Lancaster Laboratories, Inc. v. Com.

• Decision Date: 24 August 1993
• Citation: 158 Pa.Cmwlth. 165,631 A.2d 739
• Parties: LANCASTER LABORATORIES, INC., Petitioner, v. COMMONWEALTH of Pennsylvania, Respondent.
• Court: Pennsylvania Commonwealth Court

Page 739

631 A.2d 739

158 Pa.Cmwlth. 165

LANCASTER LABORATORIES, INC., Petitioner, v. COMMONWEALTH of Pennsylvania, Respondent.

Commonwealth Court of Pennsylvania.

Argued June 17, 1993.

Decided Aug. 24, 1993.

Russell J. Ober, Jr., for petitioner.

Bart J. DeLuca, Jr., Sr. Deputy Atty. Gen., for respondent.

Before McGINLEY and FRIEDMAN, JJ., and SILVESTRI, Senior Judge.

McGINLEY, Judge.

Lancaster Laboratories Inc. (Lancaster) appeals from an order of the Board of Finance and Revenue (Board), dated March 29, 1988, that sustained a Board of Appeals' decision denying Lancaster's petition for resettlement of the Department of Revenue's (Department) initial resettlement, in the nature of an increase, of Lancaster's 1984-85 capital stock tax from $4,291.59 to $18,108.13. The Board based its order on the grounds that Lancaster is not entitled to claim the manufacturing or the research and development exemption set forth under Section 602(a) of the Tax Reform Code of 1971, Act of March 4, 1971, P.L. 6, as amended, 72 P.S. § 7602(a), because it is primarily engaged in the testing of products and manufacturing methods of others rather than creating new products or refining products.

The issues presented for our review are (1) whether Lancaster is entitled to the capital stock tax exemption for research or development; (2) whether Lancaster is entitled to the capital stock tax exemption as a manufacturer; and (3) whether Lancaster is entitled to a capital stock tax exemption based upon the exempt activities of its clients. We affirm.

As findings we adopt the relevant facts as stipulated by the parties. In summary, the parties agree that Lancaster is engaged in the business of providing scientific analyses, studies and/or testing services for its clients. Lancaster's operations typically involve the receipt of one or more samples from a client, which samples are subjected to a test or series of tests. The data generated from the tests, analyses of that data, and transmittal of that data are in the form of a report. Examples of the types of samples Lancaster receives from a client include prepared food products such as a candy bar; semi-prepared food products such as dry cake mix; raw materials to be used in the manufacturing process such as cocoa beans; animal feed products; drugs; manufacturing by-products such as waste water; air or potable water samples; or materials such as wood or metals.

Lancaster receives with the sample a request that it be tested for the presence or absence of certain elements, compounds, pollutants, or biological contaminants. Lancaster may also, for example, be requested to test the absorption rate of a drug; the presence or absence of asbestos in an air or water sample or the amount of certain nutrients or calories in a food product. Lancaster then identifies the samples, inputs information regarding the sample into its computer system; and stores the sample until it can be tested. The storage normally lasts from several hours to several days, although it may be tested immediately. Once the sample is removed from storage, it is taken to one of Lancaster's six departments. These departments are: Chemistry I (Food and Drug), which performs analyses for drug potency, comprehensive nutritional labeling analyses for food products and miscellaneous food analyses; Chemistry II (Water Quality), which involves verification of the efficiency of pollution control and treatment equipment and facilities; Chemistry (Industrial Hygiene), which performs primarily asbestos testing and studies of building materials; Chemistry IV (Organic Chemistry), which tests solid and liquid waste materials for heavy metals; Chemistry V (Organic Chemistry), which tests water or waste materials for the presence of various organic compounds; and Microbiology, which conducts studies to ascertain the presence of bacterial or extraneous matter in food products.

The respective departments then use Lancaster's equipment and computers to subject the samples to an integrated series of operations or procedures, exposing them to various chemicals, light, heat or other elements. These operations produce data regarding the samples. Upon completion of the analyses, Lancaster provides the client with a report containing the information requested.

Lancaster filed a tax return for the period of October 1, 1984, through September 30, 1985, reporting a capital stock tax of $4,291.59. The Department subsequently resettled Lancaster's capital stock tax at $18,108.13. Lancaster then filed a petition for resettlement alleging that its operations were within the scope of the manufacturing and research and development exemption. The Board of Appeals and thereafter the Board of Finance and Revenue rejected Lancaster's arguments. Lancaster appeals.

The capital stock tax imposed by Section 602(a) of the Tax Reform Code, 72 P.S. § 7602(a) applies to "every domestic entity" as defined in Section 601(a):

Every corporation having capital stock, every joint-stock association, limited partnership and every company whatsoever, now or hereafter organized or incorporated by or under any laws of the Commonwealth, other than corporations of the first class, nonprofit corporations and cooperative agricultural associations not having capital stock and not conducted for profit, banks, savings institutions, title insurance or trust companies, building and loan associations and insurance companies is a domestic entity.

72 P.S. § 7601(a).

Clearly Lancaster qualifies as a domestic entity under Section 601(a) and is subject to the capital stock tax. However, Lancaster bases its claims for an exemption upon the following language in Section 602(a):

[T]he provisions of this section [capital stock tax] shall not apply to the taxation of the capital stock of entities organized for manufacturing, processing, research or development purposes, which is invested in and actually and exclusively employed in carrying on manufacturing, processing, research or development within this State.

72 P.S. § 7602(a). Before examining Lancaster's arguments, we note that the above manufacturing and research and development provisions are exemptions to the capital stock tax and are to be strictly construed against the taxpayer. ¹ Commonwealth v. Deitch Co., 449 Pa. 88, 95, 295 A.2d 834, 838 (1972).

Lancaster's first contention is that it is entitled to a "research and development" exemption to the capital stock tax. In Section 601(a) research and development is defined as, "The activities relating to the discovery of new and the refinement of known substances, products, processes, theories and ideas, but not including activities directed primarily to the accumulation or analysis of commercial, financial or mercantile data." 72 P.S. § 7601(a). Lancaster argues that it is engaged by its clients to assist them in the development of either new and improved products or new methods of production of existing products. As the parties note, there is a dearth of legal precedent interpreting the research and development exemption to the capital stock tax.

Our review of the stipulated facts indicates that Lancaster's activities do not constitute research and development as envisioned by the legislature in drafting Section 601(a). Lancaster receives samples from its customers and tests the samples for the presence of various elements, compounds or pollutants. Lancaster then reports its analyses to its clients. Lancaster does not research or develop any products. In other words, Lancaster is purely a testing laboratory. Consequently, we conclude that Lancaster is not entitled to the research and development exemption in Section 602(a).

Lancaster's second contention is that if it is not engaged in research and development, it is surely engaged in manufacturing activities and is therefore entitled to the capital stock tax exemption on that basis. Although "manufacturing" is not defined either in Section 601(a) of the Tax Reform Code or in the Department's regulations, this Court in Kirks Milk Products Inc. v. Commonwealth, 58 Pa.Commonwealth Ct. 230, 427 A.2d 688 (1981), defined "manufacturing" for purposes of the capital stock tax exemption in Section 602(a). In Kirks Milk Products we established a two-prong test to determine whether an activity is manufacturing. First, the taxpayer's operations must involve a high degree of skill, science and labor, and second, there must be a substantial change in the form, qualities and adaptability in the use of the original ingredients so as to create a new, different and useful product. Id. at 234, 427 A.2d at 690 (citing...