ATTORNEYS FOR PETITIONER:    ATTORNEYS FOR RESPONDENT:
THOMAS F. SCHNELLENBERGER    JEFFREY A. MODISETT
STEPHEN L. HODGE
    ATTORNEY GENERAL OF INDIANA
McHALE, COOK & WELCH    Indianapolis, IN
Indianapolis, IN    
    JEFFREY S. McQUARY
    DEPUTY ATTORNEY GENERAL
    Indianapolis, IN

_____________________________________________________________________

IN THE
INDIANA TAX COURT _____________________________________________________________________

HUDSON FOODS, INC.,                                                   )
                                                                           )
    
                                                                          Petitioner,                                                            )
        
                                                                  
                                                                           )
        
                                                                  
    v.                                                                     )Cause No. 49T10-9711-TA-192
        
                                                                  
                                                                           )
INDIANA DEPARTMENT OF STATE REVENUE,                                       )
                                                                           )
    Respondent.    )    
_____________________________________________________________________

ON APPEAL FROM A FINAL DETERMINATION OF THE
INDIANA DEPARTMENT OF STATE REVENUE
_____________________________________________________________________

October 7, 1999

NOT FOR PUBLICATION

FISHER, J.
    Petitioner, Hudson Foods, Inc. (Hudson), appeals the final determination by Respondent, Indiana Department of State Revenue (Department), denying Hudson's claim for refund of state gross retail (sales) and use taxes for the tax years ending December 31, 1991, 1992 and 1993. In this original tax appeal, Hudson asserts that it is entitled to claim certain manufacturing exemptions for the tax years in question.
FACTS AND PROCEDURAL HISTORY
    Hudson operates a poultry processing facility in Corydon, Indiana. Live chickens are unloaded and brought inside Hudson's plant to be stunned, slaughtered and eviscerated. The poultry first is dropped into a water cooler, chilling it in order to retard bacterial growth. The poultry is then sorted and cut prior to being packaged in sealed plastic bags. The sealed poultry is placed in boxes for shipping to customers. Depending on customers' written specifications, Hudson sometimes places a scoop of dry ice in the boxes with the poultry. The dry ice helps bring down the poultry's temperature to a specific level within a specific time frame. Further, the dry ice prevents bacterial contamination of the poultry, allowing the poultry to maintain a longer “shelf life.” (Trial Tr. at 13).
    Following an audit, the Department issued proposed assessments of deficiencies in Hudson's payment of sales and use taxes. Hudson protested the proposed assessments. On April 10, 1996, the Department conducted an administrative hearing on the protest. On June 24, 1996, the Department issued a Letter of Findings denying Hudson's protest. With a check dated August 5, 1996, in the amount of $2,752.54, Hudson paid the proposed assessment. On April 11, 1997, Hudson filed a claim for refund. On August 20, 1997, the Department issued an order denying the claim for refund. Hudson then filed this original tax appeal. Other facts will be provided where necessary.
ANALYSIS AND OPINION
Standard of Review

