Taxpayer is an Indiana corporation which manufactures sanitation chemicals and equipment used by food processers and the meat industry. The Indiana Department of Revenue ("Department") conducted an audit for the tax years 2010, 2011, and 2012 and proposed assessments of base tax, penalties, and interest.
Taxpayer protests the use tax imposed on the purchase of sodium chloride and parts for its wells. All tax assessments are prima facie evidence that the Department's claim for the tax is valid, and the taxpayer bears the burden of proving that any assessment is incorrect. IC § 6-8.1-5-1(c); Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012). The issue before the Department is whether Taxpayer met its burden to prove the Department's assessment is incorrect.
Taxpayer argues that the sodium chloride and well are part of the Taxpayer's production process and therefore exempt from sales or use tax. Generally, "all purchases of tangible personal property by persons engaged in the direct production [or] manufacture . . . of tangible personal property are taxable."
45 IAC 2.2-5-8(a). However, "transactions involving manufacturing machinery, tools, and equipment are exempt" if they are purchased for "direct use in the direct production [or] manufacture . . . of other tangible personal property." IC § 6-2.5-5-3(b); 45 IAC 2.2-5-8(a).
To claim this exemption, a taxpayer must first demonstrate that it produces tangible personal property, because "without production there can be no exemption." Indianapolis Fruit Co. v. Dept. of State Revenue, 691 N.E.2d 1379, 1384 (Ind. Tax Ct. 1998).
Second, a taxpayer must show that the property was acquired for the "direct use in the direct production [or] manufacture . . . of other tangible personal property." IC § 6-2.5-5-3(b). Courts have recognized that the legislature's "repetition of the requirement that the use be direct" was intended to provide for a narrow construction of the exemption. Indiana Dept. of State Revenue v. RCA Corp., 310 N.E.2d 96, 100 (Ind. Ct. App. 1974). Therefore, to be considered directly used in direct production or manufacture, the property must be "an essential and integral part of an integrated process that produces tangible personal property." Kimball, 520 N.E.2d at 457;
45 IAC 2.2-5-8(c). Whether property is essential and integral to an integrated process is determined "by identifying the points where production begins and where it ends." Indianapolis Fruit, 691 N.E.2d at 1384. The production process "begins at the point of the first operation or activity constituting part of the integrated production process and ends at the point that the production has altered the item to its completed form, including packaging, if required." 45 IAC 2.2-5-8(d).
Replacement parts and property used in the normal maintenance or repair of exempt property is also exempt from tax.
45 IAC 2.2-5-8(h). Property that is "consumed in direct production by the purchaser in the business of producing tangible personal property by manufacturing. . ." is also exempt. 45 IAC 2.2-5-11(a). However, property may not be essential and integral to an integrated production process even though it is "considered essential to the conduct of the business of manufacturing." 45 IAC 2.2-5-8(g).
The Department's audit report recognized that Taxpayer produces tangible personal property, i.e. "sanitation chemicals and equipment." Therefore, the issues in this case are whether the sodium chloride and the well are essential and integral to an integrated production process.
1. Sodium Chloride
The audit report states that the sodium chloride "is taxable because it is used to clean the softener (filter) while the softener is out of production." The report recognized that "[w]hen the taxpayer softens the water . . . the softener is like a production machine acting on and changing the water," but found that "when a production machine is shut down for cleaning, anything used to clean the machine is taxable." The audit report found that the sodium chloride "is used to clean the filter in the softener" and taxable.
Taxpayer asserts that "[t]he sodium chloride is . . . used to 'regenerate' the softener process which is a part of the production process." Taxpayer states that the "water softener is not shut down for cleaning." Taxpayer explains that "[i]n order for the other raw ingredients to be solubilized properly, the water must be treated to remove calcium and magnesium ions and replace them with sodium ions from salt (sodium chloride or potassium chloride). This is accomplished by using a sodium zeolite water softener." The "softener is regenerated with sodium or potassium chloride three times per week to keep [Taxpayer's] production water down to 0-5 parts per million hardness." The "[t]reated water is [Taxpayer's] primary utilized raw material for all of [its] manufacturing." Taxpayer states it uses a different product to clean the softener.
Taxpayer's explanation did not satisfactorily explain the difference between "regeneration" and "cleaning." The process of regeneration is not continuous throughout the production process. Although Taxpayer indicated that the water softener is not shut down for cleaning, its explanation indicates that the process of regeneration occurs only three times per week. This appears to confirm the audit report's finding that the softener is out of production when the "regeneration" or "cleaning" takes place. Taxpayer's explanation, while detailed, does not address the Department's conclusions outlined in the audit report. Therefore, Taxpayer has not met its burden to show that the Department's proposed assessment is incorrect. The sodium chloride has not been shown to be directly used in direct production or manufacture of other tangible personal property; therefore Taxpayer's purchase of the sodium chloride is not exempt. Taxpayer's protest is respectfully denied.
The audit report indicates that the wells are not a part of the production process, finding that "parts for wells" were acquired for preproduction activity pursuant to
45 IAC 2.2-5-8(d). Taxpayer disagrees indicating that its "production process begins with the well since the well pumps filter impediments and foreign objects found in the extracted water."
For the purposes of this exemption, the production process "begins at the point of the first operation or activity constituting part of the integrated production process and ends at the point that the production has altered the item to its completed form, including packaging, if required."
45 IAC 2.2-5-8(d). The Department has consistently held that water wells are not part of the production process. The drawing up and filtering of water is a preproduction activity since it does not directly affect the manufacturing process. The water is transported, not transformed, even though the well pumps filter out "impediments and foreign objects found in the extracted water." Taxpayer's protest is respectfully denied.
In this case, Taxpayer has not demonstrated that it used ordinary business care and prudence in not reporting and paying the assessed use tax in this case. Taxpayer's protest is respectfully denied.