In re Western Resources, Inc., 92,379.

Decision Date28 April 2006
Docket NumberNo. 92,379.,92,379.
Citation132 P.3d 950
CourtKansas Supreme Court
PartiesIn the Matter of the Appeal of WESTERN RESOURCES, INC./ KANSAS GAS & ELECTRIC COMPANY, from an Order of the Division of Taxation on Denial of Sales and Use Tax Refund Claim.

S. Lucky DeFries, of Coffman, DeFries & Nothern, of Topeka, argued the cause, and Jeffrey A. Wietharn, of the same firm, was with him on the briefs for appellant/cross-appellee Western Resources, Inc./Kansas Gas & Electric Co.

David J. Dunlap, of Legal Services Bureau, Kansas Department of Revenue, argued the cause and was on the briefs for appellee/cross-appellant Kansas Department of Revenue.

The opinion was delivered by LUCKERT, J.:

In this sales and compensating use tax exemption case, the Board of Tax Appeals (BOTA) ruled that Western Resources, Inc./Kansas Gas & Electric Company (Taxpayer) was entitled to a refund of $2,676,245.51 for sales and compensating use tax paid on purchases of machinery and equipment used for manufacturing, processing, and distributing electricity for resale. The Taxpayer appeals that portion of BOTA's order ruling that, pursuant to K.S.A. 2005 Supp. 79-3609(e), the refund should be paid in equal annual installments over 10 years with no interest accruing. The Kansas Department of Revenue (KDR) cross-appeals BOTA's decision that the purchases were exempt under K.S.A. 79-3606(kk).

The Taxpayer, an electric utility business, sought a refund of sales and compensating use tax paid on the purchase of machinery and equipment it claimed was exempt under K.S.A. 79-3606(kk). The Taxpayer's machinery and equipment included such items as transformers, substations, lines, poles, and related items, none of which were located within the immediate boundaries of the Taxpayer's generation plant. Some power plant equipment was also included in the Taxpayer's claim; the KDR concedes that this portion of the claim qualified for tax exemption and, at oral argument, indicated this portion of the claim had settled.

The KDR denied the requested refund on machinery and equipment which was not located within the immediate boundaries of the Taxpayer's generation plant on the ground that the machinery and equipment, which was used to distribute electricity from the generation plant to the customer, was not located at the plant as required by K.S.A. 79-3606(kk). The Taxpayer timely appealed to BOTA.

BOTA found that "electricity generation occurring at the Taxpayer's generation plant is only the first step in the process of manufacturing electricity." The electricity continues to be manufactured and processed by machinery and equipment outside the generation plant and is not in usable form until the manufacturing process is completed just before the customer's metering device, "which is when the electricity is at the voltage and quality suitable for use by the ultimate consumer." BOTA also found that, "[a]lthough some of the subject equipment serves a distribution function, it is also manufacturing and processing equipment required to convert the electrical energy into a form useable by the ultimate consumers" and "[a]ll of the subject equipment, including the lines and poles, is necessary to produce and process the electrical energy."

BOTA concluded that the Taxpayer's machinery and equipment was "used directly and primarily for the purposes of manufacturing, assembling, processing, finishing, or distributing tangible personal property (electricity) for resale," thus the Taxpayer's purchases of that machinery and equipment were exempt from taxation under K.S.A. 79-3606(kk). Accordingly, BOTA granted the Taxpayer's refund claim in the total amount of $2,676,245.51. In an Order on Limited Reconsideration, BOTA found that K.S.A. 2005 Supp. 79-3609(e)(1)(B) was applicable and that, to the extent each of the Taxpayer's individual vendor refund claims exceeded $50,000, such refunds should be paid in equal installments over a 10-year period and without interest.

The Taxpayer and the KDR each filed a timely notice of appeal on the same day. The KDR's appeal has been labeled as a cross-appeal. The case was transferred to this court on the court's own motion pursuant to K.S.A. 20-3018(c).

ANALYSIS

We begin our analysis with the fundamental issue underlying this case: Did BOTA erroneously interpret K.S.A. 79-3606(kk) when it ruled that the Taxpayer's purchases of machinery and equipment qualified for the tax exemption?

Standard of Review

BOTA orders are subject to review under the Kansas Act for Judicial Review and Civil Enforcement of Agency Actions, K.S.A. 77-601 et seq. In re Tax Appeal of Sprint Communications Co., 278 Kan. 690, 694, 101 P.3d 1239 (2004). K.S.A. 77-621 sets out the scope and standard of review and provides in relevant part that a court may grant relief if it determines "the agency has erroneously interpreted or applied the law" or "the agency action is otherwise unreasonable, arbitrary or capricious." K.S.A. 77-621(c)(4) and (c)(8).

