Eaton Kenway, Inc. v. Auditing Div. of Utah State Tax Com'n

• Decision Date: 06 November 1995
• Docket Number: No. 940126,940126
• Citation: 906 P.2d 882
• Parties: EATON KENWAY, INC., Petitioner, v. AUDITING DIVISION OF the UTAH STATE TAX COMMISSION, Respondent.
• Court: Utah Supreme Court

Page 882

906 P.2d 882

EATON KENWAY, INC., Petitioner, v. AUDITING DIVISION OF the UTAH STATE TAX COMMISSION, Respondent.

No. 940126.

Supreme Court of Utah.

Nov. 6, 1995.

F. Lavar Christensen, Salt Lake City, for petitioner.

Jan Graham, Atty. Gen., Susan L. Barnum, Asst. Atty. Gen., Salt Lake City, for respondent.

Maxwell A. Miller, Kent Winterholler, Salt Lake City, for amici Utah Manufacturers Association and Utah Taxpayers Association.

HOWE, Justice:

Petitioner Eaton Kenway, Inc. (Eaton), seeks review of a decision by the Utah State Tax Commission assessing sales tax on Eaton's purchase of a new manufacturing machine and its conversion of engineering drawings to computer disks.

Utah levies a tax on "retail sales of tangible personal property made within the state." Utah Code Ann. § 59-12-103(1)(a). The Auditing Division of the Commission conducted a sales and use tax audit of Eaton's operations for the period from April 1989 until March 1992. Following this audit, the Division assessed sales taxes on (1) a computer numerically controlled (CNC) machine, and (2) computer disks containing scanned drawings. ¹ Eaton disagreed with the assessments and requested a hearing before the Commission. The Commission conducted a formal evidentiary hearing and issued a final decision affirming the assessments. Eaton seeks our review. We examine the two items separately.

I. CNC MACHINE

A. Facts

Eaton is a manufacturer of automated guided vehicle systems (AGVs) and storage/retrieval vehicles (SRVs). These mechanical vehicles are typically used in warehouse settings to perform forklift-type maneuvers. In 1988, Eaton decided to devote more money to the research and development of its products to better compete with its competitors and to stay ahead of the industry. As a result of this changed direction, Eaton's research and development team began designing improved AGVs and SRVs.

Prior to purchasing the CNC machine, Eaton used six machines which required manual assistance to complete cutting and drilling tasks, making exact duplication of parts difficult. These machines required operators to stop and restart them with every tool change and angle adjustment, and the machines could not cut long sections of steel. The machines were in fair to good condition and ranged from twelve to twenty years old. They were capable of producing the old product line satisfactorily and were not necessarily outdated equipment.

Six days after retiring these machines, Eaton installed the new CNC machine. The computerized machine was purchased to meet an increased production schedule, reduce production costs, and meet the closer tolerances required to produce the new product line. It is able to drill, cut, and tap holes with extreme accuracy and speed. It automatically changes drill ends without manual intervention. Thus, it is able to make parts that the previous six machines were incapable of producing and enables Eaton to develop stronger, quicker, and more stable AGVs and SRVs. With the CNC machine in operation, Eaton reduced production time by fifty percent. As a result, Eaton reduced its manufacturing personnel in its machine shop.

B. Analysis

Eaton contends that the purchase of the CNC machine is exempt from sales tax under Utah Code Ann. § 59-12-104, which provides:

The following sales and uses are exempt from the taxes imposed by this chapter:

....

(15) sales or leases of machinery and equipment purchased or leased by a manufacturer for use in new or expanding operations (excluding normal operating replacements, which includes replacement machinery and equipment even though they may increase plant production or capacity, as determined by the commission) in any manufacturing facility in Utah.... For purposes of this subsection, the commission shall by rule define "new or expanding operations"....

Utah Code Ann. § 59-12-104 (Supp.1993) (emphasis added). ²

We apply a correction of error standard to the Commission's conclusions of law, except where "there is an explicit grant of discretion contained in a statute at issue." Utah Code Ann. § 59-1-610(1)(b). When the legislature explicitly grants discretion to the Commission, as it did in the underlined portions of section 59-12-104(15) above, we review the Commission's actions under a reasonableness standard. Union Pac. R.R. v. Auditing Div., 842 P.2d 876, 881 (Utah 1992) (citing Morton Int'l, Inc. v. Auditing Div., 814 P.2d 581, 587-89 (Utah 1991)).

The statute distinguishes between tax-exempt "new or expanding operations" and taxable "normal operating replacements." Both of these terms have been defined by administrative rule: ³

"New or expanding operations" means manufacturing, processing, or assembling activities which:

(a) are substantially different in nature, character, or purpose from prior activities;

(b) are begun in a new physical plant location in Utah; or

(c) increase production or capacity. This definition is subject to limitations dealing with normal operating replacements.

