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Ohio Manufacturing Exemptions: Caustic Solutions and Harsh Decisions

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Welcome to the new Ohio State Sales Tax Blog! I look forward to discussing many Ohio sales tax issues in these posts. I may select topics that are particularly timely or challenging – or simply an item that I find particularly fascinating. However in some cases – I’ll also write on topics suggested by readers – so please let me know if there are particular Ohio sales or use tax issues that you’d like addressed.

For this first post I’ve decided to discuss Ohio’s manufacturing sales and use tax exemption. Manufacturing is a capital intensive industry, and given about 17% of Ohio's economy is tied to manufacturing (vs. 12% nationwide), the exemption is a very important topic.Ohio exempts from sales and use tax purchases of property used primarily in a manufacturing operation to produce tangible personal property. Property eligible for the exemption includes production machinery and equipment that make the product, materials handling equipment (i.e. forklifts, cranes) which move the product through a continuous production process, catalysts, solvents and other consumables that interact with the product and are integral to the manufacturing operation, Fuel, power, electricity consumed to power manufacturing equipment, and equipment and other property used to manufacture production equipment.

In order to demonstrate the complexities associated with these exemptions – I’d like to review the Todd Perren decision issued by the Ohio Board of Tax Appeals ("B.T.A.") on 8/29/2014. This case resulted from the assessment by the Ohio Tax Commissioner ("Commissioner") on the purchase of a "caustic" solution applied to dies after a manufacturing run.

The Ohio Revised Code ("O.R.C.") uses a unique term for this property, calling it "the thing transferred". Another section of the O.R.C. defines the term for purposes of the exemption, both in terms of what qualifies and what does not qualify. A lengthy administrative ruling attempts to provide further clarification by providing more than 60 examples describing what types of purchases are exempt and what types of purchases are taxable.

Under the facts in the case, the solution is applied to the dies after the manufacturing runs for the day to prepare it for the following day’s runs, or if there is a quality control issue i.e. the die is not operating to produce a product to required specifications or if there is a mechanical problem. The solution removed excess aluminum residue from the die that would otherwise negatively impact the product being produced. The Taxpayer's position was that the caustic solution was exempt from tax as a purchase of "machinery, equipment, and other tangible personal property used during the manufacturing operation that control, physically support, produce power for, lubricate, or are otherwise necessary for the functioning of production machinery and equipment and the continuation of the manufacturing operation." Meanwhile the Commissioner's position was the solution was taxable as the purchase of "tools, equipment, and supplies made or purchased by the manufacturer for use in maintaining, installing, repairing, or cleaning its property, real or personal".

Analysis of the Decision

My first observation of the decision notes Mr. Perren is the controller of Extrudex Aluminum ("Taxpayer"), a manufacturer of quality aluminum extrusion products, with facilities in Ohio, Ontario and Quebec, Canada. Mr. Perren appears to have been the only representative of the Taxpayer in the B.T.A. proceedings, and it's hard for me to think this did not have any bearing on the outcome.

The decision held the caustic solution did not qualify for exemption from tax. The B.T.A. reasoned the solution was used to maintain and clean the dies and was not used in a continuous manufacturing process. Two fatal flaws led to this outcome: 1. in order to apply the solution to the dies, it was necessary to remove the dies from the machines; meaning the manufacturing process halted. Indeed this fact is similar to a 2001 Ohio Supreme Court case holding a forklift used to remove and replace dies from a press was subject to tax since the manufacturing process halted when the forklift was used to remove and replace dies, weighing anywhere from a few hundred pounds to as much as seventy thousand pounds. And 2. In testimony as well as the Taxpayer's appeal, the process of applying the solution to the dies was described as a "repair operation". Repair of tangible personal property is subject to sales and use tax in Ohio.

Take Away

While property used in a manufacturing plant may very well be necessary for the manufacturing process to function properly, it does not follow under Ohio law that it qualifies for exemption from sales tax. If use of the property causes the manufacturing process to halt, notwithstanding its proximity or importance to the manufacturing process, it will likely be deemed ineligible for the manufacturing exemption. It seems rather harsh; however it is what the statute and case law hold. Compare the result in this decision to example 49 in the regulation where washing equipment used to clean overspray is treated as exempt. The difference is the seemingly continuous use of the washing equipment during the manufacturing process which itself is not halted while the washing equipment is in use.

How one describes a process is very important in determining the effect of a purchase under the sales and use tax law. The description of the application of the solution to the dies as a "repair process" by the Taxpayer required the B.T.A. to judge the purchase taxable as a repair of tangible property. Accordingly, a complete analysis of the process by an independent advisor is most valuable in ferreting out these issues and resolving them early on before an audit brings a nasty surprise.

Have a comment or question? Is there a topic you'd like to see discussed? Submit your question or comment below and we'll be sure to get in touch!

Guy J. Nevers CPA MT is the founding member of Nevers Consulting Group, LLC; a firm that offers a full spectrum of sales and use tax services as well as other federal and state tax services. You can learn more about him on his bio page as well as his Firm Profile.

Other recent “Ohio (OH)” posts by Guy Nevers, CPA, MT:

NOTE: All blog content, comments, and participation subject to disclaimer at bottom of page.

Comments

4 Responses to Ohio Manufacturing Exemptions: Caustic Solutions and Harsh Decisions

  • Posted by Otis on October 8, 2015 8:53pm:

    Which will lead to more cost in production. A halted process in production is a bad news for this industry. They have paid taxes too, haven't they? It is bigger than most people has paid.

    • Posted by Guy on October 12, 2015 1:24pm:

      Otis; Thanks for the comment. I agree, taxing items that are necessary to the manufacturing process but are only useful when the manufacturing process stops does increase the cost of production for manufacturers.

      In the case above, it hardly seems reasonable that a forklift necessary to remove a die from a press for cleaning and repair should be subject to sales tax. That die is necessary for the production of parts and is itself exempt from sales tax.

      Repair parts installed on the machine itself is exempt from sales tax. It seems reasonable to me that anything necessary for the manufacturing process should be exempt from sales tax even if use of that machine, or in this case the forklift, causes the process to halt temporarily.

  • Posted by Jim on March 16, 2015 10:06am:

    Guy,
    We have a commercial construction project in Ohio. Is sales tax due on only the material portion of a contract or is sales tax also on the labor to fabricate material for Incorporation into a project.
    Jim

    • Posted by Guy on March 16, 2015 4:39pm:

      Good evening Jim, Thanks for the question!
      When you say "labor to fabricate material for Incorporation into a project", I presume you have contracted with a vendor to fabricate a fixture to your specification so you can incorporate it into a real property contract. Let me know if I am mistaken.
      Construction contractors are considered consumers of the materials they purchase to incorporate into a construction contract. Not only does this include "raw" materials, but also produced materials as well. The cost of the fabricated fixture is a material cost to you. If the vendor includes labor costs in the price charged to you, then it is part of your materials cost, and is subject to sales tax. Even if the labor is separately stated, it is still subject to sales tax for the same reason. You are the consumer of the property incorporated into the contract, and the labor is part of your cost.
      Let me know if this helps, or if I've misunderstood your fact pattern.
      Guy

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