Taxpayer is an Indiana formulator and manufacturer of thermostat molding compounds. All sales are directly to manufacturers. Taxpayer is a disregarded entity for income tax purposes and is included in its parent's 1120S return for federal purposes and the IT-20S for Indiana income tax purposes. Taxpayer is registered as a retail merchant in Indiana.
The Indiana Department of Revenue (the "Department") audited Taxpayer's business and tax records for sales and use tax compliance for the tax years 2009, 2010, and 2011. A review of transactions made during a test period (July through September 2011) revealed that all sales were exempt. However, as a result of the audit, the Department assessed
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Taxpayer did not remit use tax to the Department during the audit period even though Taxpayer had been previously audited by the Department. Taxpayer claims that all its purchases are subject to the industrial production exemptions.
Because of the large volume of Taxpayer records, a projection method was used to determine Taxpayer's additional taxable purchases to which Taxpayer agreed. Certain vendor purchases from 2011 were selected to be reviewed as representative of the audit period. An error rate was determined based upon purchases made by Taxpayer for items used in its business and for which no sales tax was paid at the point of purchase or where Taxpayer could not provide evidence that it paid sales tax. The errors noted were totaled by account and represent the numerator of the account error percentage. The denominator base consists of the account balances for the accounts where errors were noted during the test period. For 2009 and 2010, the Department's audit multiplied the error percentage by the account balance totals for the same accounts where errors were noted for 2011 during the test period. However, Taxpayer did not provide the account balances for 2009 and 2010, therefore, the Department's audit adjusted the 2011 account balances using the annual Producer Price Index (which is published by the Bureau of Labor Statistics using data from manufacturing industries). Items purchased by Taxpayer for which Taxpayer could not provide evidence of sales tax paid at the point of purchase include gloves, pallets, building maintenance items, advertising, equipment repair, small tools, office supplies, computer supplies, printing items, safety items, subscriptions, and other items.
All of Taxpayer's capital asset purchase invoices and depreciation schedules for assets purchased during the audit period were reviewed. Taxpayer purchased software, warehouse racking, maintenance materials, a forklift, and other items for use in its business. Taxpayer was unable to provide evidence that sales tax had been paid on these capital assets at the point of purchase.
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Taxpayer operates a production facility which undoubtedly contains equipment and processes which are entitled to the cited exemptions. However, there are also undoubtedly areas which are outside the "integrated production process" which would preclude Taxpayer from claiming the relief it seeks. Under IC § 6-8.1-5-1(c), Taxpayer is required to prove the original assessment was wrong.
During the Department's audit, the auditor requested additional information from Taxpayer to substantiate its claims for the industrial production exemptions. Taxpayer did not provide any documentation during the audit. Subsequent to the hearing, Taxpayer provided some documentation which will be addressed as each of the protested items is discussed below.
(1) Gloves
Taxpayer protests the assessment of use tax on its use of certain gloves. IC § 6-2.5-5-3 provides an exemption for equipment directly used in the direct production of tangible personal property. In support of its protest, Taxpayer states:
Gloves are required by our employees throughout the entire production process. In particular, because our product is made with Fiberglass, which can result in a skin irritation along with to prevent any contamination.
Along with this statement, Taxpayer presented several photographs of its employees wearing gloves during its production process.
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Taxpayer met its burden of demonstrating that the gloves were directly used by its employees in the direct manufacturing process to protect themselves from injury and to prevent contamination of its product.
Therefore, Taxpayer is sustained on its protest of the assessment of use tax on the gloves.
(2) Mitsubishi Forklift
Taxpayer protests the assessment of use tax on a Mitsubishi forklift citing to45 IAC 2.2-5-8 (f), which states in relevant part:
(3) Transportation equipment used to transport work-in-process or semi-finished materials to or from storage is not subject to tax if the transportation is within the production process.
Taxpayer states that the "[f]orklift [is] needed to transport WIP [work in process] to a temporary storage area as part of the production process along with materials within the production process." Obviously, it is not enough for Taxpayer to mirror the requirements of the regulation. Taxpayer also provided photographs that purport to show the forklift being used in the production process. Two of four photographs presented by Taxpayer show the forklift being directly used in what appears to be Taxpayer's direct production process, thus rendering the use exempt. However, the two other photographs do not show the direct use of the forklift in the direct production process. In these photographs the forklift appears to be (1) moving items to a loading dock which would be a post-production process, and (2) parked in the middle of a non-production area of the plant which does not provide any definitive production information about the use of the forklift.