    This Court reviews the Department's final determinations de novo and is not bound by the evidence or the issues raised at the administrative level. See Ind. Code Ann. § 6-8.1-9-1(d) (West 1989 & Supp. 1999); see also Hyatt Corp. v. Department of State Revenue, 695 N.E.2d 1051, 1052-53 (Ind. Tax Ct. 1998), review denied.
Discussion
    Indiana imposes an excise tax known as the gross retail tax or sales tax on retail transactions in Indiana. See Ind. Code Ann. § 6-2.5-2-1 (West 1989); see also Hyatt, 695 N.E.2d at 1053. In addition, Indiana imposes a complementary excise tax, the use tax, on tangible personal property stored, used, or consumed in Indiana. See Ind. Code Ann. § 6-2.5-3-2 (West 1989 & Supp. 1999); see also Hyatt, 695 N.E.2d at 1053. The legislature has provided for a variety of exemptions from these complementary taxes. See Ind. Code Ann. §§ 6-2.5-5-5-1 to _38.2 (West 1989 & Supp. 1999); see also Hyatt, 695 N.E.2d at 1053. See footnote
    The Court gives exemptions their plain, ordinary and usual meaning. See Indiana Waste Sys. of Ind., Inc. v. Indiana Dep't of State Revenue, 633 N.E.2d 359, 365 (Ind. Tax Ct. 1994). In cases of ambiguity, exemptions are strictly construed against the taxpayer and in favor of the state. See id. However, the Court's foremost goal is to give effect to the intent of the legislature. See id. The Court will not construe an exemption so narrowly that its proper application is defeated. See id. The taxpayer bears the burden of demonstrating entitlement to an exemption. See Indianapolis Fruit Co. v. Department of State Revenue, 691 N.E.2d 1379, 1383 (Ind. Tax Ct. 1998).
    Hudson contends that its purchases of dry ice during the tax years in question were exempt from the state's sales and use taxes. Hudson cites three exemptions in support of its argument. However, because the Court resolves the present case based upon an analysis of the “consumption exemption,” Ind. Code Ann. § 6-2.5-5-5.1 (West 1989 & Supp. 1999), the remaining two issues raised by Hudson will not be addressed. See footnote Section 6-2.5-5-5.1 provides in 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 . . . processing . . . .” According to the Department's regulations, “Direct consumption in the production process . . . ends at the point that the production process has altered the item to its completed form, including packaging, if required.” Ind. Admin. Code tit. 45, r. 2.2-5-12(d)(1) (1996).
    The issue before the Court is whether Hudson directly consumes the dry ice as part of its production process. See footnote In its Letter of Findings, the Department asserted that, because “the dry ice is used by the taxpayer in a post-production activity, the purchase of the dry ice is subject to [the sales and use taxes].” In its post-trial brief, the Department reasserts this claim. The Department argues that, because the dry ice is used after the poultry has been sealed in plastic bags, application of the dry ice is a post-production activity. (Resp't Br. at 4-6).
    In defining the scope of Hudson's production process, the Court must bear in mind the following principles. First, by exempting materials consumed in the production of “other tangible property,” the legislature has two purposes: (1) encouragement of industrial growth by allowing an exemption for items closely connected with the production of goods; and (2) limitation of the effect of tax pyramiding, “a situation where a tax is levied upon a tax.” Rotation Prods. Corp. v. Department of State Revenue, 690 N.E.2d 795, 798 (Ind. Tax Ct. 1998). Second, “production,” for the purpose of applying the consumption exemption, is defined broadly and focuses on the creation of a marketable good. See White River Envtl. Partnership v. Department of State Revenue, 694 N.E.2d 1248, 1251 (Ind. Tax Ct. 1998) (quoting Indianapolis Fruit Co. v. Department of State Revenue, 694 N.E.2d 1379, 1383 (Ind. Tax Ct. 1998); see also Mid-America Energy Resources v. Department of Revenue, 681 N.E.2d 259, 263 (Ind. Tax Ct. 1997) (holding that taxpayer's operation, the chilling and distribution of water for use in air conditioning for Indianapolis downtown businesses, constitutes direct production of other tangible personal property because it “creates a new and marketable good”), review denied.
    To determine whether a particular activity constitutes production, the Court examines whether a taxpayer's product satisfies any market. Two cases illustrate this point. In White River Environmental Partnership v. Department of State Revenue, 694 N.E.2d 1248, 1252 (Ind. Tax Ct. 1998), this Court determined that the legislature had not intended to apply the consumption exemption to the taxpayer's production process. The taxpayer, which operated a wastewater treatment facility, claimed an exemption for the sales and use taxes it paid on chemicals and materials consumed during its treatment process. The Court concluded that byproducts generated by the treatment process_clean water, ash and sludge_were not part of a production process “because the 'products' of [the taxpayer's] treatment process do not satisfy any market . . . .” Id.
    The Court reached a different result in Harlan Sprague Dawley, Inc. v. Indiana Department of Revenue, 605 N.E.2d 1222 (Ind. Tax 1992). In Harlan Sprague, the Court found that the taxpayer's breeding of laboratory rats constituted production for purposes of the industrial exemptions. See footnote See id. at 1229-30. In reaching its conclusion, the Court reasoned that the taxpayer's operation “propagates laboratory rats, producing scarce economic goods for human use and encouraging various industrial activities.” Id. at 1230.
