SC Lawyer, Jan. 2004, #6. South Carolina springs for tax refunds for manufacturers The machine exemption from sales and use tax for manufacturers.

• Author: By Jeff Z. Brooker III

South Carolina Lawyer

2004.

SC Lawyer, Jan. 2004, #6.

South Carolina springs for tax refunds for manufacturers The machine exemption from sales and use tax for manufacturers

South Carolina LawyerJanuary 2004 South Carolina springs for tax refunds for manufacturers The machine exemption from sales and use tax for manufacturersBy Jeff Z. Brooker IIIIn calendar year 2003, the "machine exemption" (as defined below) from sales and use tax in South Carolina was significantly expanded in its application to machines and parts of machines by an unpublished Court of Appeals opinion and the denial of certiorari by the South Carolina Supreme Court on October 8, 2003. As discussed below, the expanded application of the machine exemption could mean that manufacturers operating manufacuring facilities in South Carolina may now be entitled to refunds for sales and use taxes paid for items previously believed to be "non-exempt." This article discusses the underlying opinion from the South Carolina Administrative Law Judge Division and its potential application to lawyers representing South Carolina taxpayers engaged in manufacturing within South Carolina.

At the outset, the judicial interpretation of the "machine exemption" appears in an unpublished opinion of the Court of Appeals. As such, the ruling is subject to SCACR 239, which provides in part that, "Memorandum opinions and unpublished orders have no precedential value and should not be cited except in proceedings in which they are directly involved." Thus, a manufacturer / taxpayer may cite the case for the strict issue of the applicability of the "machine exemption" to which it may be entitled, although by rule such a citation has no precedential value.

"Manufacturer taxpayers, however, should be able to invoke the doctrine of "offensive collateral estoppel" against the Department of Revenue under the theory that the Department of Revenue has previously litigated the issue. "Only a party to a prior action or one in privity with the party can be precluded from relitigating an issue on the basis of offensive collateral estoppel." Nelson v. QHG of South Carolina Inc., 354 S.C. 290, 306, 580 S.E.2d 171, 179 (Ct. App. 2003).

South Carolina has long recognized an exemption from the South Carolina Sales and Use Tax Act (the Act) for "machines used in manufacturing, processing, recycling, compounding, mining, or quarrying tangible personal property for sale." S.C. Code Ann. § 12-36-2120(17) (1976, as amended). The statute continues:

"Machines" include the parts of machines, attachments, and replacements used, or manufactured for use, on or in the operation of the machines and which (a) are necessary to the operation of the machines and are customarily so used, or (b) are necessary to comply with the order of an agency of the United States or of this State for the prevention or abatement of pollution of air, water, or noise that is caused or threatened by any machine used as provided in this section. This exemption does not include automobiles or trucks. Id.

The foregoing statutory exemption from the sales and use tax is commonly referred to as the "machine exemption."

The purposes of the machine exemption include exempting property that will be used to make tangible personal property to be sold at retail and to reduce multiple taxes that would otherwise ultimately be paid by the end-use consumer (who would pay the taxes in the form of increased price).

The South Carolina Department of Revenue (DOR) has traditionally interpreted the machine exemption as applying only to machines (as defined above) which are "in the production line." Anonymous Corp. v. SC Dept. of Rev., 99-ALJ-17-0153-CC, aff'd, SC Dept. of Rev. v. Springs Industries, Inc., Unpublished Opinion No. 2003-UP-029, cert. denied (10/8/03). Accordingly, the corresponding provisions of the South Carolina Administrative Code provided the following "machines" were not exempt from the Act:

(a) warehouse machines used only for warehouse purposes, such as loading and unloading, storing or transporting raw materials or finished products; (b) storage tanks and piping leading to and from storage tanks and piping bringing gas or water into the plant. (c) power lines bringing electricity into the plant; (d) dippers used for measuring purposes in a textile bleachery, dye or finishing plant; (e) machines used for maintenance purposes; (f) pipe, valves, fittings, etc., regardless of size, that are purchased by paper manufacturers specifically for use in drinking water lines, fire protection lines, or for transmission of water from source to water treatment plant or from water treatment plant itself; and (g) piping furnished and installed along with pump houses and well connections by a contractor when intended for use by a paper manufacturer to supply his plant with the water necessary to the manufacturer of paper. S.C. Code Regs. § 117-302.5 (1976, as amended).

