Indiana Department of Revenue v. Interstate Warehousing, Inc.

Attorney for Appellant

Steve Carter
Attorney General

Nandita G. Shepherd
Deputy Attorney General
Indianapolis, IN

Attorneys for Appellee

Craig R. Finlayson
Swift & Finlayson
Fort Wayne, IN

IN THE
INDIANA SUPREME COURT

INDIANA DEPARTMENT OF REVENUE
Appellant (Defendant below),

v.

INTERSTATE WAREHOUSING, INC.
Appellee (Plaintiff below).

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) Supreme Court No.
) 49S10-0205-TA-00266
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APPEAL FROM THE INDIANA TAX COURT
The Honorable Thomas G. Fisher, Judge
Cause No. 49T10-9806-TA-71

ON PETITION FOR REVIEW

February 14, 2003

SULLIVAN, Justice.

Interstate Warehousing, Inc., uses electricity to liquify ammonia that
is then used to chill warehouse space that Interstate rents to customers to
store perishables. Interstate seeks to avoid the taxes due on its
electricity purchases. We find that Interstate does not qualify for the
statutory tax exemption it seeks because Interstate’s use of the ammonia
does not constitute the “production of other tangible personal property”
and because Interstate is not in the “business of … processing.”

Background

Interstate Warehousing, Inc. (“Interstate”), is an Indiana corporation
that operates two refrigerated warehouse facilities, located in
Indianapolis and Lafayette. Interstate Warehousing, Inc. v. Indiana Dep’t
of State Revenue, 764 N.E.2d 313, 314 (Ind. Tax Ct. 2002), review granted,
2002 Ind. LEXIS 351 (Ind. May 3, 2002). Food manufacturers and retailers
of frozen agricultural goods deliver to and store frozen and agricultural
goods in Interstate’s warehouses. Id.

Interstate cools the air in its storage facilities by chilling ammonia
to negative 20 degrees Fahrenheit using processes involving electrical
energy. Id. This converts the ammonia from gas form to a liquid. Id.
The liquid ammonia is then circulated through a closed loop distribution
system to lower the temperature of the air in the storage rooms. Id. When
the temperature of the chilled refrigerant ammonia rises to zero degrees,
it is returned through the same closed loop distribution system to the
compressors and condensers of the central refrigeration system. Id. Upon
receiving the warmed ammonia, Interstate again cools it and recirculates it
through the closed loop system. Id.

Interstate charges its customers based on the temperature that is
required to be maintained in the refrigerated storage area and the quantity
of perishables that the customer delivers. Id.

From 1993 to 1996, Interstate paid sales and use taxes totaling
$91,566.85 for electricity purchased for its Indianapolis and Lafayette
facilities. Claiming that these electricity purchases were exempt from
sales and use tax, Interstate sought a refund. The Department of State
Revenue (“Department”) denied Interstate’s refund claim. Interstate
appealed and the Indiana Tax Court held that Interstate was entitled to the
refund of sales and use tax it sought. Interstate Warehousing, Inc., 764
N.E.2d at 317.

Discussion

The Indiana General Assembly has imposed excises taxes, known as the
“state gross retail tax” and the “use tax,” on retail transactions. Ind.
Code §§ 6-2.5-2-1 and 6-2.5-3-2 (1993).[1] However, the Legislature has
provided an exemption from these taxes for purchases that meet the
following requirements:

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 manufacturing, processing, refining, repairing, mining,
agriculture, horticulture, floriculture, or arboriculture. This
exemption includes transactions involving acquisitions of tangible
personal property used in commercial printing as described in IC 6-2.1-
2-4.

Ind. Code § 6-2.5-5-5.1(b). “Tangible personal property” is defined to
include “electrical energy.” Id. at § 5.1 (a). Interstate claims that the
electricity it purchases is required for purposes that qualify it for this
exemption and, as such, is entitled to a refund of sales and use taxes
paid.

