Taxpayer is an Indiana business providing equipment rental and related services. As the result of an audit, the Indiana Department of Revenue ("Department") determined that Taxpayer had not paid sales tax at the time it purchased certain tangible personal property ("TPP") during the tax years 2008, 2009, and 2010. The Department therefore issued proposed assessments for use tax and interest.
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Taxpayer protests the imposition of use tax on certain purchases during the tax years 2008, 2009, and 2010. The Department based its proposed assessments of use tax for those years on the grounds that Taxpayer was renting equipment both with and without an operator, but did not pay sales tax on certain purchases for equipment which was rented with an operator. Since purchases of TPP used in such a manner are subject to sales tax when purchased by the entity renting the equipment, and since sales tax was not paid at the time of purchase by Taxpayer, the Department issued proposed assessments for use tax. The Department used a sample and projection method to determine Taxpayer's compliance rate for ordinary purchases. That rate was applied to Taxpayer's total ordinary purchases for all three years. The Department credited any sales and use taxes already remitted on such purchases and applied use tax to the remaining amounts at the previously calculated compliance rate. The Department then reviewed all capital asset purchases to determine the taxable status of such purchases.
Taxpayer protests that the equipment was often rented without an operator and that the rental was therefore taxable to its customers and exempt when it purchased the TPP. The Department notes that the burden of proving a proposed assessment wrong rests with the person upon whom the proposed assessment is made, as provided by IC § 6-8.1-5-1(c).
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Regarding the first category of purchases under protest, Taxpayer protests that the TPP in question was rented to its customers for extended periods of time and that the TPP would be used both by Taxpayer's employees and by its customer's employees. Taxpayer further explains that, even if its employees used the equipment, its employees were under the direct supervision and control of the customers' employees. Such use, Taxpayer argues, constitutes rental of TPP which is subject to sales or use tax and thus the purchase of the TPP by Taxpayer is exempt under IC § 6-2.5-5-8(b).
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In the instant case, Taxpayer has shown by documentation and explanation that while it did provide operators for the TPP it rented to its customers for some of those rentals, those customers also had sole control and direction of the TPP and the operators' actions. In some cases, the customers directly used the TPP without Taxpayer's operator's involvement, even if the rental agreement called for TPP with an operator. In either case, the rental transaction is subject to sales tax, as provided by 45 IAC 2.2-4-27 (d)(3)(A) and (C), and by Mason Metals.
Also, since Taxpayer's customers could operate the equipment without Taxpayer's employees, Taxpayer's employees were not necessary to operate the equipment and so the rental arrangement was considered a rental of TPP under IC § 6-2.5-1-21(a)(3). Since the rental/lease transactions are considered rentals of TPP and are subject to sales tax, Taxpayer's purchase of such TPP is eligible for the rental exemption found under IC § 6-2.5-5-8(b) and 45 IAC 2.2-5-15 and is therefore not subject to use tax on Taxpayer's purchase of such TPP. Therefore, while it was logical for the Department to have initially considered the rental of TPP with an operator to be a service, Taxpayer has met the burden imposed under IC § 6-8.1-5-1(c). The Department takes this opportunity to note that it will expect Taxpayer, as a retail merchant involved in retail transactions, to collect sales tax on both rental/leases of TPP alone and rental/leases of TPP with an operator.
The second category of purchases under protest involves purchases of repair and replacement parts for the rental equipment. In its audit report, the Department explained that due to the large number of purchases during the audit years, it would use a sample and projection method to determine the percentage of repair parts which were taxable and the percentage which were exempt. The Department used these calculations to arrive at a compliance percentage which was then applied to Taxpayer's total purchases for the tax years at issue.
The starting point for the calculations to reach the compliance percentage was to apply the same taxable and exempt percentages as determined in the rental/lease of TPP, as discussed above and as provided by 45 IAC 2.2-5-15 (a), which states:
The state gross retail tax shall not apply to sales of any tangible personal property to a purchaser who purchases the same for the purpose of reselling, renting or leasing, in the regular course of the purchaser's business, such tangible personal property in the form in which it is sold to such purchaser.
The Department therefore determined that some repair parts were taxable to Taxpayer when they were installed in equipment which was used in the rendition of services via equipment rental with operators and that some repair parts were exempt when they were installed in equipment which was used in the rental of TPP without an operator.
