On September 6, 2023, the Tennessee Appeals Court at Nashville issued a majority ruling upholding the Chancery Court’s decision in the case Alsco, Inc. v. Tennessee Department of Revenue, number M2022-01019-COA-R3-CV. The taxpayer, Alsco, Inc. (Alsco), was issued three industrial machinery Sales and Use Tax Certificates of Exemption which were later revoked because Alsco did not meet the definition of “manufacturing” according to the Department of Revenue. Alsco appealed to an administrative law judge who upheld the revocation. Alsco then appealed the administrative judge’s decision to the Chancery Court which reversed the administrative judge’s decision. The Appeals Court in this case found no error in the Chancery Court’s decision and upheld overturning the administrative judge.
The Appeals Court held that Tennessee manufacturing operations must contain three elements per Tenn. Code Ann. § 67-6-102(46)(A)(i) to qualify for the industrial machinery exemption: the machinery must be “necessary to and primarily for the fabrication or processing of tangible personal property”, the property must be sold for off-premises consumption, and the principal business of the manufacturer must be this activity. Since Alsco and the Department agreed on the other two elements, only the question of “processing” was considered. Alsco argued their Tennessee facilities should qualify because the machinery in question is used to clean and sanitize textiles, which they construed as processing tangible personal property. The Department of Revenue argued that Alsco was not fundamentally changing or transforming the products, rather they were adding value to already finished products and the standard by which “processing” should be viewed hinged on creating a substantially different product.
Since the statute in question notes the machinery must be “…necessary to, and primarily for, the fabrication or processing of tangible personal property…”, but does not define “processing”, the Court then looked to other cases and jurisdictions for guidance. The Court considered that dry cleaning operations which simply changed dirty items into clean ones were not granted this exemption in cases in Minnesota (AmeriPride Servs. Inc. v. Comm’r of Revenue, 2008) and Indiana (Mechs. Laundry & Supply, Inc. v. Ind. Dep’t of State Revenue, 1995), but noted that in both Minnesota and Indiana, the tax statutes include definitions requiring a substantially different end product after processing. In the end, the Appellate Court in this case used a standard established by the Ohio Supreme Court in the case Gressel Produce Co v. Kosydar Inc (1973), which held processing to be “…a transformation or conversion of materials or things into a different state or form from that in which they originally existed… changing them into marketable products” which was adopted in another Tennessee case, Beare Co. V. Tennessee Department of Revenue, 1993. The Appeals Court decided the textiles at issue here were not simply laundered or dry cleaned; before Alsco’s sanitization process, the textiles were contaminated with oils, wax, medical waste, blood, and other chemicals which would make the products unsafe to wear, use, or otherwise render them non-functional and unfit for consumption. Because of this significant change to the underlying product, the Appeals Court affirmed the Chancery Court’s decision to overturn the denial of the exemption.
Taxpayers should be alert to definitions in the state laws where they do business. Often, a nebulous or non-existent definition may be the thing a decision rests on. The definition of manufacturing or processing may be broader than the popular concept of manufacturing or processing that typically comes to mind. If a taxpayer can create a reasonable and defensible argument, it is also worth appealing decisions that initially seem to dismiss those arguments. Though the states can always pass or amend statutes to include or clarify definitions later, if a law is currently less than clear, it may be worthwhile to challenge the Department’s rulings regarding that law. (Alsco, Inc. v. Tennessee Department of Revenue, M2022-01019-COA-R3-CV. Decision dated 6 September 2023 and signed by Andy D. Bennett, Judge)