Pledger v. Baldor Intern., Inc.

• Decision Date: 30 March 1992
• Docket Number: No. 91-304,91-304
• Citation: 827 S.W.2d 646,309 Ark. 30
• Parties: Jim C. PLEDGER, Director of the Arkansas Dept. of Finance and Admin., and Timothy J. Leathers, Comm. of Revenues, Appellants, v. BALDOR INTERNATIONAL, INC., Baldor Elec. Co., Inc., and Southwestern Die Casting, Co., Inc., Appellees.
• Court: Arkansas Supreme Court

Page 646

827 S.W.2d 646

309 Ark. 30

Jim C. PLEDGER, Director of the Arkansas Dept. of Finance and Admin., and Timothy J. Leathers, Comm. of Revenues, Appellants, v. BALDOR INTERNATIONAL, INC., Baldor Elec. Co., Inc., and Southwestern Die Casting, Co., Inc., Appellees.

No. 91-304.

Supreme Court of Arkansas.

March 30, 1992.

Beth B. Carson, Little Rock, for appellants.

Richard T. Donovan, Little Rock, for appellees.

GLAZE, Justice.

This is a use tax case. The appellee, Baldor Electrical Company, manufactures industrial electric motors and grinders, and its corporate headquarters is in Fort Smith. ¹ Appellee Southwestern Die Casting Company, a fully owned subsidiary of Baldor, manufactures rotor castings that are a component part of Baldor's electric motors. The Arkansas Department of Finance and Administration (DFA) assessed a use tax on appellees' purchases of advertising goods and equipment from out-of-state vendors during the period May, 1980 thru April, 1986. Specifically, the equipment included seven different testing machines and an environmental control system. The appellees paid the tax in protest and requested an administrative hearing. The Board of Hearings and Appeals sustained DFA's assessments.

Appellees then pursued their challenge in chancery court. The chancellor found that all of the appellees' advertising goods and equipment were exempt from the use tax assessments and ordered a refund to the appellees for the amount of taxes paid for these items. DFA appeals from that ruling. We reverse the chancellor's finding of a use tax exemption for the advertising services and the environmental control system and affirm in part and reverse in part his findings that exempted all of appellees' testing machines.

Before beginning our discussion on the merits of the appellants' appeal, we recognize the following settled rules of construction used in tax exemption cases. A presumption exists in favor of the taxing power of the state, and a taxpayer has the burden of establishing the right to an exemption beyond a reasonable doubt. Pledger v. Easco Hand Tools, Inc., 304 Ark. 47, 800 S.W.2d 690 (1990). Tax exemptions must be strictly construed against exemption, and to doubt is to deny the exemption. Id. In addition, this court has stated that tax exemption cases are reviewed de novo and the appellate court does not set aside the findings of the chancellor unless they are clearly erroneous. Id.

We first address the appellants' argument that the chancellor erred in finding that the appellees were entitled to a use tax exemption for advertising services. The appellees used Atkinson Group, a Missouri advertising agency, and argued that Atkinson's billings clearly distinguished between services and goods. The chancellor agreed with the appellees' argument that the advertising services were separable from the charges for advertising materials and therefore were exempt from the use tax.

A use tax at a rate of three per cent of the sales price is assessed for the privilege of storing, using or consuming within this state any article of tangible personal property purchased for storage, use or consumption in this state. Ark.Code Ann. § 26-53-106(a) (1987). Sales price is defined as the following in the Compensation or Use Taxes provisions:

Sales price means the consideration paid or given, or contracted to be paid or given, by the purchaser to the vendor for the article of the tangible personal property including any services that are a part of the sale valued in money, whether paid in money or otherwise, and includes any amount for which credit is given to the purchaser by the vendor without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service cost, ... (Emphasis Added).

Ark.Code Ann. § 26-53-102(1) (1987); Ark.Stat.Ann. § 84-3014(a) (Repl.1980). The wording of this statutory provision, itself, makes it clear that services that are part of the sale are not to be excluded in the use tax assessment.

