United States

Indiana: Manufacturing Exemption Denied for Rehabilitating Tanker Trailers

Feb 23, 2015
From KPMG TaxWatch

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The Indiana Tax Court recently held that a taxpayer’s purchase of electricity and natural gas used in rehabilitating cryogenic tanker trailers was not exempt from sales and use tax. The taxpayer manufactured new cryogenic tanker trailers; it also rehabilitated used trailers to extend their useful life for several years. During the rehabilitation process, the tankers were not only restored to a condition that enabled them to safely perform their original function (transporting atmospheric gases in a liquid state), but they were also upgraded to reflect current industry standards. A rehabilitation typically took 750 hours over a six to eight week period. The taxpayer filed a sales tax refund claim with the Indiana Department of Revenue for sales taxes paid on electricity and natural gas used to manufacture and rehabilitate the tanker trailers.

Under Indiana law, retail sales of electricity or natural gas used by a purchaser in its manufacturing process are exempt from sales and use tax. However, the electricity and natural gas must be consumed as an “essential and integral part of an integrated process that produces tangible personal property” to qualify for the exemption. The Department approved the refund for the portion of the gas and electricity used to manufacture new trailers; however, it denied the remainder of the refund on the basis that the taxpayer was not producing tangible personal property when it rehabilitated the tanker trailers. The taxpayer appealed the denial to the Indiana Tax Court.  

In addressing whether the rehabilitation process constituted the production of tangible personal property, the court noted that it had previously recognized that repair could, in certain instances, constitute production if the work was “transformative,” rather than just ordinary repairs that “merely perpetuates existing products.” To make this determination, there were four key questions that the court analyzed. The first looked at the ‘substantiality’ and complexity of the work and the nature of the physical changes to the existing article. Although the taxpayer’s rehabilitation process took over 750 hours and six to eight weeks to complete, the court concluded that the changes made to the tanker trailers were more indicative of ordinary repair and that they did not transform the tanker into a substantially different product. The second question looked at whether the value of the property changed as a result of the rehabilitation. The court found that this question also weighed in the Department’s favor because although the rehabilitation process added value to the tanker trailers, the distressed trailers had value absent rehabilitation. The third question addressed whether there had been a change in the item’s performance post rehabilitation. The taxpayer argued that a rehabilitated tanker trailer was “as good or better” than the original and had “significantly enhanced capabilities.” The court was skeptical and found that the purpose of the rehabilitation was to restore the original capabilities and not to perform new functions. The final question was whether the work performed was part of the normal life cycle of the item. The court concluded that because a tanker trailer could be rehabbed numerous times, the rehabilitation was a normal part of the tanker’s life cycle and therefore this question also weighed in the Department’s favor. Accordingly, the court concluded that the taxpayer did not qualify for the exemption on its purchases of electricity and natural gas used to rehabilitate the tanker trailers. For more information on Alloy Custom Products, Inc. v. Indiana Dep’t of State Revenue (Ind. Tax Ct. Feb. 16, 2015), please contact Dave Perry at (513) 763-2402.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.