    In addition to ascertaining whether a taxpayer's product satisfies any market, the Court examines whether taxation of particular transactions results in tax pyramiding. As the Court explained in Rotation Products, 690 N.E.2d at 798 n.6 (internal citations omitted):
    Tax pyramiding in the sales and use context occurs where the inputs (raw materials, machinery, energy, etc.) into the production of other goods are taxed. When the other goods are sold, part of their price reflects the tax on the inputs. That part of the price reflecting the tax on the inputs is taxed again when the other goods are sold. This was the evil the legislature intended to limit when it enacted the gross retail tax and the industrial exemptions.
Both the White River and Harlan Sprague opinions also considered the effects of tax pyramiding. In White River, the taxpayer's “products” were the byproducts of wastewater treatment. The taxpayer did not sell the byproducts; instead, “solids” were either incinerated or taken to landfills and the disinfected water was discharged back into the White River. The Court first observed that the existence or non-existence of tax pyramiding, while not dispositive of the issue, is “certainly an important factor in determining whether the legislature intended an exemption to apply to a certain activity.” Id. Next, the Court found that no tax pyramiding was present, reasoning that “[w]here something is made, but not sold, the danger of tax pyramiding does not exist.” White River, 694 N.E.2d at 1252. Ultimately, the Court found that the legislature did not intend for the consumption exemption to apply under the circumstances.
    In contrast, the Court in Harlan Sprague concluded that the consumption exemption was available to the taxpayer. See Harlan Sprague, 605 N.E.2d at 1230. The Court observed that, if the taxpayer's inputs were taxed, the taxpayer would likely pass along the added costs to its customers. See id. at 1228. As a result, part of the sales tax assessed on the product's final purchase would be “a tax upon a tax_tax pyramiding.” Id. Finding that the taxpayer in Harlan Sprague was entitled to the consumption exemption, the Court noted that the taxpayer used several different types of inputs that would be subject to the sales and use taxes if not exempted. See id. at 1230.
    The cited cases focused on whether production existed, not on whether a particular activity took place during or after production. For purposes of deciding whether a particular activity is exempt, the practical effect of finding no production is the same as finding that the particular activity took place beyond the scope of a taxpayer's production process. In either case, the consumption exemption would not apply to the activity in question. Thus, the same principles previously explained may be applied in determining whether a particular activity is part of a taxpayer's production process and qualifies for the consumption exemption. In the present case, the Court must determine whether the particular activity in dispute, i.e., applying a scoop of dry ice to the sealed poultry after it has been placed in a box for shipment to customers, is an exempt activity within Hudson's production process.
    Packaging activities can be part of a production process. See General Motors Corp. v. Indiana Dep't of State Revenue, 578 N.E.2d 399, 405 (Ind. Tax Ct. 1991) (finding equipment exemptions for sales and use taxes applied to packing material used to ship component parts manufactured in-state to out-of-state assembly plants), aff'd, 599 N.E.2d 588 (Ind. 1992). Indeed, the Department's own regulations recognize this. See Ind. Admin. Code tit. 45, r. 2.2-5-12(d)(1) (1996) (consumption within production process ends at point that item is altered to its completed form, “including packaging, if required”). However, production steps must precede the packaging. See Indianapolis Fruit, 691 N.E.2d at 1386 (finding that tomato ripening did not constitute production and that, without production, taxpayer was not entitled to exemptions with regard to packaging of tomatoes); see also Mechanics Laundry & Supply, Inc. v. Indiana Dep't of State Revenue, 650 N.E.2d 1223, 1231 (Ind. Tax Ct. 1995) (concluding that laundering of soiled textiles did not constitute production of goods and, therefore, taxpayer was not entitled to consumption exemption for such activity); Faris Mailing, Inc. v. Indiana Dep't of State Revenue, 512 N.E.2d 480, 483 (Ind. Tax Ct. 1987) (determining that no new product was made so consumption exemption did not apply where taxpayer merely assembled customers' items for mailing into packages). Moreover, the packaging must be an integral and essential part of an integrated production process. See Indiana Dep't of State Revenue v. Cave Stone, Inc., 457 N.E.2d 520, 524 (Ind. 1983) (deeming transportation equipment exempt, where it was integral and essential to processing of stone).
