Emerson Elec. Co. v. Director of Revenue, SC 87146.

• Decision Date: 07 November 2006
• Docket Number: No. SC 87146.,SC 87146.
• Citation: 204 S.W.3d 642
• Parties: EMERSON ELECTRIC CO., Appellant, v. DIRECTOR OF REVENUE, Respondent.
• Court: Missouri Supreme Court

204 S.W.3d 642

EMERSON ELECTRIC CO., Appellant, v. DIRECTOR OF REVENUE, Respondent.

No. SC 87146.

Supreme Court of Missouri, En Banc.

November 7, 2006.

Brenda L. Talent, Ann K. Covington, Susana J. Coronado, St. Louis, Edward F. Downey, Carole L. Iles, Jefferson City, for Appellant.

Jeremiah W. (Jay) Nixon, Atty. Gen., James R. Layton, State Solicitor, Alana M. Barragan-Scott, Asst. Atty. Gen., James L. Dpradlin, Jefferson City, for Respondent.

RONNIE L. WHITE, Judge.

I. Introduction

Emerson Electric Co. challenged the Director of Revenue's assessment of use tax paid on machinery used to design, prototype, and test new motors. The Administrative Hearing Commission (AHC) ruled that the assessment was proper and denied Emerson a refund. Emerson seeks review of the AHC's decision. The parties' central issue is whether the equipment is "used directly in manufacturing" to qualify for the sales/use tax exemption as contemplated in section 144.030.2(5).¹ The Court declines to extend the integrated plant doctrine to these preliminary stages of production. The decision of the AHC is affirmed.

II. Facts and Procedural History

Emerson filed claims for refunds of use tax remitted on three machines purchased between 1994 and 1998. The AHC consolidated the cases, conducted a hearing on all three, and made the following findings of fact.

Emerson's Motor Technology Center

Emerson is a Missouri corporation engaged in the business of manufacturing electric motors. Its corporate headquarters in St. Louis consists of several buildings, among them the motor technology center (MTC), which is one of three advanced technology centers comprising a research and development network for the company's global operations. The MTC is a state-of-the-art research and development facility and home to Emerson's engineering group. It supports Emerson's affiliates and divisions and their customers in developing advanced motors and electronic controls. The three machines in question are located in the MTC.

The MTC occasionally undertakes co-development projects where Emerson and a customer work together, pursuant to a written "development agreement," to create a specific product. Co-development often requires considerable sampling and testing. Once the final sample is approved, the MTC engineers send the design and material specifications to the manufacturing plants to build the motors. The MTC also designs platforms, which are generic motors for general application. Emerson uses the same process of making sample motors for co-development projects that it uses for its own products.

The MTC also provides support to U.S. Electrical Motors, which is an Emerson division that supplies standard platform motors that customers can purchase from its catalogue. The MTC assists Emerson and customers with modification projects when customers request minor changes to standard motors. In this context, the MTC engineers use the CAD system to design the custom-modified motors and send the designs to the plants to build them.

The majority of the MTC's work involves engineering support for plants and their customers. Co-development represents about 30% and the remainder consists of innovation and platform design.

The Equipment

The CAD system enables engineers to produce three-dimensional designs-a blueprint in 3-D. Prior to its purchase of the 3-D CAD system for which it claims a tax exemption in this case, Emerson used a two-dimension CAD system. There is no indication in the record that Emerson claimed a refund for the 2-D system or any other low-tech predecessors previously used to create blueprint drawings. Emerson's internal documents state that the driving forces behind the acquisition of the CAD system were the acceleration of new product development, improvement of engineering and product quality, and increased engineering productivity. The CAD equipment is used 70% of the time for custom modification projects, 20% for developing platform designs, and 10% for co-development projects.

The stereolithography machine is a tool for developing mechanical parts. It reads design specifications transferred electronically from the CAD system and uses a laser and liquid polymer to make three-dimensional molded plastic sample parts. The sample parts can be used for fitting (i.e., to see if the part fits into an appliance) or for mechanical testing. These samples are not strong enough for performance testing or use in a real machine, and they are not sold to customers. Emerson's internal documents state that the stereolithography machine was purchased to provide research and development (R & D) services to various Emerson divisions, to increase the production of sample parts, to provide rapid prototyping technology to the divisions, and to ultimately increase engineering productivity. These internal documents also state that the machines would allow inexpensive experimentation of new part designs and manufacturing processes. Approximately 50 to 75% of co-development projects involve parts developed using this machine.

