Horsehead Corp. v. Dep't of Revenue & the Ill. Indep. Tax Tribunal

• Court: Appellate Court of Illinois
• Writing for the Court: JUSTICE PIERCE delivered the judgment of the court, with opinion.
• Citation: Horsehead Corp. v. Dep't of Revenue & the Ill. Indep. Tax Tribunal, 2018 IL App (1st) 172802, 112 N.E.3d 646 (Ill. App. 2018)
• Decision Date: 24 September 2018
• Docket Number: No. 1-17-2802,1-17-2802
• Parties: HORSEHEAD CORPORATION, Petitioner, v. The DEPARTMENT OF REVENUE and the Illinois Independent Tax Tribunal, Respondents.

2018 IL App (1st) 172802

112 N.E.3d 646

HORSEHEAD CORPORATION, Petitioner,

v.The DEPARTMENT OF REVENUE and the Illinois Independent Tax Tribunal, Respondents.

No. 1-17-2802

Appellate Court of Illinois, First District, FIRST DIVISION.

September 24, 2018

Kirkland & Ellis LLP, of Chicago (JoAnne Mulder Nagjee and Steven M. Cantor, of counsel), and Difede Ramsdell Bender PLLC, of Washington, D.C. (Joseph E. Bender, of counsel), for petitioner.

Lisa Madigan, Attorney General, of Chicago (David L. Franklin, Solicitor General, and John P. Schmidt, Assistant Attorney General, of counsel), for respondents.

OPINION

JUSTICE PIERCE delivered the judgment of the court, with opinion.

¶ 1 Respondent Illinois Department of Revenue (IDOR) issued petitioner Horsehead Corporation¹ two notices of tax liability for Horsehead's failure to pay use taxes on its purchases of metallurgical coke between January 2007 and June 2011. Horsehead filed a petition for review with the Illinois Independent Tax Tribunal (tax tribunal), which affirmed the notices of tax liability as well as the imposition of the use tax, interest, late filing penalties, and late payment penalties totaling approximately $1,521,041. Horsehead timely filed a petition for review in this court. For the following reasons, we affirm the tax tribunal's final decision.

¶ 2 BACKGROUND

¶ 3 Illinois imposes a use tax "upon the privilege of using in this State tangible personal property purchased at retail from a retailer." 35 ILCS 105/3 (West 2016). Relevant to the issues in this appeal, section 3-5(18) of the Use Tax Act contains an exemption from the use tax for the following manufacturing and assembling machinery and equipment:

"Manufacturing and assembling machinery and equipment used primarily in the process of manufacturing or assembling tangible personal property for wholesale or retail sale or lease, whether that sale or lease is made directly by the manufacturer or by some other person, whether the materials used in the process are owned by the manufacturer or some other person, or whether that sale or lease is made apart from or as an incident to the seller's engaging in the service occupation of producing machines, tools, dies, jigs, patterns, gauges, or other similar items of no commercial value on special order for a particular purchaser." Id. § 3-5(18).

¶ 4 Section 3-50 of the Use Tax Act contains a definition of "equipment" that includes certain "chemicals and chemicals acting as catalysts":

"§ 3-50. Manufacturing and assembly exemption. The manufacturing and assembling machinery and equipment exemption includes machinery and equipment that replaces machinery and equipment in an existing manufacturing facility as well as machinery and equipment that are for use in an expanded or new manufacturing facility. * * * For the purposes of this exemption, terms have the following meanings:

* * *

(4) ‘Equipment’ includes an independent device or tool separate from machinery but essential to an integrated manufacturing or assembly process * * *. * * * Equipment includes chemicals or chemicals acting as catalysts but only if the chemicals or chemicals acting as catalysts effect a direct and immediate change upon a product being manufactured or assembled for wholesale or retail sale or lease ." (Emphasis added.) Id. § 3-50(4).

¶ 5 Horsehead recycles electric arc furnace dust (EAF Dust) generated by steel producers. EAF Dust contains zinc oxide, iron oxide, and other impurities that may include chlorides, lead, and cadmium. Horsehead reclaims zinc and metallic oxides from EAF Dust through a recycling process that strips impurities from the zinc oxide to extract pure zinc, which is collected in powder form and sold directly to third parties. The remaining EAF Dust is heated to a higher temperature to separate impurities from the iron oxide to produce iron-rich material, which is sold to third parties for their own manufacturing processes.

¶ 6 Horsehead operates a recycling facility in Calumet City, Illinois. It employs a "Waelzing process," using a rotary Waelz kiln—a long, rotating, cylindrical oven situated at a slight angle—to "reduce" and recover the zinc as crude zinc oxide from EAF Dust. Horsehead purchases metallurgical coke—a solid material consisting almost entirely of carbon—for use in the Waelzing process. Horsehead combines EAF Dust with metallurgical coke "breeze" (i.e. , metallurgical coke in fine dust form) and water to create pellets. The pellets are then fed into one end of the kiln, and oxygen from the outside air is drawn into the kiln from the opposite side. The air inside the kiln is heated by external gas burners to between 600 and 700 degrees centigrade to dry the pellets. At this temperature, a chemical reaction starts to occur.

