ORDERS:
FINAL ORDER AND DECISION
STATEMENT
OF THE CASE
Petitioner filed a claim for a refund of sales taxes based
upon the contention that it was a construction contractor of prestress concrete
building materials eligible to pay sales taxes on its purchases of raw
materials. On or about January 29, 2004, the South Carolina Department of
Revenue (Department or Respondent) issued a Final Agency Determination agreeing
that Petitioner should be classified as a construction contractor and allowed
the proposed sales tax treatment. However, the Department further determined
that Petitioner was not entitled to the sales tax exemption available to
manufacturers for purchases of machinery under S.C. Code Ann. § 12-36-2120(17) (2000)
and, accordingly, reduced the refund claim by the sales taxes owed as a result
of Petitioner’s tax-free purchases of machines. Petitioner now challenges
that determination. A hearing was held in this matter on August 16, 2005, at
the offices of the Administrative Law Court (ALC or Court) in Columbia, South Carolina.
FINDINGS
OF FACT
Having
observed the witnesses and exhibits presented at the hearing and closely passed
upon their credibility, taking into consideration the burden of persuasion of
Petitioner and Respondent, I make the following findings of fact by a
preponderance of evidence:
1. Notice
of the time, date, place and subject matter of the hearing was given to the
parties.
2. On
or about June 9, 1999, Petitioner purchased the stock and assets, to include
the plant facility, of an existing business which made prestress concrete
building materials. Petitioner began operations producing prestress concrete
building materials for use in construction projects such as schools, parking
garages, churches, and other buildings. Petitioner’s building materials are
unique products designed for a particular construction project as
opposed to being standard or interchangeable. The building materials are used
in construction projects in South Carolina and in other states.[1]
3. Petitioner
uses the majority of the prestress concrete building materials it produces in
fulfilling its own construction contracts (also referred to as "lump sum"
or "erection contracts"). The building materials are fabricated at
Petitioner’s production facility and then transported to construction project
sites where the materials are assembled as part of the construction project.
For these contracts, Petitioner is responsible for the installation of the
building materials, even though it may hire a subcontractor to perform the
actual work. Petitioner also makes retail sales (“Free on Board” or “FOB”
sales) of its prestress concrete building materials to other contractors and
third parties. As part of an FOB sale, Petitioner delivers the building
materials to the construction site where the general contractor of that project
is responsible for its installation.
4. I
find that under the facts of this case, the total square footage of concrete
produced to fulfill its contracts and the use of the raw materials and concrete
used in making its product best reflect what portion of its business is
attributable to construction or retail sales contracts. An analysis of 15 of
the 52 contracts completed during the refund period revealed that approximately
86% of the total square footage of concrete produced for these 15 contracts was
produced for erection contracts, while 14% of the square footage of concrete
was produced for retail sales contracts.
Likewise, approximately 86% to 87% of the total raw material used by Petitioner
during the refund period was used to produce prestress concrete for construction
contracts, while 13% to 14% of the total raw material used was to produce
prestress concrete for retail sales contracts. To that end, approximately 87%
of the prestress concrete produced by Petitioner during this period was used in
construction contracts, with 13% of the prestress concrete produced being used
in retail sales contracts.[3]
5. The
revenue generated as a result of Petitioner’s business also reflects what
portions of its business are construction or retail sales contracts. During
the refund period, approximately 86% to 89% of Petitioner’s total revenue was
attributable to construction contracts and, conversely, approximately 11% to
14% of its total revenue was attributable to retail or FOB sales.
Nevertheless, though this evidence is useful in confirming the accuracy of the
evidence above, it is not as probative in evaluating the use of the machinery.[4] Similarly, the
information regarding the absolute number of retail sales contracts versus
construction contracts does not provide any information about how much concrete
was produced by the taxpayer for each type of contract.
Petitioner also offered evidence concerning the pieces of
prestress concrete it produced for its contracts during the refund period.
That evidence reflected that of the 52 total contracts fulfilled by Petitioner,
27 of the contracts required the production of prestress concrete for use by
Petitioner in its erection contracts, and 25 contracts required the production
of prestress concrete for retail sales. Additionally, of the total pieces of
prestress concrete produced by Petitioner for its contracts during the refund
period, 52% to 55% of the pieces were used in construction contracts while 45%
to 48% of the pieces were used in retail sales contracts. I find, however,
that that evidence does not accurately reflect the use of Petitioner’s
machinery in its business. The information about the number of pieces of
concrete produced for each type of contract does not provide any meaningful
information about how much concrete was produced for each type contract,
especially given the taxpayer’s acknowledgement that “retail FOB pieces tend to
be smaller than construction contract pieces.”
