Appeal of Derby Refining Co.

• Decision Date: 28 August 1992
• Docket Number: No. 67546,67546
• Citation: 838 P.2d 354,17 Kan.App.2d 377
• Parties: In the Matter of the Appeal of DERBY REFINING COMPANY from Orders of the Director of Taxation.
• Court: Kansas Court of Appeals

Page 354

838 P.2d 354

17 Kan.App.2d 377

In the Matter of the Appeal of DERBY REFINING COMPANY from

Orders of the Director of Taxation.

No. 67546.

Court of Appeals of Kansas.

Aug. 28, 1992.

Review Denied Feb. 3, 1993.

Syllabus by the Court

1. The scope of review for decisions of the Board of Tax Appeals is set forth by K.S.A. 77-621.

2. In cases of claimed exemption from taxation, taxation is the rule and exemption is the exception. The burden of proof is on the party claiming the exemption, and all doubts concerning the exemption are to be resolved against the exemption and in favor of taxation.

3. Where statutes are plain and unambiguous, courts must give effect to the intention of the legislation as expressed rather than determine what the law should or should not be. In such cases, resort may not be made to legislative history.

4. The 1970 amendments to K.S.A. 79-3602(m) and 79-3606(n) cannot be construed to exclude "catalysts" from items which may be found to be exempt from the compensating use tax.

5. The 1970 legislative amendments to K.S.A. 79-3602(m) and K.S.A. 79-3606(n) require exemption from sales tax and compensating use tax to be decided on a case-by-case basis as to items not specifically listed as exempt, and no specific items are excluded from exemption by such legislation.

6. Under the facts shown, a "catalyst" used by appellant in its refining process which is consumed and dissipated and rendered valueless within four days is exempt from compensating use tax because it is "immediately consumed" in the refining process. Following R.L. Polk & Co v. Armold, 215 Kan. 653, 527 P.2d 973 (1974).

Richard D. Greene, of Morris, Laing, Evans, Brock & Kennedy, Chartered, Wichita, for appellant.

Mark A. Burghart and James Bartle, of Kansas Dept. of Revenue, Topeka, for appellee.

Before REES, P.J., LEWIS, J., and PAUL E. MILLER, District Judge, assigned.

LEWIS, Judge:

Derby Refining Company (Derby) appeals an order of the Board of Tax Appeals (BOTA), denying it a compensating use tax exemption on the purchase of fluid catalytic cracking catalyst (FCCC), used in refining crude oil. Upon review, we are unable to distinguish this case from that of R.L. Polk & Co v. Armold, 215 Kan. 653, 527 P.2d 973 (1974). We consider that case controlling and, as a result, we reverse and remand.

Derby operates a refinery in Wichita in which it converts crude oil into products such as gasoline, diesel fuel, and liquid petroleum gas (LPG). The process of refining is complex, and the refinery is an integrated system which operates 24 hours per day.

Simplified to the extreme, Derby uses two principal methods in refining crude oil into salable products such as gasoline:

(A) Physical separation: This process takes place in a thermal separation unit where the crude oil is subjected to intense heat. The heat causes a thermal separation, which breaks down or separates other products from the crude oil.

(B) Chemical reaction: In this process, a catalyst is used to cause a chemical reaction in order to manufacture other products from crude oil. The reaction takes place in a catalytic reaction unit within the refinery. The product used to produce this chemical or catalytic reaction is the FCCC, the taxation of which is at issue in this action. It is clear that, without the FCCC, no chemical reaction would take place and no products would be manufactured from the crude oil.

The FCCC in question is a granular substance which is specifically manufactured for Derby, who purchases it from the manufacturer.

The catalytic reaction takes place in a fluid catalytic cracking unit (FCCU), and this process produces in excess of 50 percent of the gasoline produced at the refinery. It also produces other products such as LPG and diesel and, as a by-product, asphalt.

As might be expected, Derby purchases a huge quantity of the FCCC for use in its refinery. The total capacity for the catalyst in the FCCU is 90 tons. This 90 tons of catalyst moves through the system every nine minutes over 100 times per day. Fresh catalyst is added to the system at a rate of approximately 4.5 tons per day.

The catalytic reaction occurs in a closed system. Once the catalyst is placed into the system, there is no way to remove it until its economic value has been totally dissipated. Fresh catalyst alone is very active and would not produce the desired products unless mixed with used catalyst. When catalyst reacts with gas oil, it is coated with metals and coke (reactor carbon). That portion of the catalyst on which metal is laid down becomes forever useless and is unable to produce the desired chemical reaction. The portion which is coated with coke does not become immediately useless and can be used again in the system if the coke is removed. Used catalyst is moved from the reactor to a regenerator in a continuous cycle at the rate of 10 tons per minute. The purpose of the regenerator is to burn off the coke, which has been laid down in the catalytic process. The regenerator cannot remove the metal from the catalyst. After the coke is burned off, the catalyst, which is reduced in activity, is then mixed with fresh catalyst and placed back into the reactor.