Taxpayer is reminded that it is not enough for the forklift to be generally used at its production facility in order to meet the standard for industrial production exemption. In order for the use of the forklift to be exempt, it must be used directly in the direct production process. It appears that the subject forklift may indeed be partially directly used in Taxpayer's direct production process. However, given that there is also apparently non-exempt use of the forklift, and Taxpayer has still not provided sufficient documentation to quantify the exempt use of the forklift, Taxpayer has not met its burden to show the exempt use of the forklift.
Therefore, absent the required documentation, Taxpayer is denied on its protest of the assessment of use tax on the Mitsubishi forklift.
(3) Floor Coating Materials
Taxpayer protests the assessment of use tax on materials used to coat the floor of one of the rooms at its plant. Taxpayer states:
The Building that we operated in is old and thru time certain aspects of the facility have become worn and in need of an update. As Referenced White Room, this area was in need of attention and in particular the floor. Due to the nature of the floor being heavily worn and in disrepair materials were used to level the surface and fill in the areas w[h]ere the floor was in disrepair.
The completion of this project aided in the production process for the activities that are done in this area along with the safety aspect.
The flooring in Taxpayer's production facility, while obviously part of the plant itself, is not directly used in Taxpayer's direct production process. The floor does not have an immediate effect on the production process. As 45 IAC 2.2-5-8 (g) explains, "[t]he fact that particular property may be considered essential to the conduct of the business of manufacturing because its use is required either by law or by practical necessity does not itself mean that the property has an immediate effect upon the article being produced." (Internal quotation marks omitted).
Taxpayer's protest of the assessment of use tax on materials used to repair its flooring is denied.
(4) Warehouse Racking
Taxpayer protests the assessment of use tax on warehouse racks that it uses at its facility. Taxpayer states that the "[r]acking is used within our facility for Temporary Storage of WIP [work-in-process] items in a controlled temperature environment as part of the manufacturing process."
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In support of this contention, Taxpayer presented a photograph of racking in a storage area with cardboard boxes and what look like plastic bins on the racks. There is no indication that what is stored in these containers is work-in-process and not Taxpayer's finished product. As per the above referenced regulation, storage containers for finished goods after completion of the production process are subject to tax. 45 IAC-2.2-5-8(e)(2). Without further information showing that the racking is used to store work-in-process either exclusively or part of the time, Taxpayer has not met its burden to show the racks are fully or partially exempt.
Therefore, based on the above and without more information, Taxpayer's protest of the assessment of use tax on these warehouse racks is denied.
(5) Lubs Air Compressor Replacement Parts
Taxpayer protests the assessment of use tax on replacement parts for a Lubs air compressor. Taxpayer states these are "air compressor replacement parts for the compressors that are used in direct production of our equipment." Taxpayer presented photographs of the air compressor. However, Taxpayer did not provide any information, photographic or otherwise, that shows how the air compressor is connected to its production process. For the air compressor replacement parts to be exempt, the air compressor itself would have to be directly used in direct production.
Therefore, based on the above and without more information, Taxpayer's protest of the assessment of use tax on replacement parts for a Lubs air compressor is denied.
(6) Oil Used for the Compressors
Taxpayer protests the assessment of use tax on oil used in the compressors. Taxpayer states that this is "[o]il that is used in our compressors which are used in direct production of our equipment." Again, Taxpayer did not provide any information that shows how the air compressor(s) is connected to Taxpayer's production process. For the oil to be exempt, the air compressor(s) itself would have to be directly used in the Taxpayer's direct production process.
Therefore, based on the above and without more information, Taxpayer's protest of the assessment of use tax on the oil is denied.
(7) Cooling Tower
Taxpayer protests the assessment of use tax on a cooling tower. Taxpayer states:
A cooling tower is used to ensure that the product's temperature within the equipment does not go outside of specifications[.] In the event that the product is outside the desired temperature range it can [a]ffect the products performance.
Taxpayer presented photographs of a cooling tower connected to Taxpayer's plant. However, Taxpayer does not provide specific explanation of how the cooling tower is actually connected to Taxpayer's production process. It is entirely likely that the cooling tower is at least partially exempt, but other than the generalized statement above, Taxpayer has not presented more detailed explanation of how the cooling tower is used.
Therefore, based on the above and without further information, Taxpayer's protest of the assessment of use tax on the cooling tower is denied.
(8) Supplies from Motion Industries
Taxpayer protests the assessment of use tax on supplies it purchased from Motion Industries. Taxpayer states that "[t]his vendor supplies us with replacement equipment parts for use in our direct production." The Department's audit summary describes these items as "building maintenance" supplies which would suggest they are not directly used in direct production. Again, Taxpayer does not provide specific explanation of what equipment the replacement parts are used for, and how that equipment is directly used in direct production.
