Southwestern Bell v. Director of Revenue

• Decision Date: 20 December 2005
• Docket Number: No. SC 86441.,SC 86441.
• Citation: 182 S.W.3d 226
• Parties: SOUTHWESTERN BELL TELEPHONE COMPANY, Respondent, v. DIRECTOR OF REVENUE, Appellant.
• Court: Missouri Supreme Court

Page 226

182 S.W.3d 226

SOUTHWESTERN BELL TELEPHONE COMPANY, Respondent, v. DIRECTOR OF REVENUE, Appellant.

No. SC 86441.

Supreme Court of Missouri, En Banc.

December 20, 2005.

Jeremiah W. (Jay) Nixon, Atty. Gen., James R. Layton, State Solicitor, Jefferson City, for appellant.

Ann K. Covington, B. Derek Rose, St. Louis, Edward F. Downey, Jefferson City, for respondent.

MARY R. RUSSELL, Judge.

The Director of Revenue seeks review of the Administrative Hearing Commission's ("AHC") decision granting Southwestern Bell Telephone Company a refund of $598,944.14, plus interest, in use tax paid on purchases in the second quarter of 1992. The AHC's decision is affirmed in part and reversed in part, and the cause is remanded.

I. Jurisdiction and Standard of Review

This Court has jurisdiction to review the AHC's decision pursuant to Mo. Const. art. V, section 3, as the case involves construction of the state revenue laws. The AHC's interpretation of revenue laws is reviewed de novo. DST Sys., Inc. v. Dir. of Revenue, 43 S.W.3d 799, 800 (Mo. banc 2001). The AHC's factual determinations will be upheld if the law supports them and, after reviewing the whole record, there is substantial evidence that supports them. Id.

A taxpayer carries the burden of showing they are entitled to an exemption under the statutes. Branson Props. USA, L.P. v. Dir. of Revenue, 110 S.W.3d 824, 825 (Mo. banc 2003). Exemptions from taxation are to be strictly construed against the taxpayer, and any doubt is resolved in favor of application of the tax. Id.

II. Background

Bell seeks a refund of the use tax it paid on machinery and equipment used to produce basic and vertical telephone services. Bell contends it is entitled to a refund under sections 144.030.2(4) and (5), RSMo Supp.1992,¹ which provide sales and use tax exemptions for certain machinery and equipment "used directly" in manufacturing a product intended for final use or consumption.²

Director denied Bell's refund claim, and Bell sought review of that decision from the AHC. The AHC affirmed Director's denial of the refund, finding that Bell did not qualify for a manufacturing exemption because telephone service was not a manufactured product. The AHC also found that, even if Bell were engaged in manufacturing, its purchases did not qualify for the exemption because the legislature had not intended for all telephone components to be exempt as "used directly" in manufacturing.

Bell sought review of the AHC's decision. In Southwestern Bell Telephone Co. v. Director of Revenue, 78 S.W.3d 763 (Mo. banc 2002) (hereinafter "Bell I"), this Court held that Bell's telephone services constituted the manufacturing of a product intended for final use and consumption for purposes of the sales and use tax exemptions.³ Bell I, 78 S.W.3d at 767-68 (holding Bell's basic telephone services and various vertical services are intangible products that are manufactured). This Court, however, remanded to the AHC for further fact-finding as to whether Bell's purchases were qualifying machinery and equipment under sections 144.030.2(4) and (5). Bell I, 78 S.W.3d at 768.

On remand from Bell I, the AHC ruled in Bell's favor. The AHC concluded that all of Bell's purchases were machinery and equipment "used directly" in manufacturing such that they qualified for the use tax exemption and, therefore, Bell was entitled to its full refund claim of $598,944.14. The AHC noted that Director had conceded that certain purchases — mostly switching components and central office equipment — were not taxable, leaving a challenged amount of $242,328.63.⁴ Director now seeks review of the AHC's decision on remand.

In Bell I, this Court remanded to the AHC so that it could review the evidence to determine if Bell's claimed purchases were for "machinery and equipment, or materials and supplies solely required for the installation or construction of such machinery and equipment." Id. Under the plain language of sections 144.030.2(4) and (5), however, this review necessarily required the AHC to determine if the purchases at issue were "used directly" in manufacturing. Under the statute, purchases must be "used directly" in order to qualify for the exemption.

Director challenges the AHC's conclusion that Bell's purchases are "used directly" in manufacturing. In reviewing the AHC's decision on remand, this Court must determine if the AHC erred in finding that all of Bell's purchases were machinery and equipment "used directly" in its manufacture of basic and vertical telephone services.