As explained above, both types of rental/leases were subject to sales tax on the rental/leases and so Taxpayer's purchases with regard to the TPP were exempt as purchases for rental. Similarly, the repair parts incorporated into all of the equipment involved in both types of rental/lease are also exempt under 45 IAC 2.2-5-15 (a). Therefore, Taxpayer's purchases of repair parts for rental/leasing equipment were wholly exempt from sales and use tax and the Department will therefore recalculate the compliance percentage after removing repair parts for rental/leasing equipment. The Department will then apply the recalculated compliance percentage to Taxpayer's total purchases for the tax years at issue. For the second category of items under protest, Taxpayer has met the burden imposed under IC § 6-8.1-5-1(c).
The third category of purchases under protest is raw materials such as steel plate and steel bars which Taxpayer used to fabricate parts for the equipment in question. The Department reviewed Taxpayer's records and determined that Taxpayer had sold a certain percentage of the manufactured replacement parts. The Department therefore imposed use tax on the percentage of raw materials which it had determined that Taxpayer used to make parts it directly used itself in the provision of services. The Department did not impose use tax on the percentage of raw materials used to make parts that Taxpayer sold to its customers in routine retail transactions.
Taxpayer protests that its use of the raw materials to produce the parts is non-taxable and refers to Mechanics Laundry & Supply Co., Inc. v. Ind. Dep't of State Revenue, 650 N.E.2d 1223 (Ind. Tax Ct. 1995), in which the Indiana Tax court explained:
While the laundering of soiled textiles does not constitute the production of goods or other tangible personal property, the parties, by joint stipulation, agree that Mechanics Laundry "produces or manufactures" over 90 percent of the logos and name [tags] Petitioner's Exhibit 1 at 14–15, ¶ 59, ¶ 60 & ¶ 62. Thus, Mechanics Laundry's purchases of "manufacturing machinery, tools, and equipment" used to produce logos and name tags are exempt from the sales tax under I.C. 6–2.5–5–3.
Id. at 1230.
Taxpayer believes that Mechanics Laundry supports its position that the raw materials are consumed in the production of other tangible personal property. The Department notes that the court in Mechanics Laundry states that Mechanics Laundry's purchases of manufacturing machinery, tools, and equipment used in production were exempt via stipulation by both parties in that case. The court did not address Mechanics Laundry's purchase of raw materials used to make the logos and tags.
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In this case, Taxpayer used the raw materials to make parts that it used in two ways. Some parts were sold to customers in traditional retail sales and some parts were installed by Taxpayer itself into the equipment used in its rental/leasing activities. As provided by45 IAC 2.2-15 (b)(3), the resale exemption only applies to TPP if it is sold or rented in the same form in which it was purchased. In this case, the raw materials undergo significant change prior to any sale or incorporation into rental/leasing equipment. Therefore, the percentage of Taxpayer's purchase of raw materials which are then used by Taxpayer for incorporation into its rental equipment is not eligible for the rental exemption.
For the traditional retail sales of parts directly to customers, 45 IAC 2.2-5-14 (b) provides that raw materials used to make parts subject to those sales are exempt from sales and use tax. However, 45 IAC 2.2-5-14 (b) also provides that the raw materials which Taxpayer used to produce tangible personal property for its own use are not exempt. A review of the documentation supplied in the protest process does not establish that the parts made from the raw materials in question were sold in transactions separate from the base rental/lease of the equipment. Taxpayer has not met the burden imposed under IC § 6-8.1-5-1(c).
In conclusion, Taxpayer has met the burden imposed under IC § 6-8.1-5-1(c) regarding the imposition of use tax on the TPP it rented to its customers in both rental with operator and leasing without an operator circumstances. Taxpayer has met the burden imposed under IC § 6-8.1-5-1(c) regarding the inclusion of replacement and repair parts for rental/leasing equipment in the Department's use tax compliance percentage calculations. Taxpayer has not met the burden imposed under IC § 6-8.1-5-1(c) regarding the imposition of use tax on raw materials it uses to fabricate parts for installation on rental/leasing equipment. The Department will conduct a supplemental audit to implement the portions of Taxpayer's protest upon which it has been sustained. After the recalculation of base tax, the Department will recalculate interest based on the revised base tax amount.
