United States

Illinois: Paint Mixing Equipment Used at Retail Stores Qualified for Manufacturing Exemption

Nov 16, 2015
From KPMG TaxWatch

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Recently, an Illinois Administrative Law Judge (ALJ) recommended that the Director of Revenue approve a taxpayer’s use tax refund for tax paid on machinery and equipment used to blend and process colored paint at the taxpayer’s retails stores. The taxpayer, a paint manufacturer and retailer, was audited for use tax compliance for the period October 1, 2003 through June 30, 2007. The auditor assessed use tax on certain machinery used by the taxpayer, at its retail stores, to blend and process paint base and colorant(s) into useable paint for sale to retail customers. The taxpayer paid the assessment, then filed a refund claim which was subsequently denied. The taxpayer protested the denial and the matter went before an Illinois Administrative Law Judge.

Under Illinois law, use tax does not apply to machinery and equipment used primarily in the process of manufacturing or assembling tangible personal property for wholesale or retail sale. The taxpayer argued that the machinery and equipment that it used at its retail stores to make useable paint from base and colorant qualified for the exemption. Notably, the taxpayer stressed that the final product sold at retail did not exist until it used the machinery and equipment at issue to change the base and colorant(s) into paint. The Department disagreed on the basis that (1) an Illinois regulation specifically listed the use of “paint mixing equipment” by a hardware store as an example of an activity not qualifying as manufacturing, and (2) the process described in the parties’ stipulations was not “commonly regarded” as manufacturing.

Before addressing the Department’s arguments, the ALJ questioned whether printers used to print labels for the paint cans were included in the scope of the machinery and equipment eligible for the exemption. In the ALJ’s view, the labels were produced after the paint production cycle was completed; thus, the printers were not used in manufacturing.

The ALJ first addressed the regulation, noting that the actual text of the regulation listed the use of paint mixing equipment as an activity that is generally not considered manufacturing. Thus, the regulation itself did not explicitly prohibit an exemption for paint mixing equipment or paint mixing activities. Further, the ALJ noted that the examples in the regulation focused on machinery used to perform a service incidental to the sale of the particular goods being sold at retail. In each example, the process of manufacturing the goods to be sold had already been completed before the retailer used the machinery to perform a service.  Reviewing the numerous stipulations made by the Department and the taxpayer, the ALJ concluded that the taxpayer used the paint mixing machinery and equipment to complete the last stage of processing its paint—at which point it transformed the base and colorant into a material with a different form or use. In other words, unlike the examples in the regulation, the taxpayer’s machinery was not used to perform a service on an already manufactured product. As such, the ALJ recommended that the Department’s position on this issue be rejected.

With respect to whether paint mixing was “commonly regarded” as manufacturing, the ALJ observed that, based on an earlier Illinois case, that the location where the machinery and equipment is used is not determinative. Thus, the fact that the taxpayer used the equipment at its retail store, as opposed to a factory, did not preclude the taxpayer from qualifying for the exemption. Furthermore, the Department had stipulated that many of the taxpayer’s activities constituted manufacturing. The ALJ recommended that the taxpayer’s use tax refund for the machinery and equipment (other than the printers) be granted. For more information on Administrative Hearing Decision No. ST 15-11, please contact Drew Olson at 312-665-2897.

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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.