Therefore, based on the above and without further information, Taxpayer's protest of the assessment of use tax on supplies from Motion Industries is denied.
(9) Items from Versatile Mold and Design
Taxpayer protests the assessment of use tax on items from Versatile Mold and Design. Taxpayer states:
Molds are purchased/made to [e]nsure the quality control o[f] our products. More specifically as part of QC our product is extruded through our equipment to ensure that our product conforms to the customer specifications.
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Taxpayer has not provided a more specific description of the use of these items along with, for example, documentation of industry standards or customer specifications that illustrate the necessity for their use during production.
Taxpayer has not provided a more specific description of the use of these items along with, for example, documentation of industry standards or customer specifications that illustrate the necessity for their use during production.
Therefore, based on the above and without further information, Taxpayer's protest of the assessment of use tax on its use of these items purchased from Versatile Mold and Design is denied.
(10) Labels
Taxpayer protests the assessment of use tax on certain labels. Taxpayer states that the labels are an "integral component of the finished goods." Taxpayer provides photographs that depict the use of the contested labels. The labels appear to be affixed to the exterior of large cardboard boxes and other large containers. Taxpayer states that these containers hold "finished goods," but there is no visual depiction of the contents. Taxpayer cites to45 IAC 2.2-5-14 (d) in support of its protest of the assessment of use tax on the labels.
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These labels, according to the photographs Taxpayer presented, appear to contain descriptions of the content of the containers, inventory tracking bar codes and numbers, and identification of the taxpayer. There can be little dispute that Taxpayer's labels are an essential component within taxpayer's marketing and distribution process. Notwithstanding, the use by Taxpayer of these labels is not entitled to the industrial production exemption afforded under IC § 6-2.5-5-6 because the labels do not become a "material part" of Taxpayer's products. The labels do not "constitute a material or integral part of the finished product," because the labels are not essential to Taxpayer's finished product.45 IAC 2.2-5-14 (d)(2). The labels are not themselves an actual physical part of the "finished good." The labels are merely the ancillary means by which Taxpayer's finished product finds its way to the ultimate consumer.
Taxpayer has not shown that the labels it uses qualify for the industrial production incorporation exemption set out in IC § 6-2.5-5-6 and 45 IAC 2.2-5-14 (d)(2).
Therefore, based on the above, Taxpayer's protest of the assessment of use tax on Taxpayer's use of the labels is denied.
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Taxpayer protests the imposition of use tax on certain items used in its packaging process.
(1) Returnable Packaging
Taxpayer protests the assessment of use tax on some "returnable containers" that it states are "used as enclosures for the sale of our [m]anufactured [p]roduct." Taxpayer refers to IC § 6-2.5-5-9(b) in support of its protest.
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In order to qualify for the packaging exemption, even assuming Taxpayer has sufficiently demonstrated that the subject packaging is indeed (1) sold at retail in a taxable transaction, (2) with contents, and (3) the packaging must be billed as a separate charge to the customer. 45 IAC 2.2-5-16 (d)(2). Taxpayer has not presented documentation to show how the returnable packages are billed.
Therefore, based on the above and without additional documentation, Taxpayer's protest of the assessment of use tax on the subject packaging is denied.
(2) Non-Returnable Packaging/Wrapping Materials
Taxpayer protests the assessment of use tax on Taxpayer's use of certain pallets and/or wrapping materials. Taxpayer states that the "[p]allets are used as non returnable wrapping materials and shipping pallets that are used as enclosures for selling our product."
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Apart from Taxpayer's say-so, Taxpayer has not provided any specific documentation of how these pallets and wrapping materials are used in order for the Department to determine whether or not the use of these materials is exempt from use tax.
Therefore, based on the above and without further documentation, Taxpayer's protest of the assessment of use tax on the subject pallets and wrapping materials is denied.
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The Department issued ten percent negligence penalties for the tax years in question. Taxpayer protests the imposition of the penalties. The Department refers to IC § 6-8.1-10-2.1(a)(3), which provides "a person that . . . incurs, upon examination by the department, a deficiency that is due to negligence . . . is subject to a penalty."
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Taxpayer has not provided any rationale for not remitting use tax on the contested items other than basically everything it purchases is necessary for its production process. Taxpayer had been previously audited by the Department and therefore had some understanding of the parameters of the industrial production exemptions. Taxpayer has not met its burden of proof to show that the deficiencies they incurred are due to reasonable cause and therefore the deficiencies are subject to a penalty under IC § 6-8.1-10-2.1(a).
