State & Local Taxes
Missouri, like many states, has a sales and use tax exemption for certain machinery, equipment, and products used in manufacturing and production. Recently, the Missouri Supreme Court has decided several cases that appear to refine the scope of the exemption and provide additional guidance on what types of activities qualify for the exemption.
Missouri's manufacturing exemption applies to (1) energy, chemicals, machinery, equipment, and materials (2) used or consumed in the manufacturing, processing, compounding, mining, or producing (3) of any product (Mo. Rev. Stat. §144.054.2). Missouri tax exemptions are strictly construed against the taxpayer, and any doubt is resolved in favor of applying the sales tax.
Missouri Code of State Regulations Title 12, Section 10-110.621, provides various examples for applying the exemption. As identified in the regulation, a manufacturer purchasing propane to operate forklifts to move raw materials between production lines would be making an exempt use of the fuel. Likewise, a manufacturer using coal to fuel boilers to generate steam used to manufacture a product or a commercial printer using energy, chemicals, machinery, materials, and equipment would be making an exempt use of those items. On the other hand, a restaurant preparing food for immediate consumption, a company constructing a road or building, or a butcher shop cutting beef into steaks and hamburger does not qualify for the exemption under the regulation. The recent cases have largely dealt with the second element of the exemption, i.e., whether an activity is "manufacturing, processing, compounding, mining, or producing." The courts have looked at whether certain food processing, commercial laundering, and construction activities qualify for the exemption.
Recent cases on construction begin, oddly enough, by drawing on decisions involving food preparation. In Aquila Foreign Qualifications Corp. v. Director of Revenue, 362 S.W.3d 1 (Mo. 2012), the Missouri Supreme Court reversed a decision of the Administrative Hearing Commission (AHC). (The AHC is a tribunal with jurisdiction over determinations of various state agencies, including the Department of Revenue.) Aquila sold electricity to Casey's, a convenience store that used the electricity to prepare food. Many of the items were precooked and only required reheating before consumption. Casey's also served pizza and doughnuts, which were made from scratch on-site. Aquila (which, as the seller that remitted the sales tax, filed a complaint with the AHC on Casey's behalf) argued that all the food preparation qualified as "processing" under the statute.
The court found the term "processing" ambiguous. To resolve the ambiguity, the court noted the statute did not include "restaurants" and determined the Missouri Legislature would have included "restaurant" or similar references to food preparation, as it had done in other statutes, if it had intended the exemption to apply to food preparation. Further, to avoid unintended breadth in statutory construction, the court applied the doctrine of noscitur a sociis ("a word is known by the company it keeps"). The court reasoned "processing" must be interpreted in conjunction with the other terms in the statute (e.g., manufacturing, mining), and, like these terms, "processing" has an industrial connotation. The court determined that food preparation did not have this industrial connotation and was not an activity that qualified under the exemption.
Union Electric Co. v. Director of Revenue, 425 S.W.3d 118 (Mo. 2014), is another case involving food preparation that built upon Aquila. Union Electric was a utility company that sold natural gas and electricity to Schnucks, a grocery store chain that used the gas and electricity to prepare baked goods. Union Electric brought a refund suit on Schnucks's behalf for sales tax paid on the gas and electricity. It argued that the grocery company's preparation of baked goods was "processing," qualifying the gas and electricity as exempt under the manufacturing exemption. The court found this argument unconvincing, determining that processing and other activities within the meaning of the statute "can best be described as large-scale industrial activities, not on-site cooking or preparing of food for retail sale."
The court ruled against the taxpayer despite a favorable example in the regulations that seems on point. The example reads, "A bakery creates baked goods for sale directly to the public or through retailers. The energy sources, chemicals, machinery, equipment, and materials used by the bakery are exempt from state sales and use tax and local use tax, but not local sales tax" (Mo. Code Regs. tit. 12, §10-110.621(4)(O)). The court noted that if the regulation is inconsistent with the statute, it would apply the statute—not the regulation. Rejecting the taxpayer's reliance on the example, the court determined that a reading of "bakery" that included a retail bakery department of a grocery store was too "expansive" and reasoned that nothing in the example suggested that "bakery" should be defined so broadly.
Recently, there have been legislative efforts to provide an exemption for food preparation. In 2014, the Legislature passed a bill providing an exemption for electricity and gas used in the preparation of food; the bill was ultimately vetoed by the Missouri governor (H.B. 1865). A similar bill has been introduced this year in the Missouri House and has passed a committee vote (H.B. 101).
Are Construction Activities "Manufacturing"?
In Ben Hur Steel Worx, LLC v. Director of Revenue, 452 S.W.3d 624 (Mo. 2015), the Missouri Supreme Court determined that the taxpayer did not qualify for the manufacturing exemption. Ben Hur, a subcontractor, purchased steel beams and components, and modified these items by shaping and finishing them for incorporation into large-scale commercial buildings. Ben Hur argued that shaping and finishing the steel components met the definition of "processing" in the exemption statute.
In its analysis, the court focused on the taxpayer's post-modification installation activity. The court cited Union Electric, finding that the Legislature intended the exemption to apply only to "large-scale industrial activities," and that construction activities of the taxpayer did not fit within the exemption because "construction" was not mentioned in the statute. Further, the court noted other tax exemptions for materials purchased for construction projects for tax-exempt entities, demonstrating that the Legislature intended to differentiate between construction activities and large-scale industrial activities.