It is well established that exemption statutes are strictly construed
against a taxpayer so long as the intent and purpose of the Legislature is
not thwarted. Indiana Dep’t of State Revenue v. Fort Wayne Nat’l Corp.,
649 N.E.2d 109,113 (Ind. 1995); Monarch Steel Co. v. State Bd. of Tax
Comm’rs, 699 N.E.2d 809, 810 (Ind. Tax Ct. 1998). As such, Interstate had
the burden of establishing its entitlement to the exemption. Indiana Dep’t
of State Revenue v. Hardware Wholesalers, Inc., 622 N.E.2d 930, 933-34
(Ind. 1993); Sony Music Entertainment, Inc. v. Indiana State Bd. of Tax
Comm’rs, 681 N.E.2d 800,801 (Ind. Tax Ct. 1997), review denied, 690 N.E.2d
1182.

We hold that Interstate has failed to demonstrate that it qualifies
for the exemption here in two respects: (1) we do not find that Interstate
is engaged in the “production of other tangible personal property”; and (2)
we do not find that Interstate is in the business of “manufacturing,
processing, refining, repairing, mining, agriculture, horticulture,
floriculture, or arboriculture.” As the language of the statute makes
clear, it must satisfy both these requirements to qualify for the
exemption.

I

Beginning with the first of these two requirements – the production
of other tangible personal property – we reiterate that Interstate uses
electricity to cool gaseous ammonia to liquid form and then circulates the
liquid through its warehouse facilities to cool the air. When the
temperature of the ammonia begins to rise, it is again chilled. The
ammonia stays in the refrigeration system in what the parties refer to as a
“closed loop.” While it is certainly true that there is some
transformation of the ammonia from gas to liquid form as a consequence of
the consumption of electricity, such transformation alone is not sufficient
to constitute “production of other tangible personal property” under the
statute. By “production of other tangible personal property,” the
Legislature meant that the taxpayer must use the electricity to transform
the ammonia into a distinct marketable good. That does not occur here; the
liquid ammonia is never marketed.

The Tax Court itself has identified the elements of “production of
other tangible personal property” in a number of cases in recent years.
The “distinct marketable good” requirement is illustrated by White River
Envtl. P’ship v. Department of State Revenue, 694 N.E.2d 1248, 1252 (Ind.
Tax Ct. 1998). In that case, the taxpayer, an operator of a wastewater
treatment facility, claimed the exemption at issue here for the sales and
use taxes it paid on chemicals and materials consumed during its treatment
process. The Tax Court correctly 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 element of “transformation” is illustrated by Mechanics Laundry &
Supply, Inc. v. Indiana Dep't of State Revenue, 650 N.E.2d 1223, 1231 (Ind.
Tax Ct. 1995), and by Faris Mailing, Inc. v. Indiana Dep't of State
Revenue, 512 N.E.2d 480, 483 (Ind. Tax Ct. 1987). In Mechanics Laundry,
the taxpayer, an operator of a commercial laundry, claimed the exemption at
issue here for the sales and use taxes it paid on cleaning supplies, water,
gas, electricity, and other products consumed during the laundering of
soiled textiles. The Tax Court correctly concluded that the laundering of
soiled textiles did not constitute "production." Id. at 1229. The
taxpayer was not engaged “in an overall process directed to the production
of textiles;” instead, it was “perpetuat[ing] textiles that were produced
by others.” Id. at 1229-30.

In Faris Mailing, the taxpayer, a business that processed and prepared
mailing items for customers, claimed the exemption at issue here for sales
and use taxes it paid on labels, directories and other similar items. The
Tax Court correctly concluded that the taxpayer was not engaged in the
"production of other tangible personal property." According to the Tax
Court, “[t]he items used in [the taxpayer’s direct mail assembly] process
cannot reasonably be assumed to transform the customer's package into a new
product.” Id.

