NOTICE: IC § 4-22-7-7 permits the publication of this document in the Indiana Register. The publication of this document provides the general public with information about the Indiana Department of Revenue's official position concerning a specific set of facts and issues. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Supplemental Letter of Findings.

Business was able to establish that some items previously determined to be subject to sales and use taxes were actually exempt purchases. Therefore, the Department's calculations of use tax due from and refund due to Business will be recalculated. Both Business' refund claim and the assessments will be adjusted.

I. Sales and Use Tax–Exempt Purchases.

Authority: IC § 6-2.5-2-1; IC § 6-2.5-3-2; IC § 6-2.5-5-40; IC § 6-8.1-5-1; IC § 6-8.1-5-2; IC § 6-8.1-5-3; Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007); Aztec Partners, LLC v. Indiana Dept. of State Revenue, 35 N.E.3d 320 (Ind. Tax 2015); 45 IAC 2.2-3-4; 45 IAC 2.2-4-26; 45 IAC 2.2-5-8; 45 IAC 2.2-5-9; 45 IAC 2.2-5-14; Blacks Law Dictionary (10th ed. 2014); Sales Tax Information Bulletin 2 (March 2013) 20130327 Ind. Reg. 045130126NRA; LOF 04-20170916.

Taxpayer protests the Department's calculation of sales and use taxes refunded and use tax due.

II. Tax Administration–Penalty.

Authority: IC § 6-8.1-10-2.1; 45 IAC 15-11-2.

Taxpayer protests the imposition of the negligence penalty.

Taxpayer is an out-of-state business with Indiana operations. Taxpayer filed a claim for refund covering the tax year 2011. After reviewing the refund claim, the Indiana Department of Revenue ("Department") conducted a refund investigation of 2011 and an assessment investigation of 2012, and 2013. The Department determined that Taxpayer had made taxable purchases of tangible personal property ("TPP") during these years without paying sales tax or use tax on those purchases. The statute of limitations for assessing tax for 2011 had expired by the time of the investigation and so the results of the Department's investigation were applied to offset the claimed refund for 2011. For 2012 and 2013, the results of the investigation were applied to calculate proposed assessments of use tax. Due to the large number of transactions, the Department used a sample and projection methodology to calculate Taxpayer's use tax compliance rate for refund purposes and another sample and projection calculation for assessment purposes. Capital asset purchases were reviewed separately and as a whole, without sampling. The Department then applied the compliance rates to Taxpayer's total purchases, while deducting the amount of use tax already remitted by Taxpayer for those years. The Department therefore reduced the amount of refund for 2011 and issued proposed assessments for use tax, penalties, and interest for 2012 and 2013. Taxpayer protested that some of the TPP purchases considered taxable by the Department were actually exempt and that the Department had under-calculated the refund for 2011 and had over-calculated the amount of use tax due for 2012 and 2013.

An administrative hearing was held and the Department issued a Letter of Findings ("LOF 04-20170916") sustaining Taxpayer's protest in part and denying Taxpayer's protest in part. Taxpayer filed a request for rehearing arguing that several items ruled as taxable in LOF 04-20170916 were exempt. Taxpayer provided additional documentation and analysis in support of the rehearing request. The Department granted the request and an administrative rehearing was held. This Supplemental Letter of Findings results. Since Taxpayer's protest was partially sustained in LOF 04-20170916, this Supplemental Letter of Findings will not discuss those items already found to be exempt. Rather, this Supplemental Letter of Findings will only discuss protested items found to be taxable in LOF 04-20170916. Further facts will be supplied as required.

I. Sales and Use Tax–Exempt Purchases.

Taxpayer protests that the Department erred in its investigation and in LOF 04-20170916 when it determined that several categories of TPP which Taxpayer purchased in the years 2011-13 were subject to sales and use taxes. The Department considered that the TPP was not used in any exempt manner and therefore sales tax should have been paid at the time of purchase or use tax should have been remitted if sales tax was not paid at the time of purchase. Taxpayer argues that many of the items of TPP which the Department considered taxable were actually eligible for one or more exemptions from sales tax and use tax. In the course of the rehearing process, Taxpayer reiterated its original position regarding these purchases and also provided further analysis and supporting documentation of how the TPP was used.