¶ 7 When the pellets reach the desired temperature, the metallurgical coke reacts with the carbon dioxide, creating carbon monoxide.² As the carbon monoxide seeps into the heated pellets on the kiln bed, the carbon monoxide acts as a reducing agent to strip away oxygen from the zinc oxide and iron oxide in the EAF Dust, resulting in metallic zinc vapor and metallic iron. The process results in additional carbon dioxide, which then reacts with the heated pellets to produce additional carbon monoxide, which then seeps into the heated pellets on the kiln bed, stripping away more oxygen from the zinc oxide and iron oxide in the EAF Dust, resulting in a continuous, self-sustaining cycle of reactions. The metallic zinc vapor rises from the kiln bed and reacts with oxygen inside the kiln, producing fine particles of crude zinc oxide. The metallic iron also reacts with the oxygen inside the kiln, producing iron oxide rich material. These reoxidation processes generate heat within the kiln, making the Waelzing process self-sustaining.

¶ 8 After the Waelzing process is completed, Horsehead either sells the crude zinc oxide directly to third parties (as "Waelz oxide") or sends it to another Horsehead facility for further refining, where it is then sold to third parties. The iron oxide rich material is also sold to third parties. Virtually all of the metallurgical coke is consumed during the Waelzing process.

¶ 9 On October 3, 2014, IDOR issued Horsehead two "Notices of Tax Liability" for the period of January 1, 2007, through June 30, 2011.³ IDOR's notices informed Horsehead that it was liable for approximately $1,521,041 in use taxes, interest, late payment penalties, and late filing penalties under the Use Tax Act ( 35 ILCS 105/1 et seq. (West 2012) ) for Horsehead's out-of-state purchases of metallurgical coke used in the Waelzing processes, for which it had not paid any use tax. Horsehead filed a petition for hearing with the tax tribunal, contending that the purchases of metallurgical coke were exempt from the use tax under section 3-50(4) of the Use Tax Act because the metallurgical coke, as part of the Waelzing processes, met the definition of a chemical or a chemical acting as a catalyst to effect a direct and immediate change upon the zinc and iron in the EAF Dust. IDOR answered the petition, and the parties engaged in discovery. The tax tribunal conducted a hearing, where it heard testimony from numerous witnesses, and considered posthearing briefs from the parties.

¶ 10 The tax tribunal considered the plain meaning of the terms "direct" and "immediate," as used in section 3-50(4) of the Use Tax Act, and found those terms to be clear and unambiguous. The tax tribunal also considered IDOR's administrative regulations in section 130.330(c)(6) of Title 86 of the Illinois Administrative Code (Title 86) ( 86 Ill. Adm. Code 130.330(c)(6) (2016) ), which provides two examples of reactions that are direct and immediate. The tax tribunal's written decision concluded that the carbon monoxide acts as the reducing agent and causes a direct and immediate change on the zinc oxide and iron oxide, the product being sold by Horsehead. The tax tribunal concluded that in the Waelzing process, metallurgical coke does not directly and immediately cause a change to the zinc and iron in the EAF Dust because "[s]imply placing [metallurgical] coke next to zinc oxide or zinc does not create any chemical reaction whatsoever, a point conceded by Horsehead's own witnesses." The tax tribunal found that Horsehead was attempting to condense all of the separate chemical reactions in the Waelzing process into a continuous and single chemical reaction and that Horsehead's position "renders the language ‘direct and immediate’ void." The tax tribunal observed that it was the carbon monoxide—not the carbon in the metallurgical coke alone—that reacts with the zinc oxide and iron oxide. The tax tribunal further observed that none of Horsehead's witnesses were asked to define the term "catalyst" or testified that the metallurgical coke acted as a catalyst. Therefore, the tax tribunal concluded that Horsehead's out-of-state purchases of metallurgical coke did not qualify for the exemption set forth in section 3-50(4) of the Use Tax Act and that Horsehead was liable for the tax.

¶ 11 Before the tax tribunal, Horsehead argued that, if it were liable for the use tax, it should not have to pay the late filing and late payment penalties. Horsehead did not challenge the amount of the penalties, but instead argued that the penalties should be abated under section 700.400 of Title 86 ( 86 Ill. Adm. Code 700.400(b), (c) (2001) ). It contended that section 3-50(4) of the Use Tax Act lacks a specific definition of the term "direct and immediate change" and that it had a history of complying with its other state tax obligations. The tax tribunal agreed that Horsehead had shown compliance with its other tax obligations but observed that Horsehead failed to present any evidence of good faith with respect to the position it took toward the chemical exemption. Thus, there was no evidence as to "what or who [Horsehead] relied upon in choosing to claim its [metallurgical] coke purchases as catalysts when...