CONCLUSIONS
OF LAW
Based
on the foregoing Findings of Fact, I conclude the following as a matter of law:
1. The
ALC has jurisdiction to decide issues herein pursuant to S.C. Code Ann. Section
12-60-460 (Supp. 2004). The standard of proof in these proceedings is a
preponderance of the evidence. Anonymous v. State Board of Medical Examiners,
329 S.C. 371, 496 S.E.2d 17 (1998). Furthermore, Petitioner bears the burden
of proof in this case. See Leventis v. South Carolina Dept. of
Health & Env. Control, 340 S.C. 118, 530 S.E.2d 643 (Ct. App. 2000);
Randy R. Lowell and Stephen P. Bates, South Carolina Administrative
Practice and Procedure, 200-201 (2004). Furthermore, exemption statutes
must be strictly construed against the taxpayer such that the taxpayer must
demonstrate that it falls within the parameters of the exemption. Owen
Indus. Products, Inc. v. Sharpe, 274 S.C. 193, 262 S.E.2d 33 (1980).
2. Petitioner
asserts that it is entitled to the machine sales tax exemption under S.C. Code
Ann. § 12-36-2120(17) (2000) for its purchases of machinery during the refund
period. Section 12-36-2120(17) establishes that the sales price of “machines
used in manufacturing . . . tangible personal property for sale” are exempt
from the taxes imposed by Title 12, Chapter 36. Generally, contractors who use
the building materials they fabricate in the performance of their own
construction contracts are the ultimate consumers of those materials. These
businesses pay sales taxes based upon the cost of the raw materials used to
make the building materials, not upon the value of the finished building materials
themselves. See Revenue Ruling # 94-2. Therefore, since these
contractors are not making retail sales, they are not entitled to the “machine
exemption” under Section 12-36-2120(17).[5]
Following that supposition, the Department found in its Final Determination
that a taxpayer cannot be both a contractor and a manufacturer for sales tax
purposes. Accordingly, the Department determined that Petitioner was not
entitled to the “machine exemption.”
However,
after the issuance of its decision, the Department later determined that though
a contractor generally pays sales taxes based upon the raw materials used to
make building materials, it potentially may be entitled to enjoy the benefits
of the “machine exemption” if it meets the criteria set forth in Revenue Ruling
#04-7. Revenue Ruling #04-7 states that to qualify for the “machine
exemption,” the taxpayer must meet a three prong test.[6] In its third prong, the
Department, citing Hercules Contractors and Engineers, Inc. v. SC Tax
Commission, 280 S.C. 426, 313 S.E.2d 300 (Ct. App. 1984), stated:
The machine must be substantially “used in
manufacturing … tangible personal property for sale.” The statute does not
require that the machine be used exclusively in manufacturing; however,
incidental manufacturing use will not qualify for the exemption. In the
Department’s opinion, more than one-third of a machine’s use in
manufacturing is substantial.
(Emphasis added.) Since Petitioner did make some retail sales of its
building materials to third parties during the refund period, it used its
machines in “manufacturing . . . tangible personal property for sale” within
the meaning of Section 12-36-2120(17). Nevertheless, the Department argues
that Petitioner, in this case, still is not entitled to the machine exemption
under Section 12-36-2120(17) because it did not use its machines at least
one-third of the time in manufacturing.
Petitioner argues that it is entitled to the machine
exemption because it often sells individual pieces to the general contractor.
It contends that it must offer both options to remain competitive and operate
at full production. In addition, Petitioner maintains that the requirement
that it must use its machinery at least one-third of the time in its retail
contracts is not supported by the ruling in Hercules and is an arbitrary
approach to that determination.
The
majority of the business Petitioner performs is the production of prestress
concrete building materials for use in the performance of its own construction
contracts. Therefore, Petitioner is a contractor within the meaning of Section
12-36-110(1)(e). In Hercules, the Court of Appeals addressed the issue
of whether a contractor is entitled to a “machine exemption” emanating from its
joint use of its machinery. The case involved a wastewater treatment facility
built by the Town of Batesburg that was used by both Burlington (a
manufacturer) to treat waste from its manufacturing plant and by the Town to
treat its municipal waste. The manufacturing use of the wastewater facility
was 35%. The Tax Commission argued that if a facility is used by anyone other
than a manufacturer, the materials used to construct the facility should not be
tax exempt. The Court recognized that “it would not be reasonable to hold that
the legislature intended that only a minimum use by a manufacturer be
sufficient to make a machine tax exempt.” Id. at 308. (Emphasis added.)
Nevertheless, the Court ruled the materials used in construction of the
facility were exempt from sales or use taxes because the plant was “substantially
used in the manufacture of tangible personal property for sale, and this
was a purpose for which it was built.” Id. at 309. (Emphasis added.)
Following Hercules, the Department issued Revenue Ruling #94-2[7] on March 1, 1994, which
addresses the sales tax obligations of businesses that manufacture or fabricate
items that they will use in constructing real property. Revenue Ruling #94-2
instructs that businesses fabricating unique building materials for their own
use in construction contracts are contractors. As such, these businesses pay
sales taxes based upon the cost of the raw materials used to make the building
materials, not upon the value of the building materials themselves.
