufacturing machinery and its opinion stated: An environmental control system is clearly different from a steam turbine generator which generates electrical energy that activates the manufacturing process. The environmental control system directly affects the surroundings of the manufacturing area of Baldor s plant and thereby protects the efficiency and effectiveness of the CNR machines used to produce Baldor s electric motors. In terms of Arkansas law set out above concerning when equipment may be exempt, Baldor s environmental control system clearly is not used directly in producing [or] manufacturing Baldor s motors and neither can it be said the system is utilized directly in the actual manufacturing or processing operation. Cases from other jurisdictions support our conclusion. In Indiana Dept. of State Revenue v. RCA Corporation, 310 N.E.2d 96 (Ind. Ct. App. 1974), RCA was denied an exemption for an environmental control system even though the DFA auditor conceded that maintenance of rigidly controlled environment was an integral and essential part of the manufacturer s color picture tube manufacturing process. Id. at 36, 827 S.W.2d at 650. Here, the chip system is used to remove metal shavings from around the Taxpayer s lathe machinery. The Taxpayer s argument, that utilization of the Chip Conveyor System is necessary for the continued operation of the manufacturing process, is not persuasive. In Pledger v. Baldor International, 19

20 Inc., supra, the environmental control system was an essential part of the manufacturing process but the Court held the environmental control system was not exempt manufacturing machinery because it was not used directly in manufacturing. Similarly, the Taxpayer s use of the Chip Conveyer System is one step removed from the manufacturing process, therefore, the Chip Conveyer system is not used directly in manufacturing under the provisions of Ark. Code Ann (a) (Supp. 2013). Consequently, the Department correctly determined that the Taxpayer s purchases of the Chip Conveyer System components and services related thereto were subject to tax. VIII. Gauge and Hazmat Fees The relevant invoices contain a charge for rental of a gallon cryogenic nitrogen tank, a $20 fee, and a $4 fee. During the administrative hearing, the Department conceded that the nitrogen storage tank was exempt under the manufacturing machinery and equipment exemption but did not concede the remaining fees. The Plant Engineer testified, regarding the nitrogen tank invoices, as follows: (1) the $4.00 fee is a hazmat charge for handling the nitrogen; (2) the $20 fee is a charge for the rental of a gauge on the nitrogen tank; (3) both charges are fees that are paid with the tank rental; (4) the Taxpayer does not contact the Vendor to restock its nitrogen tank; (5) the vendor automatically refills the tank when necessary using the The Tax Auditor testified that the gauge and bills the Taxpayer. gauge on the nitrogen tank (according to an employee of the vendor) is a device that remotely measures the nitrogen supply in the storage tank for automatic refilling. 20

21 The Plant Accountant testified (1) the the outside of the nitrogen tank and is wired to a gauge is a device on device inside of the plant; (2) the gauges tells the vendor when to refill the tank, and (3) the Taxpayer pays the fee as part of the tank rental every month. The Taxpayer s Representative argued that the gauge rental fee and the hazmat fee should be considered part of the total consideration for the tank rental (which the Department conceded was exempt in this matter) and, consequently, should also be exempt. The Department s Representative argues that these fees are separately stated and not part of the gross proceeds for the tank rental. The gross proceeds for a transaction does include [a]ny charge by the seller for any service necessary to complete the sale.... Ark. Code Ann (13)(A)(iii) (Repl. 2014). Here, the record shows that these fees were charged on the same invoice with and in addition to the tank rental fee; however, it is unknown whether these fees are voluntarily incurred to receive the automatic nitrogen refilling services or if the fees are required by the seller for the tank rental. At this point in the administrative process, the Taxpayer has not established that these fees qualify for the manufacturing machinery and equipment exemption, and, thus, the Department correctly denied the relevant exemption claimed for these fees. IX. Replacement of Operator Controls on The Plant Engineer testified as follows, in pertinent part: (1) the machine operator controls (purchased from outdated process controls in the ) was a replacement of and was part of a modernization 21

