ATTORNEY FOR PETITIONER: ATTORNEYS FOR RESPONDENT:
JOHN M. DAVIS JEFFREY A. MODISETT
Attorney at Law Attorney General of Indiana
Deputy Attorney General
WHITE RIVER ENVIRONMENTAL ) PARTNERSHIP, ) ) Petitioner, ) ) ) v. ) Cause No. 49T10-9605-TA-00048 ) DEPARTMENT OF STATE REVENUE , ) ) Respondent. ) ) )_____________________________________________________________________
during 1994 and 1995. The issue to be decided is whether the treatment of wastewater
constitutes production for purposes of the sales and use tax exemptions.
the refund claim. On May 6, 1996, WREP filed this original tax appeal. The parties
filed cross motions for summary judgment, and on August 11, 1997, this Court heard
argument on those motions.
Additional facts will be supplied as necessary.
There are a variety of exemptions from these complementary taxes.See footnote
See Ind. Code
Ann. §§ 6-2.5-5-1 to -38.2 (West 1989 & Supp. 1997). WREP contends that chemicals
and materials it consumed in its wastewater treatment process are exempt from sales
and use tax under section 6-2.5-5-5.1 (the consumption exemption) and section 6-2.5-
5-30 (the environmental quality exemption). The statutes provide in relevant part:
Transactions involving tangible personal property are exempt from the state gross retail tax if the person acquiring the property acquires it for direct consumption as a material to be consumed in the direct production of other tangible personal property in the person's business of manufacturing, processing, refining, repairing, mining, agriculture, horticulture, floriculture, or arboriculture. . . .
Id. § 6-2.5-5-5.1(b) (West Supp. 1997).
Sales of tangible personal property are exempt from the state gross retail
(1) the property constitutes, is incorporated into, or is consumed in the operation
of, a device, facility, or structure predominantly used and acquired for the purpose of complying with any state, local, or federal environmental quality statutes, regulations, or standards; and
(2) the person acquiring the property is engaged in the business of
manufacturing, processing, refining, mining, or agriculture.
Id. § 6-2.5-5-30.
These exemptions, like all tax exemptions in Indiana, are strictly construed against the taxpayer, see Sony Music Entertainment, Inc. v. State Bd. of Tax Comm'rs, 681 N.E.2d 800, 801 (Ind. Tax Ct. 1997), review denied, and the taxpayer bears the burden of showing entitlement to the exemption. See id. However, the policy of strict
construction of exemption provisions does not mean that the Court will read them so
narrowly that the Court undermines the legislative purpose and intent in enacting those
provisions. See Rotation Prods. Corp. v. Department of State Revenue, 690 N.E.2d
795, 798 (Ind. Tax Ct. 1998).
As the case law makes clear, both the exemption provisions at issue in this case require the taxpayer to engage in production before receiving an exemption. See Mechanics Laundry & Supply, Inc. v. Department of State Revenue, 650 N.E.2d 1223, 1231-32 (Ind. Tax Ct. 1995). In Mechanics Laundry, this Court explained that the terms listed in the exemption provisions, i.e., processing, manufacturing, etc., "have meaning only to the extent that there is production." Id. at 1228. If there is no production of goods, the exemption provisions at issue do not apply. Id. See also Indianapolis Fruit Co., 691 N.E.2d at 1384 ("[T]here is one iron-clad rule: without production there can be no exemption."). Therefore, WREP's entitlement to a sales and use tax exemption rests not on whether wastewater treatment can be called processing, but rather whether WREP is engaged in the production of goods.
WREP contends that it is engaged in production within the meaning of the exemption provisions. In support of this contention, WREP points to the fact that the wastewater treatment process makes clean water, which may be used for irrigation, ash, which may be used for making brick and a low grade type of concrete, and sludge, which may be used as fertilizer, from wastewater. WREP also supports it contention by arguing that its wastewater treatment process works a substantial change in the wastewater it receives.
The Court agrees that WREP's wastewater treatment process works a
substantial change in the wastewater because it places the wastewater it receives in a
"form, composition, or character substantially different from that in which it was
acquired." Ind. Admin. Code tit. 45, r. 2.2-5-10(k) (1996). Removing the solids from the
wastewater "creates a significant change" in the wastewater. Mid-America Energy
Resources, 681 N.E.2d at 263; see also Jackson Excavating Co. v. Administrative
Hearing Comm'n, 646 S.W.2d 48 (Mo. 1983) (water purification results in substantial
transformation of water). Before the removal of the solids, the wastewater is unable to
be legally discharged into the White River; after the sludge removal, the wastewater is
able to be legally discharged in the White River.