This court normally gives deference to BOTA's decisions:

"`BOTA is a specialized agency and is considered to be the paramount taxing authority in this state. [Citation omitted.] BOTA is a specialized agency that exists to decide taxation issues. [Citation omitted.] Its decisions are given great weight and deference when it is acting in its area of expertise. [Citation omitted.] The party challenging BOTA's decisions has the burden to prove that the action taken was erroneous. [Citation omitted.] However, if BOTA's interpretation of law is erroneous as a matter of law, appellate courts will take corrective steps. [Citation omitted.]'" Sprint, 278 Kan. at 694-95, 101 P.3d 1239 (quoting In re Tax Appeal of Colorado Interstate Gas Co., 276 Kan. 672, 682-83, 79 P.3d 770 [2003]).

Interpretation of K.S.A. 79-3606(kk)

The KDR makes several arguments in support of its general contention that BOTA erroneously interpreted K.S.A. 79-3606(kk) in determining that the Taxpayer's purchases of machinery and equipment qualified for the tax exemption. Most importantly, the KDR contends that BOTA misinterpreted K.S.A. 79-3606(kk) by failing to recognize that the statute only exempts purchases of machinery and equipment which are located at the taxpayer's plant or facility.

Resolution of the argument will require interpretation of the provisions of K.S.A. 79-3606(kk). While statutes imposing a tax must be interpreted strictly in favor of the taxpayer, tax exemption statutes must be interpreted "`strictly in favor of imposing the tax and against allowing the exemption for one who does not clearly qualify. [Citation omitted.]'" Sprint, 278 Kan. at 695, 101 P.3d 1239 (quoting In re Tax Exemption Application of Central Illinois Public Services Co., 276 Kan. 612, 616, 78 P.3d 419 [2003]).

The statute at issue, K.S.A. 79-3606(kk), during the time period at issue in this case, August 1996 to September 1999, provided a tax exemption for

"all sales of machinery and equipment used directly and primarily for the purposes of manufacturing, assembling, processing, finishing, storing, warehousing or distributing articles of tangible personal property in this state intended for resale by a manufacturing or processing plant or facility or a storage, warehousing or distribution facility:

"(1) For purposes of this subsection, machinery and equipment shall be deemed to be used directly and primarily in the manufacture, assemblage, processing, finishing, storing, warehousing or distributing of tangible personal property where such machinery and equipment is used during a manufacturing, assembling, processing or finishing, storing, warehousing or distributing operation:

(A) To effect a direct and immediate physical change upon the tangible personal property;

. . . .

(D) to transport, convey or handle such property during the manufacturing, processing, storing, warehousing or distribution operation at the plant or facility; . . .

. . . .

"(3) `Machinery and equipment used directly and primarily' shall not include:

. . . .

(C) transportation equipment not used in the manufacturing, assembling, processing, furnishing, storing, warehousing or distributing process at the plant or facility."

The first paragraph of the statutory exemption setting out the general requirements by which sales of manufacturing machinery and equipment may qualify for exemption from sales and use tax, can be divided into two requirements. To qualify for the exemption, the machinery and equipment must be (1) used directly and primarily for one of the listed purposes, and (2) used by one of the listed plants or facilities. Regarding the first requirement, BOTA concluded "that the subject equipment is used directly and primarily for the purposes of manufacturing, assembling, processing, finishing, or distributing tangible personal property (electricity) for resale." In reaching its conclusion, BOTA cited In re Tax Appeal of Collingwood Grain, Inc., 257 Kan. 237, 891 P.2d 422 (1995); In re Appeal of Water Dist. No. 1 of Johnson County, 26 Kan.App.2d 371, 988 P.2d 267, rev. denied 268 Kan. 886 (1999); and Northern States Power Co. v. Commissioner of Revenue, 571 N.W.2d 573 (Minn.1997). Although the KDR makes some arguments regarding this requirement and the application of these cases to the determination of whether the equipment is used directly and primarily in the manufacturing of tangible personal property within the meaning of this statute, we need not resolve those issues in this appeal. The parties' focus and, likewise, ours is upon the second requirement that the equipment be used by one of the listed plants or facilities.

In framing the issue it had to decide, BOTA incorrectly stated this second requirement as being "whether the machinery and equipment is used by the Taxpayer" instead of using the statutory language which requires the equipment be used by one of the listed plants or facilities. This modification of the statutory language...

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