One final example is particularly helpful. In Indianapolis Fruit Co.
v. Department of State Revenue, 691 N.E.2d 1379, 1383 (Ind. Tax Ct. 1998),
the taxpayer, a wholesaler of fruits and vegetables, claimed that it was
engaged in “production” (under different exemptions than the one at issue
here) for sales and use taxes it paid on its banana and tomato ripening
equipment. The Tax Court noted that the taxpayer actively ripened the
bananas by introducing ethylene gas into the banana ripening booth but
allowed the tomatoes to ripen by merely placing them in a tomato processing
unit. Id. at 1382, 1385-86. The court held that the taxpayer was engaged
in production with respect to the bananas because the taxpayer had
physically and chemically transformed the bananas from unmarketable bananas
to marketable ones. Id. at 1381, 1385. The Court, however, found that the
taxpayer's tomato ripening process did not constitute production because
the taxpayer did not trigger the ripening process but merely passively
allowed it to occur. Id. at 1381, 1385-86

The common thread in all of these cases is that where the taxpayer did
not transform property into a distinct marketable product for customer
consumption, the Tax Court held that the taxpayer was not engaged in the
“production of other tangible personal property.” We agree with the Tax
Court’s analysis in those cases. Applying the same analysis to the facts
here, we find that Interstate’s liquification of ammonia within the “closed
loop” of its warehouses’ refrigeration systems may meet the transformation
requirement but, because the liquefied ammonia is not purchased by
Interstate’s Warehouse customers, the “distinct marketable good”
requirement is not met. Interstate is not engaged in the “production of
other tangible personal property.”[2]

II

A second requirement of the exemption at issue here is that the
taxpayer’s business be “manufacturing, processing, refining,” or one of the
other businesses listed in the statute. Interstate contends that it meets
this requirement because it is engaged in “processing.” Pet’r’s Mem. In
Supp. Of Mot. For Summ. J. (“Pet’r’s Mem.”), Appendix at 96. The Indiana
Administrative Code defines “processing” for these purposes as follows:

Processing or refining is defined as the performance by a
business of an integrated series of operations which places tangible
personal property in a form, composition, or character different from
that in which it was acquired. The change in form, composition, or
character must be a substantial change. Operations such as distilling,
brewing, pasteurizing, electroplating, galvanizing, anodizing,
impregnating, cooking, heat treating, and slaughtering of animals for
meal or meal products are illustrative of the types of operations
which constitute processing or refining, although any operation which
has such a result may be processing or refining. A processed or
refined end product, however, must be substantially different from the
component materials used.

Ind. Admin. Code tit. 45 r. 2.2-5-10(k). Interstate argues that it is
engaged in processing because it processes chilled ammonia to produce
conditioned air and sells “the cooled, dehydrated and conditioned air that
it processes.” Pet’r’s Mem., App. at 90. But we think the Department has
the better part of the argument: “Interstate [does not] ‘perform an
integrated series of operations’ resulting in a transformed end product to
Interstate’s customer. … The cool air merely maintains the customer’s
previously manufactured goods. There is no substantial change in ‘form,
composition, or character’ to those goods. The cold air is only incidental
to the service of storing previously manufactured goods.” Mem. in Supp. of
Resp. to Mot. For Summ. J. and Cross-Mot. For Summ. J., App. at 76. We
hold that Interstate is not engaged in the “business of … processing.”

III

In deciding this case in favor of Interstate, the Tax Court relied
heavily on its opinion in Mid-America Energy Resources, Inc. v. Indiana
Dept. of State Revenue, 681 N.E.2d 259 (Ind. Tax Ct. 1997), review denied,
690 N.E.2d 1184. Because of this emphasis, we believe we should explain
why we read Mid-America differently.

The taxpayer in Mid-America was an Indiana corporation that provided
chilled water for air conditioning to downtown Indianapolis businesses.
Mid-America, 681 N.E.2d at 260. Mid-America operated a central processing
plant where it chilled and chemically treated water before distributing the
water to its customers through an underground, closed loop, distribution
system. Id. When the water became too warm to serve its purpose, it was
returned to the central plant through the closed loop and the process was
repeated. Id. Mid-America charged its customers based on the quantity of
water delivered and the temperature differences in the water that returned.
Id. It collected sales tax on the sales made, remitting sales taxes
collected from non-exempt customers to the appropriate authorities. Id.

