North Star Steel Co. v. Iowa Dept. of Revenue

• Decision Date: 15 January 1986
• Docket Number: No. 84-1870,84-1870
• Citation: 380 N.W.2d 677
• Parties: NORTH STAR STEEL CO., Appellee, v. IOWA DEPARTMENT OF REVENUE, Appellant.
• Court: Iowa Supreme Court

Page 677

380 N.W.2d 677

NORTH STAR STEEL CO., Appellee, v. IOWA DEPARTMENT OF REVENUE, Appellant.

No. 84-1870.

Supreme Court of Iowa.

Jan. 15, 1986.

Thomas J. Miller, Atty. Gen., Harry M. Griger, Sp. Asst. Atty. Gen., and Thomas M. Donahue, Asst. Atty. Gen., for appellant.

F. Richard Lyford and Barbara G. Barrett, of Dickinson, Throckmorton, Parker, Mannheimer & Raife, Des Moines, for appellee.

Considered by REYNOLDSON, C.J., and UHLENHOPP, McCORMICK, SCHULTZ, and WOLLE, JJ.

WOLLE, Justice.

The Iowa Department of Revenue (department) contends that North Star Steel Company (North Star) must pay Iowa use tax on the refractory materials and carbon electrodes which it purchased for use in the production of steel in its electric arc furnace during the assessment period of October 1, 1977, through September 30, 1978. The final agency decision of the department upheld assessment of the use tax on the furnace materials. The district court on judicial review of that agency decision determined that the refractory materials but not the electrodes were subject to the use tax, and both parties have appealed. We conclude that the department applied an incorrect legal standard, a "primary use" test, in deciding that the materials were subject to use tax. North Star established as a matter of law that both the refractory materials and carbon electrodes were exempt from the use tax because they were used in "processing" as that term is defined in Iowa Code section 423.1(1)(a) (1977). (All statutory references herein are to the 1977 Code of Iowa, unless otherwise indicated.) Consequently, we affirm on the department's appeal and reverse on North Star's cross appeal.

North Star owns and operates a steel mill in Wilton, Iowa. In the operation of the mill North Star produces and sells steel, slag, and bag dust. The issues on appeal concern the taxable status of refractory materials and carbon electrodes--property used in North Star's electric arc furnace.

The components of the electric arc furnace used by North Star in its production of steel can be described with the help of the following rough sketch.

NOTE: OPINION CONTAINS TABLE OR OTHER DATA THAT IS NOT VIEWABLE

The furnace has the shape of a large covered bowl. The manufacturing process consists of three stages--a "melting period", a "refining period", and a "repair period".

At the beginning of the melting cycle the bottom of the furnace is filled with various raw materials, collectively referred to as the "charge." Graphite rods, referred to as carbon electrodes, are then lowered into the furnace and positioned approximately one-half inch above the charge. A high-voltage current is sent through the rods, resulting in an electric arc which passes through the air between the electrodes. The electric arc generates intense heat which reduces the charge to a molten mass, referred to as the "bath." During the melting period the carbon reacts with oxygen and hydrogen to drive impurities from the steel. The melting cycle lasts from sixty to ninety minutes.

At the beginning of the refining cycle a small sample of the molten metal is analyzed to determine the presence or absence of various substances within the steel. Depending upon the result of the chemical analysis and the intended use of the finished product, some materials may be added to or taken from the bath. Carbon is a crucial element of finished steel. On occasion, the graphite electrodes are dipped into the molten mass to increase its carbon content. The dipping procedure can also be used to cause a chemical reaction which purges the steel of certain impurities such as sulphur, phosphorous, or magnesium. During the refining period the electrodes are not used to conduct electricity; the electric current is turned off once the raw materials become a molten mass. The refining cycle lasts between thirty and forty-five minutes.

When all impurities have been removed from the steel and any necessary materials added, the repair cycle begins. This stage is necessary to replace the refractory material that has been worn away in the steel-making process.