22 of the machine; (2) involved the installation of a new control board in the and the repair of a control module to recognize the new controller; and (3) eventually, all four of the controls were replaced on the. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. As stated above in the discussion regarding the Control Panel, control panels are generally considered as component parts of the machinery that they control and the language contained in Ark. Code Ann (a)(2)(C) cannot override the requirement that replacements be substantial. Here, the operator control is a component part of the and did not represent a complete replacement of the entire machine. Consequently, the Department correctly determined that these transactions were subject to tax. X. Gauge Replacements The Plant Engineer testified as follows, in pertinent part: (1) involved the installation of gauges that measure the bearing as it is ground and disengages the turning wheel when the right diameter is reached; (2) the angle head grinders; and (3) the gauges work in concert with the gauge is attached to the control panel. 22

23 The Taxpayer s Representative argued that the gauge should be exempt as testing machinery or equipment. The Department s Representative asserted that the relevant item functions as a component of the grinders and represents a non-substantial replacement part. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. Ark. Code Ann (c)(2)(B)(iii) provides that [t]esting equipment to measure the quality of the finished product at any stage of the manufacturing process is considered exempt manufacturing machinery and equipment. However, Arkansas Gross Receipts Tax Rule GR-55(I) requires testing equipment to otherwise meet all other requirements of the manufacturing machinery and equipment exemption. Ark. Code Ann (a)(2)(B) would still require a substantial replacement of all the items involved in the quality control function. Here, the gauge is a replacement part and functions in conjunction with the controls for the angle head grinders to disengage the machine when the correct bar diameter is obtained. Its function in disengaging the angle head grinder is its primary function. Even assuming, however, that this item could qualify as testing equipment 13, it is apparent that the gauge does not function independently but is connected to other pieces of 13 Generally, Arkansas Gross Receipts Tax Rule GR-55(J) treats peripheral equipment that directly controls a piece of manufacturing machinery as a component part of that machine. 23

24 machinery and equipment that operate the gauge and receive and process the information received from the gauge itself. It appears that none of those components were replaced in this transaction. Consequently, the Taxpayer has not borne its burden of proving entitlement to the exemption even assuming that the gauge otherwise qualifies as testing equipment and the Department correctly determined that these transactions were taxable. XI. Blacklight Used with The Plant Engineer testified as follows, in pertinent part: (1) the machine runs an electric current through a part that was produced to magnetize it, and the florescent chemical is then ran over the part; (2) the chemical adheres to imperfections in the product; and (3) is a replacement of the handheld black light that plugs into a separate outlet 14 and allows a person to view the adhesion of the into cracks on the surface. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. As stated above, in order for separate components to be considered a component of a single machine, the Arkansas Supreme Court in Southern Steel and the governing regulation at Arkansas Gross Receipts Tax Rule GR-55(D)(3) generally require that items be interconnected 14 This assertion was supported by photographs provided during the hearing. 24

25 and function simultaneously. Here, no interconnection is present and it is not shown that the machine and blacklight function simultaneously. Consequently, the black light is not considered a component part of the machine. Since the transaction involved the purchase of a complete replacement of the black light and that light is used in testing the finished product, this item qualifies as manufacturing machinery and equipment and the Department incorrectly denied the Taxpayer s exemption claim. XII. Purchases The Plant Engineer testified as follows, in pertinent part: (1) are used as cushions in the brass to reduce scratches on the straightener machine, are made of softer, and ensure that the straightening hammers do not damage a ; (2) the essentially hammer the to remove bowing that occurs during the manufacturing process; (3) the straighteners are used multiple times during the manufacturing process; and (4) straightener blocks are also used in the straightener to support the during the straightening process. These items are essentially heads for hammers that are used in a straightening machine to apply force to straighten. The Department argued that these items are insubstantial replacements of the straightening machine. The Taxpayer s Representative argued that these qualified as dies. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when 25