As a threshold issue, it is the Taxpayer's responsibility to establish that the existing tax assessment is incorrect. As stated in IC § 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the department's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made." Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007). Consequently, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Further, "[w]hen [courts] examine a statute that an agency is 'charged with enforcing. . .[courts] defer to the agency's reasonable interpretation of [the] statute even over an equally reasonable interpretation by another party.'" Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014). Thus, all interpretations of Indiana tax law contained within this decision, as well as the preceding audit, shall be entitled to deference.

Sales tax is imposed by IC § 6-2.5-2-1, which states:

Use tax is imposed by IC § 6-2.5-3-2(a), which states:

Also, 45 IAC 2.2-3-4 provides:

Therefore, when tangible personal property is used, stored, or consumed in Indiana, use tax is due unless sales tax was paid at the time of the transaction or unless the transaction is exempt from taxation in some manner.

One exemption is found under IC § 6-2.5-5-3(b), which states:

Also, 45 IAC 2.2-5-8(h) states:

Taxpayer's first point of protest is that, while the Department sustained Taxpayer's protest that welders were exempt production machinery, the Department did not sustain Taxpayer's protest that wire feeders and repair parts for wire feeders were exempt. In the course of the rehearing process, Taxpayer was able to provide additional documentation and analysis in support of its position that the wire feeders and repair parts qualified for the exemption provided by IC § 6-2.5-5-3(b).

The Indiana Tax Court stated in Aztec Partners, LLC v. Indiana Dept. of State Revenue, 35 N.E.3d 320 (Ind. Tax 2015):

Also, Blacks Law Dictionary (10th ed. 2014) provides:

The Department considered that the wire feeders actually served as storage devices for the wire until pulled out for use in the welders. As a result of the protest process, Taxpayer has established that when placed in the wire feeders, the wire had not been put away for future use, as "storage" is defined in Blacks. Rather, the wire feeders worked in conjunction with the welders in an integrated production process. The fact that the wire feeders did not directly have a transformational effect on Taxpayer's products is not determinative, as provided by the court in Aztec Partners. Therefore, the wire feeders did qualify as production equipment and were exempt from tax, as provided by IC § 6-2.5-5-3(b). Also, repair parts for exempt equipment are exempt as provided by 45 IAC 2.2-5-8(h). Taxpayer has met the burden imposed under IC § 6-8.1-5-1(c) of proving this portion of the proposed assessments wrong.

Taxpayer's next point of protest is in regard to other machinery which Taxpayer states is used in the direct production of its product. The other machinery was listed as: chillers, slag pans, Fronius plasma cutters, CD & PD drive controls for benders, control panels for production machinery, & equipment, software to operate production machinery & equipment, weld mandrel and flanger lines, turntables, robotic welders with pedestals added, de-stackers, laser etchers, spin form machines, trim machines, Weil tube former machines, other machinery and equipment, and repair parts for the aforementioned TPP. Using the same analysis as discussed above for the wire feeders under IC § 6-2.5-5-3(b) in LOF 04-20170916, the Department was not convinced that Taxpayer had established that the various pieces of machinery were used in an exempt manner.

Further, 45 IAC 2.2-5-8 provides in relevant parts:

After review of the analysis and supporting documentation (including written descriptions, photographs, and video of these items in operation) provided in the hearing and rehearing process, the Department now agrees with Taxpayer's protest that most of the pieces of TPP listed above qualify for the manufacturing exemption listed under IC § 6-2.5-5-3(b) and 45 IAC 2.2-5-8. The only categories listed above with which the Department does not agree are exempt are the slag pans, the "other machinery and equipment," and the spare/replacement parts for those two categories.