Further, the case of Larey v. Dungan-Allen, 244 Ark. 908, 428 S.W.2d 71 (1968), is instructive on this issue. In that case, this court refused to separate a photographer's services from the materials, holding that it is the exercise of the skill that makes the photograph saleable. The photographer charged a $25.00 hourly rate for his services, but the photographs were sold for $2.00 each. However, we concluded that the photograph should not be priced solely on the basis of its constituent materials, but that such things as invested capital, education or technical training, professional skill labor and overhead expenses can be expected to contribute to the value and selling price of the finished product.

While we note that the Dungan-Allen case involved a gross receipts tax, the same language forbidding the deduction for services from the sales price, as cited in the use tax provisions, is found in the definition of "gross proceeds," Ark.Code Ann. § 26-52-103 (1987). Thus, we find the rationale in Dungan-Allen applicable to the present case. Here, the professional skills and labor of the advertising agency are necessarily included in the costs of the final product or advertising materials. Therefore, we must reverse the chancellor's holding on this point.

Likewise, we find merit in the appellant's second argument that the chancellor erred in holding that the appellees were entitled to a use tax exemption for appellees' environmental control system. Mike Mann, the Executive Vice President of Baldor, testified that in 1980 Baldor modernized its facility by investing around $10,000,000 in sophisticated equipment like Computer Numeric Control lathes (CNC machines) that cut raw materials within very specific and minute tolerances. When Baldor first purchased the CNC machines, it had no environmental control system, and as a result the machines broke down frequently. After exploring other similarly priced alternatives, Baldor installed an environmental control system only in the manufacturing area of the plant. Although DFA admitted that Baldor's environmental control system was necessary for the effective operation of Baldor's CNC machines, DFA's auditor denied the exemption because the system was not used directly in the manufacturing of Baldor's product--its electric motor.

Whether an environmental control system is entitled to a use tax exemption is a question of first impression for this court. Under statutory law, the following use tax exemption is recognized:

Machinery and equipment used directly in producing, manufacturing, fabricating, assembling, processing, finishing, or packaging of articles of commerce and [at] manufacturing or processing plants or facilities in the State of Arkansas....

(a) Such machinery and equipment will be exempt under this section if it is purchased and used to create new facilities within this state or to expand existing facilities within this state;

(c) It is the intent of this subsection to exempt only such machinery and equipment as shall be utilized directly in the actual manufacturing or processing operation at any time from the initial stage where actual manufacturing or processing begins through the completion of the finished article of commerce and the packaging of the finished end product. The term "directly" as used in this Act is to limit the exemption to only the machinery and equipment used in actual production during processing, fabricating or assembling raw materials or semifinished materials into form in which such personal property is to be sold in the commercial market. Hand tools, buildings, transportation equipment, office machines, and equipment, machinery and equipment used in administrative, accounting, sales or other such activities of the business involved and all other machinery and equipment not directly used in the manufacturing or processing operation are not included or classified as exempt. (Emphasis added).

Ark.Stat.Ann. § 34-3106(D)(2) (Repl.1980).

In interpreting, "used directly in manufacturing", this court has not required the equipment to directly come into contact with the finished product before qualifying for an exemption. For instance, in Cheney v. Georgia-Pacific Paper Corporation, 237 Ark. 161, 371 S.W.2d 843 (1963), this court allowed a use tax exemption for Georgia Pacific's steam turbine generators finding that they performed a dual function--first, they utilized steam to generate electrical energy, and second, in so doing, they reduced the steam pressure and emitted it at certain levels to component parts of the paper manufacturing process where it was used for various purposes, such as cooking, drying and heating. The chancery court concluded that the steam turbine generator was a primary facility in the paper manufacturing process, and if the generator were removed, the manufacturing process would cease.

An environmental control system is clearly different from a steam turbine generator which generates electrical energy that activates the manufacturing process. The environmental control system directly affects the surroundings of the manufacturing area of...