The Tax Court correctly found that Mid-America was entitled to the
exemption at issue in this case on chemicals it purchased because its
operation of chilling and treating water for the purpose of conditioning
air in its customers’ buildings constituted production of other tangible
personal property. Id. at 264. Mid-America chilled and treated water that
its customers purchased and used to condition the air in their respective
buildings.

In its opinion in this case, the Tax Court compared the factual
background of Mid-America but focused only on the chilling processes used
by the respective companies. Certainly, Interstate’s process for chilling
and distributing ammonia is similar to the process Mid-America used for the
cooling and distribution of water. We also agree with the Tax Court that
both companies distributed their coolants through a closed loop system with
similar types of machinery. See Interstate Warehouse, Inc., 764 N.E.2d at
316-317.

However, as discussed in Part I, supra, we conclude that the Tax Court
failed to apply the “distinct marketable good” requirement. Interstate
primarily provides the service of storing frozen goods. A necessary
component of this service is a climate-controlled environment.
Interstate’s customers did not purchase the processed ammonia – just like
White River’s customers did not purchase distinct marketable products. In
contrast, Mid-America’s customers bought – and paid sales tax on – a
distinct marketable product: chilled water. The process Interstate uses to
achieve an air conditioned environment is incidental to the service of
providing storage for frozen goods. Its customers are neither purchasing,
nor paying sales or use taxes on the goods used to provide the service.

IV

Interstate also claimed exemption from sales and use tax on its
energy purchases under Ind. Code § 6-2.5-4-5. This exemption applies to
certain purchases of “power” (defined as “electrical energy, natural or
artificial gas, water, steam, or steam heating”). Id. The Tax Court,
finding that Interstate was entitled to the exemption discussed above,
declined to reach this issue. Interstate Warehousing, 764 N.E.2d at 314,
n.1. It is not clear to us that Interstate sought a refund on this basis.
See Order Denying Refund, App. at 122-23. In any event, we note that for
Interstate to be eligible for this exemption, it would be required to
purchase power for use in the “production” of “tangible personal property.”
We have already determined that Interstate is not engaged in the
production of tangible personal property.

Conclusion

We reverse the judgment of the Indiana Tax Court and affirm the
decision of the Indiana Department of Revenue denying Interstate exemption
from sales and use tax under Ind. Code § 6-2.5-5-5.1 in this case.

SHEPARD, C.J., and DICKSON, BOEHM, and RUCKER, JJ., concur.
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[1] The language of the statutory provisions relevant to this case remained
unchanged throughout the tax years in question.
[2] In addition to ascertaining whether a taxpayer's product satisfies any
market, the Tax Court has in other cases (but not this one) examined
whether the taxation of particular transactions results in the “evil” of
“tax pyramiding.” See Rotation Products Corp. v. Dep’t of State Revenue,
690 N.E.2d 795, 799 (Ind. Tax Court 1998); Harlan Sprague Dawley, Inc. v.
Ind. Dep’t of State Revenue, 605 N.E.2d 1222, 1228 (Ind. Tax Ct. 1992);
General Motors Corp. v. Ind. Dep’t of State Revenue, 598 N.E.2d 399, 405
(Ind. Tax Ct. 1991). When it uses this language, the Tax Court is
referring to a series of transactions where a taxpayer pays sales or use
tax on property it uses in production and then passes along the added costs
to its customers who then pay sales tax on their purchases – a “tax upon a
tax.” While we believe that value judgments as to whether a particular
taxation scheme constitutes “pyramiding” or is “evil” are best left to the
legislative arena, we do think the Tax Court is probably right in its
suggestion that there is certain economic activity that the Legislature
only wants to tax once and that is at the point of final retail sale. See
Welsh v. Sells, 244 Ind. 423, 434-35, 192 N.E.2d 753, 759 (Ind. 1963)
(quoting Current Studies of Ind. Tax Policy, The Retail Sales Tax, Ind.
Comm’n. On St. Tax & Financing Policy First Report – 1962, page 11). We
think an inescapable corollary of this principle, however, is that there be
a point of final sale. That is, one of the reasons the exemption was not
available in the White River case – and is not available in this one – is
that there is no product on which the taxpayer’s customer pays sales or use
tax.