Saturday, August 31, 2013

Revenue Finds Removal System and Bailer Not Exempt Because Taxpayer did not Manufacture "Scrap Paper"

Taxpayer is an Indiana manufacturer. As the result of an audit, the Indiana Department of Revenue ("Department") determined that Taxpayer owed use tax. The Department therefore issued proposed assessments for use tax and interest.

Taxpayer protests the imposition of use tax on its "Scrap removal system, baling equipment and related parts." Taxpayer states that the equipment is necessary as part of its production process and is therefore exempt from Indiana sales and use tax. The Department notes that the burden of proving a proposed assessment wrong rests with the person against whom the proposed assessment is made, as provided by IC § 6-8.1-5-1(c).
Taxpayer manufactures cardboard boxes. During the cutting of the cardboard, a scrap removal system collects the scrap that falls below the production machinery. The removal system then carries the scrap to the baler where it is bundled for shipment. Taxpayer argues that the scrap removal system and baler both fall within this exemption. Taxpayer explains, "If the scrap is not removed [the product] cannot be further processed, therefore the removal of the scrap has a direct effect on the boxes being produced."
While the scrap removal system may be necessary, it does not satisfy the "double direct" test provided in IC 6-2.5-5-3(b) which states that the property must be directly used in direct production. Here the scrap remover is not part of direct production, but is instead part of post production. Once the scrap has been punched out, it is no longer part of production. Therefore the machinery used solely for the removal of the post production scrap is not considered part of direct production.
With regards to the baler, Taxpayer argues "we are however engaged in producing other tangible property for sale, that being bales of paper."
The Department refers to 45 IAC 2.2-5-10(k) which states:
"Definitions. Processing or refining is defined as the performance by a business of an integrated series of operations which places tangible personal property in a form, composition, or character different from that in which it was acquired. The change in form, composition, or character must be a substantial change. Operations such as distilling, brewing, pasteurizing, electroplating, galvanizing, anodizing, impregnating, cooking, heat treating, and slaughtering of animals for meal or meal products are illustrative of the types of operations which constitute processing or refining, although any operation which has such a result may be processing or refining. A processed or refined end product, however, must be substantially different from the component materials used." (Emphasis added)
Here the Taxpayer is not engaged in the production of a new or refined end product. While Taxpayer may sell the scrap, it is not a "product" manufactured by Taxpayer. The scrap is a by-product of Taxpayer's manufacturing process that Taxpayer sells in secondary markets. The scrap is not an item that is manufactured by the transformation of component raw materials into a distinct product. Taxpayer begins with scrap paper, and ends with scrap paper. Taxpayer does not make a new, "substantially different product." Therefore, in this instance, the removal system and bailer that are used to transport and bundle the scrap do not qualify for exemption. As a result, Taxpayer has not met its burden to prove the proposed assessment wrong, as provided by IC § 6-8.1-5-1(c).