The Department notes that the slag pans, while physically attached to the exempt welding machines, are separately-purchased TPP and do not directly contribute to Taxpayer's direct production of its product. As provided by 45 IAC 2.2-5-8(k), "Direct production, manufacture, fabrication, assembly, or finishing of tangible personal property" is performance as a business of an integrated series of operations which places TPP in a form, composition, or character different from that in which it was acquired. The slag pans catch excess material from the welding process, but are not integrated into Taxpayer's series of operations which places TPP in a different form, composition, or character than that in which it was acquired. Therefore, the slag pans are taxable.

With regard to the "other machinery and equipment," the Department is not convinced that this area is specific enough to determine how the TPP is used. Without confirmation of the nature of the TPP and its use, the Department cannot agree that it qualifies for the exemption listed under IC § 6-2.5-5-3(b) and 45 IAC 2.2-5-8. Therefore, these items will be considered subject to sales and use tax as determined in the audit and in LOF 04-20170916.

Taxpayer's next point of protest concerns TPP it claims was used for safety purposes. The relevant exemption is found at 45 IAC 2.2-5-8(c), which states in relevant part(s):

In LOF 04-20170916, the Department sustained Taxpayer's protest regarding some of the claimed safety equipment. However, LOF 04-20170916 denied Taxpayer's protest regarding the two categories of "fencing" and "guarding" which Taxpayer claimed were exempt as safety equipment. The Department determined that Taxpayer had not established that all of the TPP listed in these categories were required to allow a worker to participate in the production process without injury or to prevent contamination of the product during production, as provided by 45 IAC 2.2-5-8(c). After review of the analysis and supporting documentation provided in the hearing and rehearing process, the Department agrees with Taxpayer's protest regarding the fencing and guarding TPP. The items reviewed in the rehearing process served no other purpose than to prevent injury to Taxpayer's workers in the course of producing Taxpayer's product. Therefore, the Department now agrees that the fencing and guarding TPP was used in an exempt manner as provided by 45 IAC 2.2-5-8(c).

Taxpayer's next point of protest concerns material handling equipment. Taxpayer protests that the various items of TPP, such as conveyors, racks, cranes, de-stackers, and certain tables used in a continuous production process, qualify for the exemption found at 45 IAC 2.2-5-8(d), which provides:

The Department's investigation and LOF 04-20170916 both determined that Taxpayer had not provided sufficient documentation and analysis of the use of these pieces of TPP to establish that they were used in an exempt manner. In the course of the rehearing process, Taxpayer was able to provide additional analysis and documentation to establish that the TPP in question was used in an integrated production process to either transport or temporarily store work-in-process. Therefore, the material handling equipment under protest qualifies for the exemption provided under 45 IAC 2.2-5-8(d).

Taxpayer's next point of protest concerns plastic containers, knock-down totes, blue totes, shelving, and heavy duty totes. Taxpayer protests that these categories of TPP were used to temporarily store, transport, or handle work-in-process. Such use, Taxpayer argues, qualifies for the exemption found under IC § 6-2.5-5-3(b) and 45 IAC 2.2-5-8. Further, Taxpayer states that it agrees that the TPP in question is not exclusively used in an exempt manner. Taxpayer provided documentation and analysis supporting its position that the TPP found under these categories were used fifty percent of the time in an exempt manner. After review of the documentation and analysis provided in the rehearing process, the Department agrees that these purchases qualify as fifty percent exempt.

Taxpayer's next point of protest concerns forklifts. The Department determined that Taxpayer used its forklifts in a fifty-five percent taxable manner and forty-five percent exempt manner. In the course of the hearing and rehearing process, Taxpayer provided a forklift usage study in which Taxpayer determined that its forklifts were used in a 65.26 percent exempt manner. 45 IAC 2.2-5-8(f) provides in relevant part:

Therefore, when forklifts are used for both taxable and non-taxable purposes, forklifts may be partially taxable and partially non-taxable. In the instant case, Taxpayer's forklift study has addressed the Department's initial concerns regarding some uses of the forklifts and the Department now accepts that the forklifts and forklift-associated purchases are used in a 65.26 percent non-taxable manner.