The dynamometer is used to test motors for compliance with industry and customer standards regarding horsepower, efficiency, speed, and torque. It tests samples for development purposes as well as real motors for quality control. This particular machine can also calibrate other dynamometers used in Emerson's manufacturing plants. Its accuracy enables engineers to test and evaluate new design solutions and improvements in manufacturing processes. Emerson's internal documents state that the dynamometer was purchased to provide a testing facility to certify compliance with industry guidelines, permit engineers to conduct accurate developmental tests, and provide future motor designs. The dynamometer is used approximately 15% of the time for modifying existing platform motors.

The director conducted an audit and concluded that the MTC is an R & D facility that is not engaged in manufacturing. After hearing, the AHC concluded that the three machines were purchased and used for engineering design, prototyping, and sample testing, which are R & D functions distinguishable from manufacturing within the meaning of section 144.030.2(5). As such, the director's assessment was proper.

III. Jurisdiction and Standard of Review

This Court has jurisdiction pursuant to Mo. Const. art. V, section 3 and reviews de novo the AHC's interpretation of revenue law.² The AHC's factual determinations are upheld if they are supported by the law and, after reviewing the whole record, there is substantial evidence to support them.³ A taxpayer bears the burden of showing they are entitled to an exemption.⁴ Exemptions from taxation are to be strictly construed against the taxpayer, and any doubt is resolved in favor of application of the tax.⁵

IV. Applicable Law

Section 144.030.2(5) provides sales and use tax exemption for:

Machinery and equipment, and the materials and supplies solely required for the installation or construction of such machinery and equipment, purchased and used to establish new or to expand existing manufacturing, mining or fabricating plants in the state if such machinery and equipment is used directly in manufacturing, mining or fabricating a product which is intended to be sold ultimately for final use or consumption.⁶

This Court first considered the scope of this exemption in Floyd Charcoal Co. v. Director of Revenue,⁷ where it adopted the "integrated plant doctrine" for determining what is "directly used" in manufacturing. "The basic questions are the following: (1) Is the disputed item necessary to production? (2) How close, physically and causally, is the disputed item to the finished product? (3) Does the disputed item operate harmoniously with the admittedly exempt machinery to make an integrated and synchronized system?"⁸ In Floyd, we concluded that a system of conveyors and storage bins that removed starch from railroad cars and conveyed it to a processing area was "used directly in manufacturing."

This Court also applied the integrated plant theory in Noranda Aluminum, Inc. v. Missouri Department of Revenue.⁹ There, machines used to produce anodes, which in turn were used on an aluminum production line, were "essential to and comprise an integral part of Noranda's manufacturing process."¹⁰ In addition, laboratory equipment used to test the aluminum for impurities was "essential to and a part of the manufacturing process."¹¹

In Concord Publishing House, Inc. v. Director of Revenue,¹² this Court concluded that computer equipment used by journalists and editors to compose and format newspaper content was "directly used" to manufacture the newspaper. Similarly, in DST Systems v. Director of Revenue,¹³ the Court allowed the exemption for computer equipment used to process and store financial information and produce printed reports for consumers.

In Concord Publishing, DST Systems, and more recently in Southwestern Bell Telephone Company v. Director of Revenue,¹⁴ the Court clarified that the physical distance between disputed equipment and exempt equipment was not determinative.

V. Discussion

Emerson asserts that the AHC erred in ruling that the CAD system, stereolithography machine, and dynamometer are not exempt under section 144.030.2(5). Both parties focus primarily on the second part of the statute regarding what constitutes "direct use in manufacturing." However, Emerson's failure to establish the key element of the first part of the statute, largely overlooked by the parties but central to its legislative purpose, is at least equally sufficient to affirm.

Are the disputed machines directly used in manufacturing the product intended for sale?

First, Emerson contends that the machines were used directly in manufacturing a product intended for sale in that Emerson used the machines for designing, prototyping, and testing, and such activities are essential and integral parts of the manufacturing process.

The parties agree...