Thursday, February 21, 2008
Louisiana Supreme Court Reaffirms the Traditional Three-Part Test for the Sales
and Use Tax Raw Material Exclusion
A
recent decision rendered by the Louisiana Supreme Court was of great interest
to manufacturers throughout the state in connection with Louisiana’s sales tax exclusion for
raw materials purchased to be processed into end products. In International
Paper, Inc. v. Bridges, 07-1151, (La.
1/16/08), the court reversed a decision by the 2nd Circuit Court of Appeal and
reaffirmed that the sales and use tax raw material exclusion in Louisiana is
based on a three-part test. In
order to be excluded from sales or use tax, the raw material in question must
become a recognizable and identifiable component of the end product, it must be
beneficial to the end product, and the raw material must be a material for
further processing that was purchased with the purpose of inclusion in the end
product.
The
dispute began when International Paper sought a refund from the state for sales
tax paid on three chemicals it used in its paper manufacturing process, sodium
chlorate, hydrogen peroxide, and elemental oxygen. The chemicals at issue were utilized by
IP in order to “decolorize” the ligin contained in the pulp so that
white paper, as opposed to brown paper, could be the end product
manufactured. The wood pulp
involved would be bleached when oxygen atoms, derived from the raw materials,
would break away from the original chemical compounds and recombine with the
ligin molecules producing a substance that reflects all of the visible light
spectrum, thereby giving the pulp a white color. An additional benefit of these raw materials
is that they tend to dissolve additional ligin molecules during the bleaching
process thereby eliminating more of the color producing materials in the pulp
so as to result in the ultimate end product, the white paper. In its refund request IP argued that the
three chemicals became incorporated within the end product, and served as
beneficial components of the end product and that, as such, should have been
covered by Louisiana’s
further processing exclusion, a/k/a the raw material exclusion.
The
Louisiana Board of Tax Appeals agreed with IP and awarded the refund
sought. A district court reviewing
the case agreed with the Board of Tax Appeals, however, on April 4, 2007 the
2nd Circuit Court of Appeal reversed the BTA’s decision and in the course
of its opinion set forth a four-part test for the raw material exclusion that
included some requirements that caused great concern to manufacturing taxpayers
throughout Louisiana.
In
its opinion, the 2nd Circuit stated that in order for the raw material exclusion
to apply (1) the material itself must be processed into tangible personal
property for sale at retail, (2) the raw material must become a recognizable,
integral part of the end product, (3) the presence of the material as a
component of the end product must be of benefit to the end product, and (4) the
primary purpose for the purchase of
the material must be to process it into the end product. The circuit court claimed that the
fourth prong of the test as described above, the “primary purpose”
element, could be gleaned from Louisiana
jurisprudence. This assertion by
the 2nd Circuit was the first time that a “primary purpose” test
had been put forth as a requirement for the raw material exclusion.
Applying
its test to the facts of the IP case, the 2nd Circuit concluded that the three
chemicals at issue were not primarily purchased for the purpose of being
processed into the end product, but rather were processing agents bought by IP
to be used by IP for the purpose of removing and modifying ligin already in the
wood and not for further processing the chemicals themselves into an article of
tangible personal property for sale at retail.
In
setting forth its analysis, the Louisiana Supreme Court relied to a great
extent on a regulation adopted by the Louisiana Department of Revenue many
years ago that precipitated the formation of the “three-pronged
test” for the raw material exclusion. The court also examined the case law
that had developed interpreting the raw material exclusion in terms of the Department
of Revenue’s own administrative rule. In Traigle
v. PDG Industries, Inc., 332 So. 2d 777 (La. 1976), the court utilized the Department
of Revenue’s administrative rule to determine whether graphite blades
purchased by the taxpayer and utilized in the manufacture of chlorine could be
excluded under the raw material exclusion.
Traigle resulted in the rule
that the raw materials must be purposefully incorporated into the end product,
and not be there incidentally or by accident. The traces of carbon from the graphite
blades that ended up in the end product were more in the nature of impurities
and showed that the blades had not been purchased for incorporation
“into” the manufactured product, but rather only to be used in the
process of producing the manufactured product for sale.
The
next case analyzed was Vulcan Foundry,
Inc. v. McNamara, 414 So. 2d 1193 (La.
1982). Vulcan involved the question of whether coke purchased to melt iron
ore for manhole covers qualified for the raw material exclusion. The taxpayer was not successful, and the
case established the principle that while a material may be recognizable and
identifiable in the end product, and beneficial to the end product, if the
material was purchased not for incorporation into the end product, but rather
for some other purpose, e.g., such as
to be used as a fuel, then it would not be covered by the raw material
exclusion.
Turning
to the facts before it the court concluded that based upon its review of the
applicable law and jurisprudence, the raw material exclusion does not require
that the raw materials themselves (the exact chemical/physical compositions of
the raw materials) must appear in the end product nor that the primary purpose for the purchase of the
raw materials must be the incorporation into the end product. This conclusion was a favorable one for
manufacturing concerns all over Louisiana. The decision reaffirms the understanding
that one can look at elements, molecules, or even atoms of a raw material, and
that as long as those elements are recognizable and identifiable in the end
product, or beneficial to the end product, and were purchased for the purpose
of processing them into the end product, then the sales and use tax exclusion
will cover the purchase and use of that raw material by the manufacturer.
Overall,
Louisiana
does not have the most welcoming environment in terms of sales and use tax when
dealing with manufacturers.
However, the International Paper decision
by the Louisiana Supreme Court served to prevent any backsliding in the
attempts to foster a more business-friendly atmosphere for Louisiana manufacturers.
For more information, please contact Robert S. Angelico at rsangelico@liskow.com or James C. Exnicios at jexnicios@liskow.com or go to www.liskow.com.