26 purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. As stated previously, a die must impart a predetermined and distinctive shape. The provided testimony indicates that the is better described as a cushion for a hammer used during the straightening process. Since the do not impart a predetermined and distinctive shape and are components of the larger straightening machine, the Department correctly determined that the Taxpayer s purchase of the are taxable replacement parts that do not qualify for the exemption. XIII. The Plant Accountant testified as follows regarding this category: state that the motors were tore down, inspected, and tested but there is no guarantee that those services were performed since the purchase order lists the fees as evaluation fees. The Tax Auditor testified as follows regarding this item: state that Baldor motors were tore down, inspected, and tested, which is taxable because a tear down altered the motor. Here, the relevant invoices describe a taxable alteration to a piece of machinery. The Taxpayer was unable to prove that the services described and billed in the invoice were not performed. Consequently, the Department correctly determined that these transactions were taxable. XIV. Invoice 26

27 The Plant Engineer testified that involved a roof repair and the invoice did not separately state the cost of some gutter cleaning that was performed in conjunction with the roof repair. The Department argued that the entire invoice was taxable because gutter cleaning is taxable and those amounts were not separately stated. The Taxpayer s Representative argued that gutter cleaning services were performed in anticipation of a nontaxable roof repair service and should be nontaxable similar to cleaning services performed by a contractor as part of a construction job under Arkansas Gross Receipts Tax Rule GR-9.4(D). Gutter cleaning services are specifically enumerated as taxable services. Ark. Code Ann (a)(3) (Supp. 2015). Additionally, when a sale involves both taxable and nontaxable transactions, the items must be separately stated or the entire charge is subject to Arkansas sales tax. Weiss v. Best Enterprises, Inc., 323 Ark. 712, 917 S.W. 2d 543 (1996). Arkansas Gross Receipts Tax Rule GR- 9.4(D) does exempt certain otherwise taxable cleaning services that are performed by a contractor which are ancillary to the provision of a nontaxable contractor service. 15 Here, neither the invoice nor the work authorization demonstrates that the gutter cleaning was a necessary preparatory step to the roof repair rather than the provision of an additional service in conjunction with the roof repair. Consequently, the gutter cleaning is taxable and, since the charge for that service 15 For instance, GR-9.4(D)(2) provides the example of a painter cleaning a wall in preparation of painting the wall and explains that the cleaning would not be considered a taxable cleaning service. 27

28 is not separately stated within the invoice, the Department correctly denied the Taxpayer s refund claim on this transaction. XV. Jaws and Chucks and Drill Bushings Engineering Support testified as follows: (1) hey mill jaws and three jaw chucks actually clamp a and hold it in place on the lathe and do not function as tool holders; (2) the three jaw chuck was a replacement part; and (3) a drill bushing is a guide that is drilled through to hold the drill straight and is a fixture of a lathe in the Machine Center. The Plant Engineer testified as follows, in pertinent part: (1) hey mill jaws eventually wear out and have to be replaced and (2) a pneumatic chuck is a part that allows the chuck to be open and close more quickly to reduce cycle time. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. As stated above, an exempt replacement must substantially replace all of the interconnected components of a machine. Here, the purchases discussed above represent component parts of lathes. The Taxpayer has not demonstrated that the replacement of these items represented substantial replacement of the components of the lathes. Consequently, the Department correctly determined that these purchases are taxable. XVI. Media 28

29 The Plant Engineer testified as follows, in pertinent part: (1) involves the purchase of media comprised of specific rock sizes and shapes (triangular, etc.) based on customer specifications; (2) the media is essentially placed a large tub on top of one of three machines that vibrate the media over the to polish the ; and (3) the media is purchased by the pallet load, eventually wears downs, and must be completely replaced every 3 to 6 months. The Department s Representative argued that the media was taxable as a consumable supply and did not qualify as a die because it was not attached to a piece of manufacturing machinery. Initially, all items in this category represent sales of tangible personal property that are generally taxable under the Arkansas sales tax and whose storage, use, and consumption is generally taxable under Arkansas use tax when purchased outside of Arkansas. Ark. Code Ann (Repl. 2014) and (Repl. 2014). Consequently, this analysis will address the applicability of the Taxpayer s exemption claim. 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)(2)(B)(ii) (Supp. 2015) (Emphasis supplied). Specifically, a Taxpayer must demonstrate that the item 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. 29