However, the fact that WREP substantially changes the wastewater does not ispo facto lead to the conclusion that production for purposes of the exemption provisions is taking place. See Indianapolis Fruit Co., 691 N.E.2d at 1385 n.4; Rotation Prods., 690 N.E.2d at 804 n.16. Production, within the context of the exemption provisions at issue, "is defined broadly and focuses on the creation of a marketable good." Indianapolis Fruit Co., 691 N.E.2d at 1383 (quoting Mid-America Energy Resources, 681 N.E.2d at 262) (internal quotation marks omitted). In this case, the "products" of the wastewater treatment process (clean water, ash, and sludge) are not sold to others. The clean water is discharged into the White River, and the ash and sludge are disposed in a landfill. WREP has designated evidence tending to show that it is attempting to market these "products," but it has not shown that it actually sold any of them. WREP contends that this fact is not fatal to its exemption claim.
In Mumma Bros. Drilling Co. v. Department of State Revenue, 411 N.E.2d 676
(Ind. Ct. App. 1980), the court dealt with an issue similar to that raised here.See footnote
Mumma Bros., the court evaluated a taxpayer's sales and use tax exemption claim
under a previous exemption provision.See footnote
In that case, the taxpayer drilled water wells
and installed pumps and plumbing for residences, farms and commercial entities in
order to provide water for animal and human consumption. The taxpayer claimed that
its drilling equipment was exempt from sales and use tax because it was used in the
extraction of tangible personal property, namely water.
The court disagreed. It found that because the evidence showed that the extracted water was not resold, the taxpayer did not qualify for the exemption. Id. at 677. See also generally, Annotation, What Constitutes Manufacturing and Who is a Manufacturer under Tax Laws, 17 A.L.R.3d 7, 31-32 (1968 & Supp. 1997). In arriving at its conclusion, the court found that the nature and reason for the exemption did not
support the granting of the exemption in that case.See footnote
Id. at 678. The legislature enacted
the sales and use tax exemption in order to prevent tax pyramiding, i.e., a situation
where a tax is levied upon a tax. Id. (quoting Welsh v. Sells, 244 Ind. 423, 434-35, 192
N.E.2d 753, 759-60 (1963)). See also Rotation Prods., 690 N.E.2d at 798 n.6. In
Mumma Bros., a situation where the "product," i.e., the extracted water, was not resold,
there was no tax pyramiding to prevent. Accordingly, the purposes of the exemption
were not served. In light of this and the fact that a tax exemption is strictly construed,
the court found that "the exemption was [not] meant to apply to the extraction of water
for personal . . . use." Id.
This Court finds the reasoning of Mumma Bros. persuasive. Although the existence or non-existence of tax pyramiding is not dispositive of whether a sales and use tax exemption exists, it is certainly an important factor in determining whether the legislature intended an exemption to apply to a certain activity. See Rotation Prods., 690 N.E.2d at 805. Where something is made, but not sold, the danger of tax pyramiding does not exist. Cf. Appeal of Clayton-Marcus Co., 210 S.E.2d 199, 205 (N.C. 1974) (court should not press definition of manufactured to extreme so as to include persons who do not sell their products).
In this case, the danger of tax pyramiding does not exist. Although the sales and use taxes levied on WREP's purchases of chemicals and other materials increase the cost of its wastewater treatment process, the imposition of those taxes does not result
in a situation where the tax of the sale of a product is increased by previous taxes on
that product's inputs. See Rotation Prods., 690 N.E.2d at 798 n.6. The tax merely
increases WREP's cost of doing business, as all taxes do.
Despite the possibility that the clean water, ash, and sludge created by WREP's waste treatment process may be sold in the future, the fact remains that those byproducts are not sold in the present. Accordingly, they remain the byproducts of a useful service, not goods for the marketplace. See Cave Stone, 457 N.E.2d at 524 (production encompasses all activity directed to increasing the number of scarce economic goods, i.e., goods to be sold in the marketplace). Additionally, the possibility of sales in the future does nothing to demonstrate the existence of tax pyramiding in the present.
It is impossible to conclude that the legislature intended the exemption provisions to apply to the facts of this case.See footnote 5 WREP is in the business of treating wastewater, not producing goods for the marketplace. It is possible to state that in the course of its wastewater treatment process, WREP "produces" clean water, ash, and sludge. However, these are byproducts of the wastewater treatment process, and this is not the type of production the legislature had in mind when enacting the exemption provisions because the "products" of WREP's wastewater treatment process do not satisfy any market, and there is no tax pyramiding to prevent.
In arriving at this conclusion, the Court notes that WREP's waste treatment
process serves a very important public interest. This interest would be promoted by
granting an exemption in this case because the sales and use taxes at issue in this
case make WREP's waste treatment process more expensive. In other words, the
imposition of sales and use taxes increase the cost of this beneficial activity. However,
this court may not grant exemptions simply because it may think that doing so would be
sound public policy. See Rotation Prods., 690 N.E.2d at 798 (court may not grant an
exemption in the absence of statutory authority). Such judgments are left to the
legislature. See Mechanics Laundry, 650 N.E.2d at 1230 n.11; Area Interstate
Trucking, Inc. v. Department of State Revenue, 605 N.E.2d 272, 278 (Ind. Tax Ct.
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