III. What is "used directly"?

The standard for determining what is "used directly" in manufacturing has evolved as manufacturing itself has changed from traditional rust-belt factories to industries that are increasingly reliant on what the AHC appropriately calls "technology of a new millennium." Keeping pace with modern industry, especially in information and communication technologies, has required consideration of how the manufacturing exemption applies to intangible products or services. Bell I, 78 S.W.3d at 766. As technology has evolved, consideration has been given to how the manufacturing exemption applies when a company's machinery and equipment is connected by telephone lines and via data processing connections. As noted in Bell I, this case requires "`the application of a statutory framework that first took shape in the thirties and forties to [current] technology.'" Id. at 763-64 (quoting Bridge Data Co. v. Dir. of Revenue, 794 S.W.2d 204, 205 (Mo. banc 1990), abrogated by Int'l Bus. Machs. Corp. v. Dir. of Revenue, 958 S.W.2d 554 (Mo. banc 1997)).

The meaning of "used directly in manufacturing a product" was first addressed in Floyd Charcoal Co., Inc. v. Director of Revenue, 599 S.W.2d 173, 176 (Mo. banc 1980), abrogated on other grounds by Al-Tom Inv., Inc. v. Dir. of Revenue, 774 S.W.2d 131 (Mo. banc 1989). In Floyd Charcoal, this Court adopted the "integrated plant" theory⁵ for determining what is "directly used" in manufacturing. 599 S.W.2d at 177-78.

The "integrated plant" theory stresses that:

`The basic questions are the following: (1) Is the disputed item necessary to production? (2) How close, physically and causally, is the disputed item to the finished product? (3) Does the disputed item operate harmoniously with the admittedly exempt machinery to make an integrated and synchronized system?

. . . .

It is not practical to divide [the] plant into `distinct' stages. It was not built that way, and it does not operate that way. The words `directly and exclusively' should not be construed to require the division into theoretically distinct stages of what is in fact continuous and indivisible.'

Id. at 177 (quoting Niagara Mohawk Power Corp. v. Wanamaker, 286 A.D. 446, 144 N.Y.S.2d 458, 461-62 (1955), aff'd, 2 N.Y.2d 764, 157 N.Y.S.2d 972, 139 N.E.2d 150 (1956)).

Floyd Charcoal rejected the argument that equipment could not qualify for the manufacturing exemption if it did not produce a change in the composition of raw materials involved in the manufacturing process, stating:

Modern manufacturing facilities are designed to operate on an integrated basis . . . . [and] limit[ing] the exemption to those items of machinery or equipment which produce a change in the composition of the raw materials involved in the manufacturing process would ignore the essential contribution of the devices required for such operation.

Floyd Charcoal, 599 S.W.2d at 178.

Floyd Charcoal also rejected the contention that the relevant question was "whether or not the manufacturing operation may be carried on without the machinery in question," because "[s]uch a test does not comport with the reality of the process involved." Id.

Floyd Charcoal's adoption of the three-prong "integrated plant" theory approach was consistent with the purpose of Missouri's manufacturing exemption, which was enacted by the legislature to encourage the production of items ultimately subject to sales tax and to encourage the location and expansion of industry in Missouri. Id.; Concord Publ'g House, Inc. v. Dir. of Revenue, 916 S.W.2d 186, 190 (Mo. banc 1996). The exemption reduces multiple taxation that occurs where purchases for resale are taxed numerous times during the journey of goods to the ultimate consumer, such that the tax paid by the manufacturer is passed on to the consumer, who is, in turn, effectively taxed on a tax.

Since Floyd Charcoal, other cases have considered the "integrated plant" theory in deciding whether items are "used directly" in manufacturing such that they are exempt from sales and use tax.

The "integrated plant" theory as adopted in Floyd Charcoal was applied in Noranda Aluminum, Inc. v. Missouri Department of Revenue, 599 S.W.2d 1 (Mo. 1980), wherein this Court discussed that the equipment at issue was "used in steps or operations that are essential to and comprise an integral part of [the] manufacturing process, and [was, therefore,] used directly for manufacturing or fabricating a product. . . ." Noranda, 599 S.W.2d at 4 (internal citations omitted).

Concord, 916 S.W.2d 186, reiterated that Floyd Charcoal had rejected strict interpretation of the phrase "directly used" to exempt only machines that physically alter raw materials to a finished product. Concord, 916 S.W.2d at 191-92. It asserted that "Missouri has adopted the integrated plant doctrine, viewing manufacturing operations as continuous and indivisible." Id. at 191 (internal citations omitted). In Concord, computers used in manufacturing⁶ a newspaper were determined to be "directly used in manufacturing because they [were] an integral part of the publication process" and provided "the most important step in manufacturing a newspaper, the composition and editing of its contents." Id. at 192.

In holding that the computers were exempt in Concord, this Court found the "integrated plant" doctrine can apply where two distinct corporations are cooperatively involved in...