United States

Louisiana: State Supreme Court Reverses Lower Courts in Case Addressing the Further Processing Exclusion

May 09, 2016
From KPMG TaxWatch

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Recently, the Louisiana Supreme Court addressed whether limestone purchased and used for the dual purpose of inhibiting sulfur in the production of electricity and producing ash for sale qualified for the “further processing exclusion” from sales and use tax. The taxpayer at issue was in the business of generating electricity and steam for sale to customers. The technology used to manufacture electricity also caused sulfur emissions. To comply with state and federal regulations, the taxpayer used limestone in the manufacturing process. The limestone inhibited the sulfur and simultaneously produced ash. The taxpayer sold the ash at retail for about $6.8 million annually. The taxpayer did not pay sales tax on its purchases of limestone and the issue arose as to whether the limestone was purchased under the “further processing exclusion.” After a trial court and appeals court ruled in favor of the state and parish taxing authorities, the taxpayer appealed.

Under Louisiana law, sales at retail do not include sales of “materials for further processing into articles of tangible personal property for sale at retail.” Purchases of raw materials will qualify for the exclusion if they are (1) identifiable components of the end product, (2) are beneficial to the end product, and (3) are purchased for the purpose of inclusion in the end product. The court first clarified that the “further processing exclusion” was in fact, an exclusion, rather than an exemption. As an exclusion, it was to be liberally construed in the taxpayer’s favor. The court next addressed whether electricity or ash was the proper “end product” for the purpose of applying the three-part test. Finding nothing in the law that required the end product to be the taxpayer’s primary product, the court held that the lower courts erred to the extent that they did not begin their analysis of the exclusion using ash as the end product. The court next applied the further processing exclusion’s three-part test. It was generally undisputed that the limestone was an identifiable part of the ash and benefited the ash. The final prong of the test addressed whether the limestone was purchased for the purpose of inclusion in the end product. The court determined that the lower courts had improperly added a primary purpose test to this third prong—in essence asking whether the taxpayer’s primary purpose for purchasing the limestone was for inclusion in the ash. In the court’s view, the only question to ask was whether the limestone was purchased with the purpose (although not necessarily the primary purpose) of inclusion in the ash. The court determined that the record “undeniably supports an affirmative answer to this inquiry.” The court also noted that the lower courts appeared to erroneously emphasize the small profit derived from the sale of ash, as compared to the cost of the limestone and the profit generated from the sale of electricity. The fact that the ash profit acted as a cost offset, rather than the company’s principal income, did not change the fact that the ash was nevertheless an article of tangible personal property that was resold to another consumer. Accordingly, the court concluded that the taxpayer purchased the limestone for the purpose of making a saleable end product of ash. Please contact Randy Serpas at 504-569-8810 with questions on Bridges v. NISCO.

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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.