Illinois Courts Consistently Enforce Manufacturing Exemption Despite Department of Revenue Opposition

By on October 14, 2014
Posted In Illinois, Sales Tax

Illinois courts have issued three taxpayer-friendly manufacturing rulings in 2013 and 2014, underscoring the breadth of the exemption from use tax afforded to equipment and chemicals used in the process of manufacturing.

Cook County Circuit Court Holds Chemicals Effectuate a “Direct and Immediate” Change on a Product Being Manufactured and Thus are Tax-exempt

Most recently, in in PPG Industries, Inc. v. Illinois Dep’t of Revenue, No. 13 L 050140 (Cir. Ct. of Cook County, Ill. Sept. 9, 2014), the Circuit Court of Cook County, Illinois, reversed an administrative determination denying PPG a refund of use tax paid on its purchase of chemicals used in a manufacturing process, on the basis that the chemicals effectuated a “direct and immediate change” on the glass that was being manufactured.  The exemption at issue exempts from tax “chemicals or chemicals acting as catalysts but only if the chemicals or chemicals acting as catalysts effect a direct and immediate change upon a product being manufactured or assembled for sale or lease.”  86 Ill. Admin. Code § 130.330(c)(6); see 35 ILCS 105/3-50(4) (exempt “equipment” includes same).

The Circuit Court opinion found that the Administrative Law Judge’s opinion was clearly erroneous under the facts as presented at the hearing.  The Court rejected the ALJ’s finding that in order to be found to have a “direct and immediate” change on a product being manufactured, there must be a chemical reaction between the chemical for which the tax exemption is sought and the product being manufactured.  The Court determined that the glass being manufactured underwent “an observable direct and immediate physical change as a result of” the chemicals at issue, finding that nothing in the exemption requires that the direct and immediate change relate to a chemical change and not a physical one.  Additionally, the Court characterized a “direct” change as one in which after the chemicals at issue are added to the manufacturing process, “no additional steps or agencies in the manufacturing process intervene or are required to effect vital changes” on the product being manufactured.  It remains to be seen whether the Illinois Department of Review (Department) will appeal the decision.

Illinois Appellate Court Finds Gas Leasing Corporation Owes No Tax on Hazmat Fees or Cryogenic Systems 

On September 5, 2013, the Illinois Appellate Court issued a ruling in favor of ILMO Products Co. (ILMO), holding that ILMO did not owe Retailers’ Occupation Tax on the hazmat fees it charged in connection with its rentals of high pressure gas cylinders because the fees were part of a nontaxable rental and were not a taxable sale of gas.  ILMO Prods. Co. v. Ill. Dep’t of Revenue, 2013 IL App (4th) 120973-U (Sept. 5, 2013).  The Appellate Court also held that ILMO did not owe use tax on its purchase of cryogenic systems because the systems primarily were used as part of a manufacturing process.

The Appellate Court resolved the hazmat fee issue based on the parties’ pre-trial stipulations that the hazmat fee was a fee on a (non-taxable) rental collected to pay costs related to compliance with hazmat laws and regulations.  The court found the stipulation binding, and it rejected the Department’s argument that ILMO was required to produce evidence to confirm the truth of the stipulation.

The Appellate Court found that the cryogenic systems, which were used by ILMO and its customers to convert liquefied gas to a gaseous state, were exempt from use tax because they were primarily used in a manufacturing process.  The decision recognizes that an integrated manufacturing process can take place at more than one location and involve more than one manufacturer.  There is strong support for this conclusion in the statutory definition of “manufacturing process,” which extends to “a recognized integrated business composed of a series of operations that collectively constitute manufacturing, or individually constitute manufacturing operations,” and which “commences with the first operation or stage of production in the series and does not end until the completion of the final product in the last operation or stage of production in the series.  35 ILCS 105/3-50 (emphasis added).

Peoria Circuit Court Determines That Machinery and Equipment Used in Quality Inspection Qualifies for Manufacturing and Hand Tool Exemptions

Finally, in August 2013, the Circuit Court of Peoria County, Illinois, issued a verdict in favor of Supply Chain Services, LLC (SCSI) in a dispute with the Department regarding whether the equipment that SCSI used to perform quality inspection at Caterpillar’s Mossville, Illinois engine plant was part of a manufacturing process.  On audit, the Department denied SCSI’s claim for the machinery and equipment exemption.  The Department claimed that the inspection equipment was used in a “preproduction” area before the manufacturing process had started.

At trial, the court found that SCSI’s inspection of the incoming machined components was part of Caterpillar’s integrated manufacturing process.  The Court concluded that SCSI’s “actions herein were much more than handling parts prior to their entrance into the production cycle but instead were part of an integrated quality control manufacturing process meant to be exempt under 130.330(d)(3)(C).”

In addition to its ruling on the scope of the manufacturing process, the case establishes that handheld measuring equipment qualifies for the exemption.  SCSI used sophisticated handheld measuring devices like micrometers, calipers and tread depth gauges.  Rejecting the Department’s argument that the handheld measuring devices were nonexempt hand tools, the court found that the sophisticated measuring devices qualified as exempt equipment when used as an integral part of the production flow to inspect, test or measure the property being manufactured.

The Department did not appeal the trial court’s ruling.  SCSI, LLC v. Ill. Dep’t of Revenue, No. 10 CH 116 (10th Judicial Circuit, Peoria County, Aug. 7, 2013).

Mary Kay McCalla Martire
Mary Kay McCalla Martire focuses her practice on state and local tax disputes. She helps clients with audits, tax-related litigation, letter rulings and settlement conferences. Mary Kay has experience resolving disputes involving income, sales and use, utility and telecommunications taxes, as well as premium and retaliatory tax. Read Mary Kay McCalla Martire's full bio.




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