The taxpayer in Anonymous Corp. v. SC Dept. of Rev., however, prevailed in its argument that the standard for the machine exemption in South Carolina should be more liberal and should include any "machine" that is "integral and necessary to the operation of the plant, not whether it is an actual part of the process of manufacturing." Anonymous Corp., supra.

In a thorough opinion, Judge Marvin Kittrell (and later the Court of Appeals), reasoned that the terms of the statute in South Carolina were not as limiting as those advanced by the DOR. Specifically, the Administrative Law Judge (ALJ) ruled that:

In reviewing the South Carolina machine exemption statute and in contrasting it with exemption statutes from other states, it is noted that the South Carolina statute uses the phrase "machines used in manufacturing." Our statutory language does not contain the words "used or consumed in or during the actual manufacturing" or "used directly" in manufacturing as do certain other state statutes. Notwithstanding the language of the statute, Respondent contends that the machine exemption should only be available for machines which are in the production line. Id.

After finding that the machine exemption, as set forth in the statute, was not as limited as the position advanced by the DOR, the ALJ further ruled that:

I decline to adopt Respondent's argument and to impose additional restrictions sought by Respondent which would require that the machinery must be a part of the "production line." Obviously, the court in [Hercules Contractors and Engineers, Inc. v. The South Carolina Tax Commission, 280 S.C. 426, 313 S.E.2d 300 (Ct. App. 1984)], in its interpretation of the exemption statute, imposed no such restrictions. Thus, the proper test for the exemption, as enunciated in the Hercules case, is whether or not the machinery or its parts is "integral and necessary" to the manufacturing process. Id.

After adopting the taxpayer's position that the machine exemption covers not only machines used in the production line, but also those "machines" that are "integral and necessary to the manufacturing process," the ALJ then turned to the question of what items met the definition of "machines" as contemplated by the statute. The taxpayer advanced the position that various machines, chemicals and other items fell within the machine exemption. The ALJ addressed 11 items, three of which were found ineligible for the machine exemption. Although eight categories of items were held to be exempt, this article addresses only those items that would appear to be more universal to all manufacturers.

The taxpayer in this case was Springs Industries, Inc., a textile manufacturer. The items taxpayer produces include "textile products in many colors and patterns." Anonymous Corp., supra. In order to produce the different colors and patterns, the screens used by the taxpayer were required to be washed in a separate machine that was not part of the "production line." The DOR had argued that the screen washers were part of the machine shop machinery of the taxpayer and, therefore, not exempt from the Act. S.C. Code Regs. 117-174.110 (1976). The ALJ concluded, however, that the legislature had clarified the machine shop machinery provision of the regulations by stating that "Machines customarily used for both maintenance and manufacturing of tangible personal property will normally be considered to come within the machine exemption, except where manufacturing is an occasional, incidental or inconsequential part of the use of the machine." Anonymous Corp., supra, relying on S.C. Code Regs. 117-174.110 (1976). The ALJ then concluded that, although the screen washers were not part of the "production line" and although they could also be potentially classified as "machine shop machinery," the screen washers were utilized often, necessary and not inconsequential to the manufacturing process and were, therefore, eligible for the machine exemption. Anonymous Corp., supra.

Next, the taxpayer advanced the position that chemicals used to clean the screens were exempt as "parts of machines" pursuant to the machine exemption. In deciding in favor of the taxpayer, the ALJ noted that, "Chemicals are recognized as machines and parts of machines both generally and in the tax decisions of other states" and that because the chemicals "are integral, necessary and indispensable to the manufacturing process," they are also exempt. Id.

The taxpayer also successfully argued that waste water chemicals should be exempt pursuant to the machine exemption. For the same reasons chemicals used to clean machines or parts of machines are exempt under the machine exemption, the ALJ ruled that the waste water chemicals are also exempt pursuant to the machine exemption. The ALJ stated the following:

While recognizing an exemption for the machinery required to abate or minimize pollution, the Department of Revenue has refused to allow exemption for the chemicals used in the machinery, without which the machinery would be useless. Other states, such as Maine, Massachusetts, Arizona and Texas, which have reviewed this issue, have held that chemicals used in pollution control equipment qualify as machinery and/or parts of machines. Id.

Two other items that the ALJ recognized as exempt pursuant to the machine exemption included (i) trucks, which are used "both to transport material back and forth to the production process machinery and also for warehouse purposes, such as loading and unloading, storing materials, etc.," and (ii) battery chargers, which "provide fuel or electricity which causes the trucks to move." Id. As the ALJ noted, without "such electricity, the trucks could not operate, the material would not be taken to and from the production line, and the production process would halt." Id.