Nevertheless, in recognition that a contractor may perform as both a contractor
and a manufacturer, Revenue Ruling # 94-2 opines that an exception exists to the
normal rule that contractors are not entitled to the machine exemption when the
contractor’s manufacturing activities are “substantial:”
In addition, as a contractor, the taxpayer
is not entitled to the exemptions and exclusions provided in Code
Sections 12-36-2120(9), 12-36-2120(17), 12-36-2120(19) and 12-36-120, unless
a substantial portion of its business also includes the fabrication of “unique
products” (and/or standard finished products) that it sells to contractors and
other consumers. . . .
(Emphasis added.)
The Department had not defined what level of a machine’s manufacturing use it
believed qualified as “substantial” in order to allow a machine to be exempt
from sales tax under the “machine exemption” until its recent issuance of
Revenue Ruling #04-7.[8]
Revenue Ruling #04-7 provides that “incidental manufacturing use will not
qualify for the exemption. In the Department’s opinion, more than one-third of
a machine’s use in manufacturing is substantial.”
Based
upon the foregoing, I find that the Department’s position that
“substantial use” requires a level of manufacturing use in excess of one-third
is an incorrect interpretation and application of Hercules and its revenue
ruling. In Hercules, the Court set forth the requirement that minimal
use of a machine is not sufficient and that in order to obtain the “machine
exemption,” the machine must be substantially used in the manufacturing
process. Though it approves the “machine exemption” because 35% of the
wastewater facility was used to treat waste from the manufacturing plant, it
did not establish the requisite that a machine must be used in manufacturing
35% of the time. Moreover, Revenue Ruling #04-7, in keeping with the Hercules holding, correctly sets forth that “incidental manufacturing use will not
qualify” for the machine exemption. Furthermore, though Revenue Ruling #04-07
opines that “more than one-third of a machine’s use in manufacturing is
substantial,” it does not state that the use must be at least
one-third. Accordingly, I find that in order to obtain a machine exemption in
this case, Petitioner must establish that the use of its machinery to make
retail sales to other contractors and third parties was not minimal or
incidental but rather substantial.
3. Nevertheless,
the quantitative use that must be made of a machine in order to be considered “substantial”
is still undefined.
In construing statutes, we seek to
effectuate legislative intent. The cardinal rule of statutory construction is
that words used therein must be given their plain and ordinary meaning without
resort to subtle or forced construction to limit or expand its operation. The
language must also be read in a sense which harmonizes with its subject matter
and accords with its general purpose.
Hitachi Data Sys. Corp. v. Leatherman, 309 S.C. 174, 178, 420 S.E.2d 843, 846
(1992) (citation omitted). “Where a word is not defined in a statute, our
appellate courts have looked to the usual dictionary meaning to supply its
meaning.” Lee v. Thermal Engineering Corp., 352 S.C. 81, 91-92, 572
S.E.2d 298, 303 (Ct. App. 2002). "Substantial" is defined as:
“Considerable in importance, value, degree, amount, or extent.” American
Heritage Dictionary of the English Language 1354 (3d ed. 1993). See also Merriam-Webster Online (2005), available at http://www.m-w.com. ("substantial"
defined as “considerable in quantity: significantly great”).
Here,
evidence shows that approximately 87% of the concrete Petitioner produced was
used for construction contracts, while only 13 to 14% of the concrete produced
was used for retail sales contracts. Given that only 13% of the prestress
concrete produced was used for retail sales contracts, I find that Petitioner’s
manufacturing use of its machinery during the relevant time period is not sufficiently
considerable in quantity or value so as to be substantial. Therefore,
Petitioner is not entitled to the machine exemption pursuant to Section
12-36-2120(17) for its purchases of machinery during the refund period. If,
however, Petitioner subsequently begins substantially using its machinery to produce
prestress concrete for retail contracts, it may be entitled to utilize the machine
sales tax exemption for future machine purchases.
In
conclusion, prior to its refund request, Petitioner was taxed as a
manufacturer. As a manufacturer, Petitioner paid sales taxes based upon the
fair market value of its prestress concrete building materials at the time of
their use pursuant to Section 12-36-110(d)(1). Petitioner was also allowed as
a manufacturer to use the machine exemption for its machinery used
substantially in manufacturing.[9]
Petitioner thereafter sought the sales tax advantage of being recognized as a
contractor for purposes of its construction contracts so that it could instead
pay sales taxes on its purchase of raw materials. By carving out 87% of its
business to be characterized as a construction contractor, the taxpayer fell
below the Hercules standard for the substantial use of its machinery
during the refund period. Having been recognized as a construction contractor
for this use, the Petitioner must now accept the sales tax consequences that
come along with the benefits of its contractor designation.
ORDER
Based
upon the foregoing Findings of Fact and Conclusions of Law:
IT
IS HEREBY ORDERED that Petitioner’s request for the machine sales tax
exemption under Section 12-36-2120(17) be denied.
AND
IT IS SO ORDERED.
________________________________
Ralph
King Anderson, III
Administrative
Law Judge
December 7, 2005
Columbia, South Carolina
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