The Kentucky Board of Tax Appeals (BOTA) recently issued an order explaining the application of Kentucky's sales tax exemptions for items used in manufacturing. Progress Metal Reclamation Co. v. Cmmw., Fin. and Admin Cabinet, Or. No. K-22015 (Ky. Bd. of Tax Apps. Apr. 18, 2012).
The taxpayer in the case was a recycler and manufacturer of scrap metal for steel mills. The scrap metal recycler argued that hammer pins and bulk liquid oxygen it purchased for use in its business qualified for sales tax exemptions.
The scrap metal recycler challenged two rulings made by the Department of Revenue (DOR). First, the DOR had determined that hammer pins purchased by the taxpayer were not industrial tools, so they did not qualify for Kentucky's exemption for items used in manufacturing tangible personal property for sale. See Ky. Rev. Stat. Ann. sec. 139.470(11)(a)(2)(c). Second, the DOR determined that the liquid oxygen used by the taxpayer in a cutting torch was considered to be an energy producing fuel and could not be exempted as an industrial supply. See Ky. Rev. Stat. Ann. secs. 139.470(11)(a)(2)(c), 139.480(3).
Kentucky provides three limited exemptions that may apply to items purchased for use in manufacturing. First, Kentucky exempts sales of tangible personal property to be used at a plant facility in the manufacturing or industrial processing of tangible personal property that will be for sale. Kentucky specifically outlines the following three categories of tangible personal property that qualify for this exemption:
Ky. Rev. Stat. Ann. secs. 139.010(16), (21), (26), 139.470(11).
Second, Kentucky exempts sales of "energy or energy-producing fuels" used in manufacturing to the extent that the total cost to the manufacturer of such fuel exceeds three (3%) percent of the cost of production. Ky. Rev. Stat. Ann. secs. 139.010(16), (21), 139.480(3); 103 Ky. Admin. Regs. 30:140.
Third, Kentucky also exempts sales of machinery for new and expanded industry. There are four requirements for this exemption: (1) the item must be machinery; (2) it must be used directly in the manufacturing process; (3) it must be incorporated for the first time into plant facilities established in Kentucky; and (4) it must not replace other machinery. Ky. Rev. Stat. Ann. secs. 139.010(16), (21), 139.480(10); 103 Ky. Admin. Regs. 30:120.
The scrap metal recycler did not argue that it purchased the hammer pins or oxygen for a new or expanded industry; instead, its arguments focused on the first exemption. The scrap metal recycler argued that the hammer pins and liquid oxygen qualified for exemption as items used in manufacturing tangible personal property. The DOR argued that the liquid oxygen was a fuel, so it had to treated under the limited exemption for energy-producing fuels and could not be treated as supply used in manufacturing.
Because the hammer pins were not hand tools and only incidentally came into contact with the metal being produced, the BOTA concluded that the hammer pins were not industrial tools. Instead, the BOTA determined that the hammer pins were replacement parts, which are not exempt. Accordingly, the BOTA upheld the DOR's ruling that the hammer pins were subject to sales tax.
But, the BOTA disagreed with the DOR about the liquid oxygen. The BOTA reasoned that liquid oxygen by itself is not flammable and will not burn, so it is not clearly a fuel covered only by the sales tax exemption for energy-producing fuels. The BOTA also considered the fact that the DOR had treated liquid oxygen as an exempt industrial supply from 1965 until 2004, when the DOR, without prompting from the legislature, changed its interpretation and began treating liquid oxygen as a fuel. The BOTA applied the doctrine of contemporaneous construction and concluded that the DOR was previously correct to treat the liquid oxygen as an exempt industrial supply. Consequently, the BOTA reversed the DOR's ruling with respect to liquid oxygen, so the scrap metal recycler's purchases of the liquid oxygen were exempt.