Refractory material is used in the lining and construction of the furnace. It comes in a variety of forms including brick, plaster, and spray. The refractory material protects the furnace and associated vulnerable steel-making equipment from the intense heat generated during the steel-making process. Because it is in direct contact with the molten "bath" the refractory material is attacked and slowly consumed, with much of the material transformed into slag and bag dust which North Star sells as by-products of the steel-making process. Consumption of the refractory materials makes necessary a repair cycle which lasts from fifteen to twenty-five minutes. Even refractory material that does not come into direct contact with the molten material deteriorates during the manufacturing process and must be replaced periodically. Approximately every thirty days, the furnace is shut down to completely reline its side walls with new refractory material.

On May 5, 1980, the department assessed North Star a use tax on North Star's purchase and use of electrodes and refractory materials during the period from October 1977 through September 1978. North Star filed a consumer use tax protest in which it denied liability for use tax on these purchased products. North Star argued that the electrodes and refractory materials were not taxable because its use of those products constituted "processing," a use excepted from use tax by specific statutory language.

A contested case hearing was held and on May 28, 1981, the hearing officer entered an order finding the refractory materials taxable and the electrodes nontaxable. The director of the department of revenue, however, applied a "primary use" test to North Star's use of these materials which serve several functions and held that North Star's use of both products was taxable. On review the board of tax review in the final agency decision adopted without change the director's order taxing North Star's use of both products.

North Star sought judicial review of that decision, and on October 26, 1984, the district court held that the refractory materials were taxable but the electrodes were nontaxable. Both parties have appealed, the department contending that both the refractory materials and electrodes are taxable and North Star contending that both are exempt from use tax.

We first summarize the general legal principles governing this judicial review proceeding. We then analyze the statutory language and Iowa case law to decide whether the department erred in applying a "primary use" test in determining that North Star's use of the materials was not within the "processing" exemption. Finally, we apply the statute to the facts established by the final agency decision to decide whether North Star met its burden to establish the claimed exemption as a matter of law.

I. Scope of Judicial Review.

This proceeding is governed by Iowa Code section 17A.19, the judicial review provision within the Iowa Administrative Procedure Act. Our function on appeal, like that of the district court, is to correct any errors of law in the final agency decision. Kartridg Pak Co. v. Department of Revenue, 362 N.W.2d 557, 559 (Iowa 1985). The principal question of law we must answer is whether the agency correctly interpreted Iowa Code section 423.1(1)(a). In reviewing the administrative agency's interpretation of that statute we give weight to the agency's determination but are not bound by its interpretation. Ballstadt v. Iowa Department of Revenue 368 N.W.2d 147, 148 (Iowa 1985); American Home Products Corp. v. Iowa State Board of Tax Review, 302 N.W.2d 140, 142 (Iowa 1981). The meaning of a statute is always an issue of law for the court to decide. Schmitt v. Iowa Department of Social Services, 263 N.W.2d 739, 745 (Iowa 1978).

II. The "Processing" Exemption.

Iowa's use tax, set forth in Iowa Code chapter 423, is an excise tax designed to supplement and protect sales tax. Northern Natural Gas Co. v. Lauterbach, 251 Iowa 885, 887, 100 N.W.2d 908, 909 (1960). Tangible personal property purchased for use in Iowa is taxed by section 423.2 when it comes within the statutory definition of "use" found in section 423.1(1), but that subsection excepts property used in "processing." The pertinent statutory language of section 423.1(1) is as follows:

"Use" means and includes the exercise by any person of any right or power over tangible personal property incident to the ownership of that property, except that it shall not include processing, or the sale of that property in the regular course of business. Property used in "processing" within the meaning of this subsection shall mean and include (a) any tangible personal property including containers which it is intended shall, by means of fabrication, compounding, manufacturing, or germination, become an integral part of other tangible personal property intended to be sold ultimately at retail, ... (c) chemicals, solvents, sorbents, or reagents, which are directly used and are consumed, dissipated, or depleted in processing personal property, which is intended to be sold ultimately at retail, and which may not become a component or integral part of the finished product.

North Star contends that its use of the refractory materials and carbon electrodes comes within subparagraphs (a), a manufacturing process exception, and (c), a chemical process exception. Our focus is on the subsection (a) exception because we conclude that it fits North Star's use of both the carbon electrodes and refractory materials.

A. Burden of proof. The parties disagree on whether North Star or the department had the burden of proof on factual questions involving the processing exemption. Our cases clearly place the burden of proof on North Star. Although statutes which impose taxes are construed liberally in favor of the taxpayer...