The Indiana Department of Revenue (DOR) recently released a pair of letters of findings that address the state's sales tax exemptions for items used in agricultural production: Ind. Ltr. of Findings No. 04-20120228 (Dept. of Revenue Aug. 29, 2012) and Ind. Ltr. of Findings No. 04-20110434 (Dept. of Revenue Sept. 26, 2012).
The two letters of findings involved similar circumstances. The taxpayers in these cases are farmers who had purchased equipment that they used in their agricultural operations without paying sales or use tax. In both cases, the letters present the results of administrative hearings held after the farmers (the taxpayers) protested audits in which the DOR had assessed sales or use taxes on their purchases of the agricultural equipment. Thus, the issue in both cases was whether the equipment qualified for one of Indiana's sales tax exemptions for agricultural machinery and equipment.
Indiana provides two sales tax exemptions for agricultural equipment. First, Indiana exempts sales of agricultural machinery, tools, and equipment directly used in the direct production, extraction, harvesting, or processing of agricultural commodities. Ind. Code sec. 6-2.5-5-2(a). The Department of Revenue has explained that the agricultural machinery, tools, or equipment must have an immediate effect on the commodity produced in order to qualify under this provision. See Ind. Sales Tax Info. Bull. No. 9 (Dept. of Revenue July 2012).
Second, Indiana exempts sales of machinery or equipment that is designed for use in the gathering, moving, or spreading of animal waste, even when it is not directly used in the direct production of agricultural commodities, but provided that the following two additional conditions are satisfied: (1) the person acquiring the machinery or equipment is occupationally engaged in the production of food or commodities that are sold for human or animal consumption; and (2) the person acquiring the equipment acquires it for use in conjunction with the production of food or commodities for sale. Ind. Code sec. 6-2.5-5-2(b).
In both letters, the farmers claimed that the items at issue should qualify under the first of these two exemptions--the exemption for agricultural machinery, tools, and equipment directly used in the direct production, extraction, harvesting, or processing of agricultural commodities. The DOR stated that, in order to qualify for this exemption, the equipment must satisfy the "double direct test": the item must be directly used in the direct production of agricultural products. Furthermore, the DOR quoted its own regulations in order to explain that "the fact that an item is purchased for use on the farm does not necessarily make it exempt."
In the first letter (Ind. Ltr. of Findings No. 04-20120228), the DOR reasoned that equipment used to install fencing was not directly used by the farmer in the direct production of an agricultural commodity. Thus, the DOR ruled that the farmer's purchase of the equipment was taxable.
In the second letter (Ind. Ltr. of Findings No. 04-20110434), the DOR determined that the farmer used a tractor both in ways that satisfied and failed the "double direct test." When the farmer used the tractor to haul feed to livestock, he directly used the tractor in the direct production of an agricultural commodity. But the farmer also used the very same tractor to check on livestock and fencing, clean the barns, and fix waterlines. The DOR explained that, even though these activities may be necessary to farming, they do not satisfy the "double direct" test, so those activities are not directly in the direct production of agricultural products. Accordingly, the DOR allocated the tax the farmer owed on his purchase of the tractor based on the number of days the farmer used it in the taxable manner compared to the number of days it was used in an exempt manner.