    This Court's opinion in Indianapolis Fruit Company v. Department of State Revenue, 691 N.E.2d 1379 (Ind. Tax 1998) provides guidance for resolving this case. The taxpayer in Indianapolis Fruit was a wholesale supplier of fruits and vegetables and claimed exemptions contained in Ind. Code Ann. § 6-2.5-5-1 to _3 (West 1989 & Supp. 1999) for its banana and tomato ripening equipment. See footnote The issue was whether the taxpayer's ripening activities constituted production. With respect to ripening of the bananas, the Court found that production took place. See Indianapolis Fruit, 691 N.E.2d at 1385. In so concluding, the Court observed: “[The bananas] have been transformed both physically and chemically, and this transformation makes a marketable banana from an unmarketable one. Indianapolis Fruit's banana ripening process activity induced this transformation by exposing the bananas to ethylene gas. This is sufficient to constitute production.” Id.
    However, with respect to the ripening and packaging of the tomatoes, the Court found that production did not occur. See id. The Court reached this decision upon concluding that Indianapolis Fruit did nothing to trigger the substantial physical and chemical change undergone by the tomatoes. See footnote See id. Specifically, “[Indianapolis Fruit] passively awaited the ripening of the tomatoes. The ripening was not actively induced by Indianapolis Fruit and was merely incidental to the proper storage of the tomatoes.” See id. at 1385-86. According to this Court, the “critical distinction” between the banana and tomato ripening processes was that Indianapolis Fruit had not “triggered” the latter. Id. at 1386. In other words, Indianapolis Fruit “made something happen” with the bananas and “let” something happen with the tomatoes. Id. (emphasis in original). The Court further noted that Indianapolis Fruit's tomato packaging activities did not constitute production. See id. The packaging did not change the form, composition or character of the tomatoes. See id. (quoting Ind. Admin. Code tit. 45, r. 2.2-5-8(k) (1996)). Also, “[b]ecause there is no production preceding the tomato packaging, the packaging is not an integral and essential part of an integrated production process.” See id.
    Hudson's use of dry ice qualifies for the consumption exemption. Use of the dry ice by Hudson is similar to the taxpayer's use of ethylene gas in Indianapolis Fruit. In Indianapolis Fruit, the taxpayer's use of ethylene gas triggered the ripening of bananas into a marketable product. In the present case, Hudson's use of dry ice triggers a drop in temperature of the poultry, allowing the poultry to become a marketable product prior to its shipment to customers. In both Indianapolis Fruit and in the present case, the taxpayers took active roles in facilitating the physical transformation of unfinished goods into marketable consumer products; Hudson does not passively stand by as the poultry naturally chills down to the target temperature. In fact, if Hudson refused or neglected to lower the poultry's temperature with the dry ice per its customers' specifications, customers would likely not continue ordering Hudson's poultry products. See footnote Therefore, in those instances where customers require Hudson to ship the poultry with dry ice, application of the dry ice constitutes an integral and essential part of Hudson's production process. Moreover, application of the consumption exemption to Hudson's dry ice purchases would be consistent with legislative intent. It would promote industrial growth by decreasing the cost of producing frozen chickens. Also, without benefit of the exemption, Hudson would likely pass along the extra costs of doing business to its customers, resulting in the recognized evil of tax pyramiding.
    Furthermore, the Court's interpretation of the consumption exemption is consistent with Ind. Admin. Code tit. 45, r. 2.2-5-12(d)(1) (1996), which states that, “Direct consumption in the production process . . . ends at the point that the production process has altered the item to its completed form, including packaging, if required.” As with a statute, a court will give words within a regulation their plain, ordinary and usual meaning unless otherwise intended by the legislature. See GTE North Inc. v. State Bd. of Tax Commr's, 634 N.E.2d 882, 890 (Ind. Tax Ct. 1995) (quoting Kenny Kent Chevrolet Co. v. Indiana Dep't of State Revenue, 627 N.E.2d. 890, 893 (Ind. Tax Ct. 1994)). “Completed” means “Finished; nothing substantial remaining to be done; state of a thing that has been created, erected, constructed or done substantially according to contract.” Black's Law Dictionary 196 (6th ed. abr. 1991). The poultry processed by Hudson does not reach its marketable state until after its temperature has been brought down to a specified level by application of the dry ice. Hudson's customers require the company to use the dry ice in packing the poultry. Thus, the poultry does not reach its “completed form” until after application of the dry ice.     
    The Court will not draw a bright line as to when production begins and when it ends. In the present matter, the Court finds that production does not end when the poultry is sealed into plastic bags. Instead, production, for purposes of applying the consumption exemption, ends once dry ice has been applied to further chill the poultry. For the foregoing reasons, the Court concludes that the consumption exemption applied to Hudson's purchases of dry ice during the tax years in dispute.
CONCLUSION
    The Department's order denying Hudson's claim of refund is hereby REVERSED and the Department is ORDERED to reimburse Hudson for sales and use taxes paid by Hudson for its purchases of dry ice during the tax years ending December 31, 1991, 1992 and 1993.