Taxpayer's next protest point is in regard to strapping equipment. LOF 04-20170916 had previously sustained Taxpayer's protest regarding poly strapping materials, but not on the strapping equipment, as provided by 45 IAC 2.2-5-8(d) and 45 IAC 2.2-5-9(d). Taxpayer states that some of the strapping was used to move unfinished parts mid-production and that the strapping machines were therefore used as part of the integrated production process. However, in LOF 04-20170916 the Department explained that it did not agree that the strapping machinery qualified as production machinery since it did not have an immediate effect upon the article being produced, as required under 45 IAC 2.2-5-8(g). Also, the shipping materials exemption found under 45 IAC 2.2-5-9(d) specifically applies to materials used in shipping and not to the machinery used in wrapping, strapping, or otherwise preparing for shipping. In the course of the rehearing process, the Department reviewed all materials provided in support of Taxpayer's position. The Department is not convinced that the documentation supports Taxpayer's protest on this point. Therefore, the strapping machinery is taxable.

Taxpayer's next protest point is in regard to labels and label makers. In the course of the rehearing process, Taxpayer provided documentation and analysis to support its position that it prints and applies labels to various items throughout its production process and that ten percent of those labels are attached to its product as part of the final product for use by consumers. Taxpayer therefore believes that the labels and label makers should qualify for a ten percent exemption rate. The relevant regulation is 45 IAC 2.2-5-14(d), which states:

After review of the analysis and documentation provided in the rehearing process, the Department agrees that ten percent of the labels are used in an exempt manner as provided under 45 IAC 2.2-5-14(d). Therefore, Taxpayer's purchases of labels and label makers, plus related costs such as ink, ribbons, etc., for the label makers are ten percent exempt and ninety percent taxable.

Taxpayer's next protest point is in regard to research and development ("R&D") TPP. Taxpayer states that it conducted R&D activities in which it used TPP. The relevant statute is IC § 6-2.5-5-40, which states:

Therefore, IC § 6-2.5-5-40 provides that purchases were exempt from sales and use taxes if specific conditions were met. The Department notes that IC § 6-2.5-5-40 was amended effective July 1, 2013, to reflect that TPP at issue for the R&D exemption no longer needed to have a useful life of less than one year. LOF 04-20170916 denied Taxpayer's protest on the basis that Taxpayer had not established that its activities qualified for the R&D exemption provided under IC § 6-2.5-5-40. In the course of the rehearing process, Taxpayer provided additional documentation and analysis in support of its claim. After review of these materials, the Department agrees with Taxpayer's protest regarding TPP listed as eligible for the R&D exemption, as provided under both versions of IC § 6-2.5-5-40 in effect during the audit period.

Taxpayer's next point of protest is in regard to testing equipment. Taxpayer states that it purchased TPP such as camera systems, tensile testers, torque testers, and other machinery and equipment used to test its products. The relevant regulation is 45 IAC 2.2-5-8(i), which states:

LOF 04-20170916 denied Taxpayer's protest on this point on the basis that it was not possible to tell if the camera systems, tensile testers, torque testers were used in an integrated production process. In the course of the rehearing process, Taxpayer provided additional documentation and analysis in support of its protest. After review of these materials, Taxpayer was able to establish that the TPP in question was used as part of Taxpayer's quality control in the production process. Therefore, the Department agrees that the camera systems, tensile testers, torque testers were used as part of an integrated production process and therefore qualified for the exemption described under 45 IAC 2.2-5-8(i). Regarding the other machinery and equipment listed under this protest category, the Department remains unconvinced that the documentation and analysis establishes the exempt nature of this portion of the TPP under protest.