The three items that the ALJ did not recognize as exempt included curtains that performed the same function as a wall in keeping dust from settling on the machines; beam racks which were essentially for storage purposes only; and a ramp which assisted in the transportation of finished tangible personal property to be weighed. These items, the ALJ ruled, were not essential or integral to the manufacturing process and, thus, not eligible for the machine exemption. Id.

The importance of this ruling (and the fact that the Court of Appeals affirmed the case in October 2003, and that certiorari has been denied by the Supreme Court as of December 2003), is that manufacturers operating manufacturing facilities in South Carolina may now be entitled to refunds for sales and use taxes paid for items previously believed to be "non-exempt."

As most South Carolinians are aware, the Sales Tax (or the Use TAx, whichever is applicable) is a tax equal to five percent. S.C. Code Ann. § 12-36-910 (1976, as amended). As one can readily see, the potential refund for South Carolina manufacturer/taxpayers is not insubstantial. Consider, for example, a South Carolina manufacturer/taxpayer who has purchased $500,000 of chemical (which is "integral and necessary" to its manufacturing business in South Carolina) within the past three years. That client may be entitled to a refund of up to $25,000 ($500,000 x .05 = $25,000 (amount to be refunded, if applicable)).

In South Carolina, the sales and use tax return (Form ST-3), is due on or before the 20th day of the month following the close of the period covered. Anyone otherwise required to file a Form ST-3 must file a tax return for every tax reporting period, even if no tax is due for the period. S.C. Code Ann. § 12-36-2570. In order to claim a refund for the sales and use taxes previously paid, and for which a South Carolina manufacturer/taxpayer may now be entitled to a refund, the claim for refund must be filed either within three years from the time the return was timely filed or two years from the date the tax was paid, whichever is later. S.C. Code Ann. § 12-54-85(F)(1) (1976, as amended).

Because the sales and use tax return is filed and the tax paid by the 20th day of each month, South Carolina taxpayers that are in the business of manufacturing should begin to scour their records for any purchases that may have been made in the last three years that could be classified as "machines" under the machine exemption. If the South Carolina manufacturer/taxpayers does not timely file its request for a refund, then the potential benefits could be lost under the aforementioned statute of limitations. Each month that passes is a potential period for which a refund may be lost. If the client can demonstrate that the item purchased is "integral and necessary" to the manufacturing process and that the item purchased was acquired within the last three years from when the applicable sales and use tax return (Form ST-3) would have been filed, then the client may be entitled to a refund.

For example, assume that a South Carolina manufacturer/taxpayer purchases an item (that previously was deemed to be not eligible, but that under the judicial clarification of the machine exemption, is now exempt) each month and the sales and/or use tax is $700 each month. If the South Carolina manufacturer/taxpayer waits until March 21, 2004, to file its refund claim, all purchases prior to March 20, 2001, will be statutorily barred under S.C. Code Ann. § 12-54-85(F)(1) (1976, as amended).

The DOR is working to be ready for the expected high number of refund claims following these judicial developments. The DOR has requested that all South Carolina manufacturer/taxpayers seeking refunds of sales and/or use tax pursuant to these rulings, write across the top of their requests for refund that it is, "Filed pursuant to the Springs Industries, Inc. case."

Considering that manufacturing businesses are suffering under the current economic slow-down, the possibility of obtaining refunds under the clarified machine exemption from sales and use tax is a real benefit to most South Carolina manufacturers. As the appeal of the DOR in Anonymous Corp. was designated by the Court of Appeals as an "unpublished opinion," South Carolina manufacturer/taxpayers may not be aware of the ruling, thereby losing the opportunity to take full advantage of the higher court's affirmative ruling of the ALJ opinion. South Carolina lawyers representing South Carolina manufacturer/taxpayers should immediately take this opportunity to advise their clients of the potential refund now available so that such clients may take full advantage of the machine exemption for the benefit of their manufacturing businesses.

Additionally, a manufacturer should review its purchasing invoices to see if the party from whom it purchased the item withheld South Carolina sales tax. As such, the client may not have owed the DOR a Form ST-3, but because the sales tax was collected, the client may still be entitled to file a refund claim pursuant to this clarification of the machine exemption.

Mr. Brooker is a shareholder with Richardson Plowden Carpenter & Robinson, P.A. He is a Certified Specialist in Taxation Law.

Copyright (c) 2004 by the South Carolina Bar. All rights reserved. No part of this publication may be reproduced without written permission.