Footnote: Ind. Code Ann. § 6-2.5-3-4 (West 1989) exempts from the use tax property “acquired in a transaction that is wholly or partially exempt from the state gross retail tax under any part of IC 6-2.5-5, except IC 6-2.5-5-24(b), and the property is being used, stored, or consumed for the purpose for which it was exempted.” Thus, the enumerated exemptions (except for section 6-2.5-5-24-(b)) apply equally to the gross retail (sales) and use taxes.

Footnote: Hudson claims that its purchases of dry ice were also exempt from the state's sales and use taxes under the following two provisions: (1) the “component part exemption,” Ind. Code Ann. § 6-2.5-5-6 (West 1989 & Supp. 1999); and (2) the “wrapping material exemption,” Ind. Code Ann. § 6-2.5-5-9(d) (West 1989).

Footnote: Whether Hudson consumes the dry ice is not at issue in this case. It clearly does. The dry ice cannot be used again once it has been used to cool poultry shipped in a particular box. (Trial Tr. at 15-16); see also Ind. Admin. Code tit. 45, r. 2.2-5-12(g) (1996) (defining “consumed” as “the dissipation or expenditure by combustion, use, or application . . . .). Moreover, the parties stipulated that Hudson “purchases, uses and consumes dry ice.” (Stipulation of Evidence, ¶ 12).

Footnote: The term “industrial exemptions” collectively referred to the following: (1) the “equipment exemption,” Ind. Code Ann. § 6-2.5-5-3 (West 1989 & Supp. 1999); (2) the “consumption exemption,” Ind. Code Ann. § 6-2.5-5-5.1 (West 1989 & Supp. 1999); and (3) the “incorporation exemption,” Ind. Code Ann. § 6-2.5-5-6 (West 1989 & Supp. 1999).
Footnote: Sections 6-2.5-5-1 & -2 exempt tangible personal property used in agricultural production, while section 6-2.5-5-3 (the equipment exemption) exempts manufacturing machinery, tools and equipment used to produce other tangible personal property. In analyzing the agricultural and equipment exemptions together, the Court noted that, “Production does not have different meanings under different exemption provisions.” Indianapolis Fruit, 691 N.E.2d at 1383. Thus, the Court's analysis of these sections may be applied in deciding the scope of Hudson's production in the present case.

Footnote: Indianapolis Fruit did not generally apply ethylene gas to the tomatoes, as it did with the bananas, to induce ripening.
Footnote: This point is illustrated by the testimony of Mr. Charles Boyer, a Hudson employee familiar with the taxpayer's production process, who agreed that, without application of the dry ice, the poultry would not be “saleable” to customers who specifically required use of the dry ice. (Trial Tr. at 16).





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