The process described above is closed and continuous. It results in the complete dissipation of the catalyst insofar as its use and value is concerned. Of the 4.5 tons of fresh catalyst added per day, 51 percent is dissipated within 24 hours. The balance of the catalyst loses its value to make gasoline in slightly over four days. Ultimately, the deactivated catalyst is removed from the system and deposited in the city dump or landfill. It has no value whatsoever to Derby at this point.

The question involved in this appeal is whether the FCCC is exempt from compensating use tax. The Kansas Department of Revenue (KDR) audited Derby for the period 1984 through 1987. As a result of this audit, KDR assessed a compensating use tax on Derby's purchase of FCCC, which together with interest and penalties totaled $142,311. A hearing was held before the designee of the director of taxation, who upheld the assessment. The director of taxation denied Derby's petition to review that order. Derby then appealed to BOTA. BOTA upheld the assessment, and Derby appeals that decision to this court.

STANDARD OF REVIEW

Pursuant to K.S.A.1991 Supp. 74-2426(c), BOTA orders are subject to judicial review pursuant to the Act for Judicial Review and Civil Enforcement of Agency Actions, K.S.A. 77-601, et seq. In that Act, the scope of review is dictated by K.S.A. 77-621, which has a somewhat broader scope than the scope which existed before the adoption of the Act. See In re Tax Appeal of A.M. Castle & Co., 245 Kan. 739, 741, 783 P.2d 1286 (1989); Kansas State Board of Healing Arts v. Foote, 200 Kan. 447, Syl. p 1, 436 P.2d 828 (1968).

K.S.A. 77-621(c) sets forth the scope of review. Insofar as it is pertinent to the appeal in question, the statute reads as follows:

"The court shall grant relief only if it determines any one or more of the following:

....

"(4) the agency has erroneously interpreted or applied the law;

....

"(7) the agency action is based on a determination of fact, made or implied by the agency, that is not supported by evidence that is substantial when viewed in the light of the record as a whole, which includes the agency record for judicial review, supplemented by any additional evidence received by the court under this act; or

"(8) the agency action is otherwise unreasonable, arbitrary or capricious."

Derby contends that BOTA erroneously interpreted and applied the relevant law and made determinations of fact not supported by the evidence. We agree with Derby's contentions in this regard, hence, our decision to reverse and remand.

IS FCCC EXEMPT FROM PAYMENT OF COMPENSATING USE TAX?

(A) GENERAL RULES:

The question which we must decide is whether Derby's purchases of FCCC are exempt from compensating use tax. In this regard, a number of general rules have application.

In Kansas, taxation is the rule and exemption is the exception. Assembly of God v. Sangster, 178 Kan. 678, 680, 290 P.2d 1057 (1955). The burden of establishing an exemption from taxation is on the party claiming the exemption. Director of Taxation v. Kansas Krude Oil Reclaiming Co., 236 Kan. 450, 454, 691 P.2d 1303 (1984). One who claims a tax exemption must bring himself clearly within the exemption provisions of the statute. Warren v. Fink, 146 Kan. 716, Syl. p 1, 72 P.2d 968 (1937). Statutory exemption provisions are strictly construed against the party requesting exemption. Farmers Co-op v. Kansas Bd. of Tax Appeals, 236 Kan. 632, 635, 694 P.2d 462 (1985). All doubts concerning exemption are to be resolved against the exemption and in favor of taxation. Trustees of The United Methodist Church v. Cogswell, 205 Kan. 847, 851, 473 P.2d 1 (1970).

As can be seen, Derby has a considerable burden in the matter at hand. However, we have applied the rules stated above to the facts of this case. In doing so, we conclude that Derby has sustained its burden of proof, and the product in question is exempt from compensating use tax.

(B) CONTROLLING STATUTES:

As we view the issues presented on this appeal, there are two statutes which are directly applicable to the question at hand.

K.S.A.1991 Supp. 79-3606 provides a detailed listing of sales and property which are exempt from the sales tax and the compensating use tax. The specific exemption at issue is set forth in K.S.A.1991 Supp. 79-3606(n), which reads as follows:

"[A]ll sales of tangible personal property which is consumed in the production, manufacture, processing, mining, drilling, refining or compounding of tangible personal property, the providing of services or the irrigation of crops for ultimate sale at retail within or without the state of Kansas; and any purchaser of such property may obtain from the director of taxation and furnish to the supplier an...