May 30, 2016
From KPMG TaxWatch
The Arkansas Supreme Court recently addressed whether equipment used to expand a water-treatment plant was exempt from sales and use tax. The water treatment plant utilized an extensive three-phase process to convert surface water into potable drinking water. During each phase, chemicals were used to purify and clarify the water. The taxpayer claimed that certain purchases of tangible personal property—piping used to carry the chemicals and concrete holding tanks—were exempt from sales and use tax as items used to expand a manufacturing facility. On audit, the Arkansas Department of Finance and Administration assessed use tax on the taxpayer’s equipment purchases on the basis that the taxpayer did not qualify for the manufacturing exemption. In the Department’s view, the water-treatment plant cleaned, but did not manufacture the water. After a circuit court ruled in favor of the taxpayer on the basis that the “extensive mechanical and chemical treatment process turned a raw material into a finished product,” the Department timely appealed the issue to the Arkansas Supreme Court.
Under Arkansas law, equipment and machinery used directly in manufacturing is exempt from sales and use taxes. “Manufacturing” means those operations commonly understood to be manufacturing under the ordinary meaning of the term. In determining whether the water-treatment process constituted manufacturing, the court looked to several prior Arkansas cases. Under these decisions, manufacturing generally involved some kind of change or transformation, and required more than merely putting raw materials into a marketable form. In one case, the court held that combining water, sugar, cola concentrate and other ingredients to make a bottled cola beverage constituted manufacturing for purpose of the Arkansas manufacturing exemption. The court distinguished this case from the taxpayer’s water treatment process because in the soda context raw materials were transformed into a new product. The water treatment plant, in contrast, did not manufacture or process a new product. As the court observed, “it was water in the beginning, and it was water in the end.” As a result, the court held that the taxpayer was not entitled to claim the manufacturing exemption for equipment used at the water-treatment plant. Two justices dissented. In their view, treating the water was indistinguishable from manufacturing soda because the treatment involved the injection of numerous chemicals into the water and transformed non-consumable water into consumable water. For more information on Walther v. Carrothers (Ark. May 19, 2016), please contact Brandon Fulmer at (214) 840-2497.
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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.