Indiana Tax Court denies exemption for certain utilities
Sales tax required for utilities used in rehabilitation of tanker trailers.
TAX ALERT |
An Indiana Tax Court decision filed on Feb. 16, 2015, denied a sales tax refund claim associated with electricity and gas utilized to rehabilitate used cryogenic tanker trailers. However, the Indiana Department of State Revenue (the Department) previously approved the taxpayer’s refund claim for electricity and gas used for the manufacture of new cryogenic tanker trailers between September 2006 and March 2010. The decision, Alloy Custom Products, Inc. v. Indiana Dep’t of State Revenue (Ind. Tax Ct. Feb. 16, 2015), provides guidance to entities that rehabilitate or repair tangible personal property when determining whether purchases of electricity and gas are exempt from sales tax. This article outlines the four questions considered by the court in concluding that electricity and natural gas used to rehabilitate tanker trailers are not exempt from sales tax.
Indiana Code section 6-2.5-4-5(a)-(c) (2006, amended 2012) exempts from sales tax the retail sales of electricity and natural gas by a public utility to a purchaser that uses the electricity and gas in its manufacturing process. However, the exemption is limited to the electricity and natural gas consumed by the purchaser “as an essential and integral part of an integrated process that produces tangible personal property . . . .” Section 6-2.5-4-5(c) (2006, amended 2012).
Alloy Custom Products, Inc. (Alloy) is in the business of manufacturing new cryogenic tanker trailers, as well as rehabilitating used cryogenic tanker trailers. The issue in the case was whether Alloy’s rehabilitation process “produces tangible personal property” as required in Indiana Code section 6-2.5-4-5(c) (2006, amended 2012). Both parties agreed the electricity and gas are integral to the rehabilitation process.
The Department’s position in denying the refund claim was that Alloy merely repaired existing tankers and no production of tangible personal property took place. Alloy argued that, even if the rehabilitation is considered a repair, such repair is transformative, and after the rehabilitation takes place, “an entirely new product has been produced.” Based on these positions and prior case law, the court made the distinction between a “transformative repair” and an “ordinary repair,” with the former being production of tangible personal property. The court noted, and both parties agreed, that whether an activity is a transformative repair turns on the answers to the four following questions:
1. What is the substantiality and complexity of the work done on the existing article?
In answering this question in favor of the Department, the court noted that, when asked to explain its rehabilitation process, Alloy stated that it takes tankers at the end of their useful lives and makes them into tankers that can be used for another five to seven years. The court recognized that although Alloy’s rehabilitation process is time-consuming and comprised of many steps, a transformative repair requires a process that transforms tangible personal property “into a substantially different end product.” The court determined that Alloy’s rehabilitation merely increased longevity of the products and was, therefore, an ordinary repair.
2. How does the article’s value before and after the work compare?
The court again answered this question in favor of the Department. In doing so, the court recognized that a transformative repair “often occurs when property with little or no market value has been converted into a marketable product.” The court’s answer was based on the fact that the value of an un-rehabilitated tanker could range from $5,000 - $10,000, which was more than “a little” value. Thus, adding value to an article is not enough—the process must add value to an article that initially had little to no value.
3. How does the article’s performance before and after the work compare?
Again, the court answered this question in favor of the Department. The question was whether the article was “transformed in such a way that it performs as good as or better than when it was originally manufactured.” The court emphasized the improvement in the actual performance of the tankers (as opposed to appearance) and the purpose for performing the service. Alloy argued that its rehabilitation process involved “upgrading the [tanker trailer] to new standards and technologies for emissions, suspensions, engines and valves that did not exist at the time of the initial manufacture.” In the court’s opinion, the various upgrades to the tanker trailers did not improve or enhance the ability to transport liquid gas. Additionally, the court emphasized that “the whole point of the rehabilitation process is to restore the” tanker’s ability to transport gas (emphasis in original). It is unclear how this will be interpreted going forward, as upgrading an item with new technology would generally be thought to make something better than it was when originally manufactured.
4. Was the work performed contemplated as a normal part of the life cycle of the existing article?
The court answered this question in favor of the Department by analyzing whether the service performed was part of routine maintenance, which is not a transformative repair. Alloy argued that rehabilitation was not routine maintenance because an owner must decide whether to take the tanker out of service or have it rehabilitated; the court disagreed. Additionally, the court noted that many of Alloy’s customers rehabilitate their tanker trailers on cycles, as part of routine maintenance. Thus, the rehabilitation was considered routine maintenance and not a transformative repair.
After answering the four questions in favor of the Department, the court determined that the rehabilitation performed by Alloy did not produce tangible personal property. Accordingly, the court denied Alloy’s refund claim for electricity and natural gas used in rehabilitating the tanker trailers.
Based on the court’s decision in Alloy, Indiana manufacturers that repair or rehabilitate tangible personal property should consider whether their activities rise to the level of production of tangible personal property or represent ordinary repairs and treat purchases of electricity and natural gas accordingly.