....

"Normal operating replacements" means machinery or equipment which replaces existing machinery or equipment of a similar nature, even if the use results in increased plant production or capacity.

(a) If new machinery or equipment is purchased or leased which has the same or similar purpose as machinery or equipment retired from service within 12 months before or after the purchase date, such machinery or equipment is considered as replacement and is not exempt.

(b) If existing machinery or equipment is kept for back-up or infrequent use; new, similar machinery or equipment purchased would be considered as replacement and is not exempt.

Utah Admin.Code R865-19-85S(A)(3), (6) (1993) (emphasis added). ⁴

The parties stipulated that Eaton qualified as a "manufacturing facility," thereby meeting the threshold requirement of the exemption. See Utah Code Ann. § 59-12-104(15). However, the Commission concluded that the CNC machine was not a part of tax-exempt "new or expanding operations" but instead was a taxable "normal operating replacement."

1. Validity of Administrative Rule

Eaton and amici Utah Taxpayers Association and Utah Manufacturers Association--who have also filed a brief in this case--contend that the Commission's definitions for "new or expanding operations" and "normal operating replacements" in rule 865-19-85S(A)(3) and (6) are invalid because they are inconsistent with the statute establishing the exemption. A recent court of appeals decision supports this contention. In Newspaper Agency Corp. v. Utah State Tax Commission, 892 P.2d 17 (Utah Ct.App.1995), petition for cert. filed, May 1, 1995, the Newspaper Agency Corporation (NAC) sought review of an assessment of sales tax on its purchases of new machinery and equipment. The new purchases greatly increased NAC's printing capacity. Id. at 19. The Commission affirmed the assessment, concluding that NAC did not meet any of the three subparts of rule 865-19-85S(A)(3) defining "new or expanding operations." Id. at 20. The court of appeals reversed, holding that each of the three tests under the rule is invalid as contrary to the statute establishing the exemption. Id. at 21-22. On the basis of its reading of the exemption, the court concluded that NAC was entitled to the exemption because its purchases were part of "new or expanding operations." Id. at 23. ⁵

In reviewing the validity of the administrative rule, we note that Newspaper Agency acts as persuasive authority, but we are not bound under the doctrine of stare decisis to follow it. Consolidation Coal Co. v. Utah Div. of State Lands & Forestry, 886 P.2d 514, 525 n. 14 (Utah 1994) ("This court is never bound by decisions of the court of appeals and does not need to overcome any particular hurdles in overruling them."). We begin with the presumption that the Commission's rule is valid and reasonable. State v. Utah Merit Sys. Council, 614 P.2d 1259, 1263 (Utah 1980). However, we will invalidate a rule that is not in harmony with its governing statute. Sanders Brine Shrimp v. Audit Div., 846 P.2d 1304, 1306 (Utah 1993) (holding administrative rule impermissibly narrowed availability of tax exemption). We also recognize that a tax exemption is strictly construed against the taxpayer, but with sufficient latitude to accomplish the exemption's intended purpose. Hales Sand & Gravel, Inc. v. Audit Div., 842 P.2d 887, 890 (Utah 1992); Utah County v. Intermountain Health Care, Inc., 725 P.2d 1357, 1359 (Utah 1986).

The Commission allows the sales tax exemption to manufacturers that satisfy at least one of the three subparts of rule 865-19-85S(A)(3) as "new or expanding operations." Eaton contends that the purchase of the CNC machine qualifies for the exemption under subparts (a) and (c) of the rule. We examine the validity of these two subparts.

Subpart (a) allows an exemption if the purchased machinery or equipment is used in manufacturing activities that "are substantially different in nature, character, or purpose from prior activities." Utah Admin.Code R865-19-85S(A)(3)(a). In Newspaper Agency, the court of appeals held that this subpart is invalid because it is inconsistent with the usually accepted meaning of the word "expand." 892 P.2d at 21. However, the statute exempts "new or expanding operations." While subpart (a) may exclude "expanding operations," it reasonably defines "new operations." "Expanding operations" are dealt with in subpart (c). We emphasize that for a sale to qualify for this exemption, it need not satisfy each of the three subparts. In other words, a sale will be exempt if it qualifies under one of the subparts, even if it fails under the other two subparts. We conclude that subpart (a) reasonably defines "new operations" and is therefore valid.

Subpart (c) allows an exemption if the purchased machinery or equipment is used in manufacturing activities that "increase production or capacity ... subject to limitations dealing with normal...