In Fred Weber, Inc. v. Director of Revenue, No. SC 94109 (Mo. 1/13/15), issued on the same day as Ben Hur Steel, the Missouri Supreme Court reiterated its determination that the Legislature intended the manufacturing exemption to apply only to industrial-type activities. Weber sold rock base and asphalt to paving companies. Weber argued that these materials qualified for the manufacturing exemption from sales tax because paving fit the statutory definition of "processing"—performing acts on materials to "transform" them to a different state or thing.
Notably, the Weber court reversed the AHC's decision. The AHC, citing principles of statutory construction in Missouri cases, had determined that each word of the statute should be given effect to avoid finding superfluous language. Thus, the AHC determined that "processing" and "manufacturing" were different words with different meanings, allowing paving to fit within the plain meaning of "transform" and thereby fit within "processing."
The court took a different approach, noting that in Aquila, it applied the doctrine of noscitur a sociis to find that "processing" had an industrial connotation. Applying the same analysis and citing Union Electric, the court held that construction activities were not the "large-scale industrial activities" contemplated by the Legislature. Additionally, "construction" did not appear in the exemption statute, and, as demonstrated by other exemptions, the Legislature knew how to exempt construction activities by including language to cover those activities if it had wished to do so.
In AAA Laundry & Linen Supply Co. v. Director of Revenue, 425 S.W.3d 126 (Mo. 2014), the taxpayer operated a commercial laundry that used large quantities of cleaning supplies; it argued that these supplies were used in "processing" under the manufacturing exemption. The Missouri Supreme Court disagreed with the taxpayer and overruled the AHC, which had concluded that the laundering activities were "processing," and thus the supplies were exempt from the use tax.
Finding little precedent on point, the court looked to cases on a different exemption statute, Section 144.030 (regarding machinery and equipment used to abate water pollution), to determine whether laundering is "processing." In these cases, the courts determined there was little to no difference between "manufacturing" and "processing" in Section 144.030. The primary case of authority, Unitog Rental Servs., Inc. v. Director of Revenue, 779 S.W.2d 568 (Mo. 1989), involved similar facts to AAA Laundry. In Unitog, the taxpayer claimed an exemption under Section 144.030.2(5), which allows a sales tax exemption for machinery purchased and installed in a manufacturing plant. The Unitog court found that a commercial laundry's equipment was not entitled to the Section 144.030 exemption because "manufacturing" requires producing a new and different product, not simply restoration of an original article.
The Unitog opinion used the terms "manufacturing" and "processing" interchangeably, even though "processing" is not listed as an enumerated term in Section 144.030.2(5), as it is in Section 144.054.2. In AAA Laundry, the court relied on its interchangeable use of "manufacturing" and "processing" in Unitog to find that there was little to no difference between "manufacturing" and "processing." The AAA Laundry court also cited Mid-America Dairymen, Inc. v. Director of Revenue, 924 S.W.2d 280, 283 (Mo. 1996), which stated that processing is "ordinarily included" within the term "manufacturing." Notably, the taxpayer in Mid-America claimed an exemption under Section 144.030, which listed both "manufacture" and "processing" as enumerated terms (Mo. Rev. Stat. §144.030.2(13)). The court found that AAA Laundry was not engaged in manufacturing because, in effect, the court found "manufacturing" and "processing" had the same meaning, AAA Laundry was not engaged in processing, and thus its activities did not qualify for the manufacturing exemption.
This is a somewhat strange analysis, considering that Section 144.054 is a different statute from Section 144.030, and Section 144.054 was enacted in 2007, 18 years after Unitog. Normally, courts construe statutory language to avoid superfluous language, giving each enumerated term a unique meaning. In a footnote, the court reasoned that its analysis from Unitog should apply because the Legislature acted with knowledge of the settled construction that "processing" is practically the same as "manufacturing."
Possibly in response to the outcome in AAA Laundry, legislation to specifically exempt commercial or industrial laundering facilities processing large amounts of textiles (minimum 500 pounds per hour and 60,000 pounds per week) has been proposed (S.B. 20). In 2014, the Missouri governor vetoed a similar bill (S.B. 612).
Does the Taxpayer Produce a Manufactured "Product"?
The court has also looked at whether the taxpayer's activities produce a manufactured product, the third element of the exemption. In Fenix Construction Co. of St. Louis v. Director of Revenue, 449 S.W.3d 778 (Mo. 2014), the taxpayer performed concrete construction services, including the production of "tilt-up" concrete wall panels. Tilt-up work requires casting concrete and reinforced steel wall panels on the ground and then positioning the walls on the building. The casting occurs on-site.
The court ruled that the manufacturing exemption applied only when materials are used in manufacturing "any product." "Product" was determined to mean "an output with a market value" and requires the existence of a market. The court found that there was no market for the wall panels—since the panels were produced for each particular building—and there was not a market of outside buyers for the panels.
Recent cases demonstrate the Missouri Supreme Court's clear intention to avoid expanding the concept of what constitutes "manufacturing" beyond traditional notions of manufacturing or the "large-scale industrial activities" the court considers to be implied in the Legislature's choice of activities qualifying for the exemption. The cases discussed in this item show that activities not thought of as "large-scale industrial activities" may have difficulty qualifying under the manufacturing exemption. In particular, construction activities, despite their scale, have been found not to qualify. Also apparent is the difficulty that taxpayers will face in qualifying as "processing," unless that processing occurs on a large scale and results in the production of a product with a readily apparent market.
Mary Van Leuven is director, Washington National Tax, at KPMG LLP in Washington.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or email@example.com.
Unless otherwise noted, contributors are members of or associated with KPMG LLP.
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