It seems that a lot of time is lost (wasted) in states writing statutes to exempt certain business purchases from sales tax. Time is also lost by tax agencies and courts trying to interpret the statutes. The uncertainty puts sellers in a risky position of owing sales tax if they interpret the statute incorrectly or losing customers if they insist on charging the tax due to uncertainty. Litigation can result, as recently was the case in Missouri.
Union Electric Co. v. Director of Revenue, No. SC93083 (Mo S Ct, 3/11/14) – Union Electric (UE) sought a refund of sales tax it charged Schnucks (S) grocery stores. S used electricity to operate ovens and other equipment in its bakery departments. Schnucks bakes items starting with frozen dough it acquires. UE argued that these energy costs qualified for a sales tax exemption for energy used in processing products. The Missouri Department of Revenue denied the claim and the Administrative Hearing Commission (AHC) agreed with the state.
The Missouri Supreme Court upheld the holding, supported by a 2012 ruling (Aquila, 362 S.W.3d 1) that “’processing’ as used in section 144.054.2, does not include in-store preparation of cooked goods for retail sale. The relevant statute “exempts from sales tax “electrical energy and gas … used or consumed in the manufacturing, processing, compounding, mining, or producing of any product.”
The AHC concluded that S’s activities to thaw, fry and perform other activities to prepare the baked goods for sale was not “processing” but instead “was part of cooking or preparing the baked goods for retail sale and, therefore, did not fall within the exemption.” UE also argued that this fact pattern was similar to one in the related regulations that involved a bakery. The AHC found that the example did not support the statute and was, thus, not binding.
Section 144.054.1(1) defines “processing” as “any mode of treatment, act, or series of acts performed upon materials to transform or reduce them to a different state or thing.” Per UE, because S converts frozen dough to edible baked goods – a different form or state, it processes. The AHC found it to be mere cooking.
The court used rules of statutory interpretation to determine the meaning of the "processing" exemption. Per the court: "because the word at issue appears in the statute within a list of words, the Court will apply the principle of statutory construction known as noscitur a sociis − a word is known by the company it keeps." ... "If the meaning of a word is unclear from consideration of the statute alone, a court will interpret the meaning of the statute in pari materia with other statutes dealing with the same or similar subject matter." As the court had ruled in Aquila, it found that "processing" used along with manufacturing and producing was an industrial context and did not serve the same intent as food preparation for retail sale. Per the court, Aquila was engaged in activities similar to “preparing,” “furnishing,” or “serving.”
An example in the regulations for the statute includes a bakery. Per Example (O): "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."
The court put no weight in the example stating that the food prep by Schnucks was not processing as required by the statue and the question of whether Schnucks was a bakery was not an issue. So, the court did not have to rule on whether the example is valid (footnote 7). And, UE's argument that it can rely on the example, even if incorrect, because the tax agency has not removed it was incorrect and moot since the court found that type of activity Schnucks engaged in was not processing. And, the court is not required to rely on a regulation that is inconsistent with the statute - "a statute prevails over a regulation and ... a regulation cannot expand or modify a statute."
Also relevant in interpreting the statute and its terminology and noted by the court: "Tax exemptions will be strictly construed against the taxpayer, and doubts as to the taxpayer’s eligibility will be resolved in favor of taxation."
The issue of how broad sales tax exemptions for equipment used in manufacturing or processing are not new. You can find these types of ruling in most states that have a sales tax exemption for manufacturing equipment or services. For example, Colorado GIL12-015 discusses whether bakery equipment qualifies for the manufacturing equipment exemption. It doesn't reach a specific conclusion but notes that other states have interpreted manufacturing as meaning the industrial context.
Maryland explains its manufacturing exemption in the context of bakeries as follows: " Generally, food processed for sale by grocery stores, bakeries and other food retailers does not qualify for exemption. However, there is a specific exemption for the sale of equipment to be used by a retail food vendor to manufacture or process bread or bakery goods for resale. To qualify for the exemption, the vendor must operate a substantial grocery or market business (as defined in Section 11-206(a) of the Tax-General Article) at the same location where the food is sold. The taxable price of each piece of exempt equipment must be at least $2,000."
The solution - sales tax should not apply to purchases by businesses; only to purchases by consumers. This is a challenge today though, because tax collections from businesses might represent 20 - 35% of a state's sales tax collections. These amounts could gradually be replaced with an expanded sales tax base to include more types of personal consumption. I think it would be a useful and appropriate effort by state legislatures to be working towards - exempting all business purchases from sales and use tax. It would make the sales tax simpler, more efficient and avoid pyramiding (imposing a tax on a tax). Perhaps not adding or renewing income tax breaks for businesses would help in finding the dollars - and that effort would also make the tax laws simpler.
What do you think?
Other recent “Sales Tax Policy - Tales & Trends” posts by Annette Nellen, CPA, ESQ:
- Idaho Keeps Sales Tax On Groceries
- Sales Tax Policy Outlook for 2017
- Would Broader Sales Tax Base Deliver Simplification - and Savings?
- Trailing Nexus - When Does It End?
- Sales Tax As Penalty?