Taxpayer's next point of protest is in regard to the statute of limitations for imposing an assessment. Taxpayer argues that the Department was not allowed to make a determination of the taxable status of several purchases which took place in 2010, but which were capitalized in 2011, which was the year of the refund claim. The Department determined that the purchases were taxable and offset the refund claim by the corresponding amount of tax for those transactions. IC § 6-8.1-5-2(a) states:

LOF 04-20170916 determined that the offset of refund did not constitute an assessment of tax and denied the protest. In the course of the rehearing process, Taxpayer did not present new documentation or analysis regarding this issue. After reviewing the previously presented arguments and documentation, the Department does not change its decision. Offsetting a tax refund claim is not the same thing as assessing tax, therefore the three year statute of limitations established under IC § 6-8.1-5-2(a) does not apply here.

Taxpayer's next point of protest is in regard to electrical work done as an improvement to realty by a contractor under a lump-sum agreement. The Department offset the refund claim for 2011 by the amount of two such transactions. LOF 04-20170916 sustained Taxpayer's protest on one such transaction, determining that Taxpayer had met the requirements of IC § 6-2.5-3-2, which states:

Also, 45 IAC 2.2-4-26(a) states:

However, the Department denied Taxpayer's protest regarding a second such transaction. The Department determined that the contractor's own description of the transaction did not support Taxpayer's argument that the exemption applies to the second transaction. In the course of the rehearing process, the Department reviewed the documentation and analysis and now reaches the same conclusion as it did in LOF 04-20170916 regarding the second transaction. Taxpayer also states that the Department was barred from making such an adjustment by the three year statute of limitations found under IC § 6-8.1-5-2(a). As discussed above, IC § 6-8.1-5-2(a) does not apply to refund offsets.

Taxpayer's final point of protest is in regard to maintenance contracts. Taxpayer protests that the Department imposed use tax denied refund of sales and use taxes on the purchase of maintenance agreements which were for consultation only, with no provision for the transfer of TPP. Sales Tax Information Bulletin 2 (March 2013) 20130327 Ind. Reg. 045130126NRA provides:

In the instant case, Taxpayer provided documentation and analysis that establishes that the maintenance agreements in question was for consultation only. Since no transfer of TPP would occur under the agreements, no sales or use tax is due as explained in Sales Tax Information Bulletin 2.

In conclusion, Taxpayer is sustained in part or in whole on its protest of several categories as provided above. Also, Taxpayer was sustained on several categories in LOF 04-20170916, subject to audit verification. Therefore, the Department will reclassify these transactions upon which Taxpayer has been sustained as non-taxable, for both capital and expensed purchases, and will recalculate Taxpayer's compliance rates for both the claimed refund and for assessments. The Department will then apply the recalculated compliance rates and its calculations regarding capital purchases and will recalculate the amount of refund due for 2011 and the amount of the assessments for 2012 and 2013.

Taxpayer's protest is sustained in part and denied in part, as provided above.

II. Tax Administration–Penalty.

Taxpayer requested that the Department abate the negligence penalty imposed regarding the assessments of use tax for 2012 and 2013. Pursuant to IC § 6-8.1-10-2.1(a), the Department may assess a negligence penalty if the taxpayer:

The Department may waive a negligence penalty when a taxpayer establishes that its failure to pay a tax was due to reasonable cause and not due to negligence. 45 IAC 15-11-2(c). The taxpayer must demonstrate that it exercised ordinary business care in carrying out or failing to carry out a duty giving rise to the penalty. Reasonable cause is fact sensitive and will vary based on the facts of each individual case.

In this instance, Taxpayer has been sustained in part and denied in part regarding the amount of base tax due, as provided in Issue I above. Since Taxpayer will still owe a significant amount of use tax based on several areas of the purchase of TPP, the Department cannot agree that Taxpayer has demonstrated that it exercised ordinary business care in carrying out its tax duties, as required by 45 IAC 15-11-2(c). Therefore, penalty will not be waived. However, since the base tax will be reduced, as provided in Issue I above, penalty will be recalculated to reflect that reduced amount of use tax due.

Taxpayer's protest of the negligence penalty is denied.

Taxpayer is sustained in part and denied in part on Issue I regarding the imposition of use tax. Taxpayer is denied on Issue II regarding the imposition of penalty.

October 16, 2018.