SUPREME COURT OF ARIZONA
En Banc
STATE OF ARIZONA ex rel. THE ) Arizona Supreme Court
ARIZONA DEPARTMENT OF REVENUE, ) No. CV-03-0250-PR
)
Plaintiff-Appellant, ) Court of Appeals
) Division One
v. ) Nos. 1 CA-TX 01-0007
) 1 CA-TX 02-0014
CAPITOL CASTINGS, INC., ) (Consolidated)
)
Defendant-Appellee. ) Arizona Tax Court
__________________________________) Nos. TX 1996-00028
) TX 1996-00028-3
STATE OF ARIZONA ex rel. THE )
ARIZONA DEPARTMENT OF REVENUE, )
)
Plaintiff-Appellee, ) O P I N I O N
)
v. )
)
CAPITOL CASTINGS, INC., )
)
Defendant-Appellant. )
__________________________________)
Appeal from the Arizona Tax Court
The Honorable Jeffrey S. Cates, Judge
The Honorable Paul A. Katz, Judge
REVERSED AND REMANDED
Opinion of the Court of Appeals, Division One
205 Ariz. 258, 69 P.3d 29 (App. 2003)
VACATED
TERRY GODDARD, ARIZONA ATTORNEY GENERAL Phoenix
by Sara D. Branscum, Assistant Attorney General
Attorneys for Plaintiff Arizona Department of Revenue
SNELL & WILMER, L.L.P. Phoenix
by Charles A. Pulaski, Jr.
and Barbara J. Dawson
and Martha E. Gibbs
Attorneys for Defendant Capitol Castings, Inc.
FENNEMORE CRAIG, P.C. Phoenix
by Steven R. Partridge
Attorneys for Amicus Curiae
Arizona Tax Research Association
B E R C H, Justice
¶1 Arizona law exempts from use tax any “[m]achinery[] or
equipment[] used directly in manufacturing, processing,
fabricating, . . . or metallurgical operations.” Ariz. Rev.
Stat. (“A.R.S.”) § 42-5159(B)(1) (Supp. 2003).1 Capitol Castings
claimed that several items purchased for use in its foundry
facilities qualified for the use tax exemption. The court of
appeals, however, concluded that the items did not qualify for
the exemption because they were not “machinery or equipment.”
See State ex rel. Ariz. Dep’t of Revenue v. Capitol Castings,
Inc., 205 Ariz. 258, 266, ¶¶ 34, 36, 69 P.3d 29, 37 (2003)
(“Capitol II”). We granted Capitol Castings’ petition for
review and, for the reasons set forth, vacate the opinion of the
court of appeals, resolve the exemption status of several items,
and remand the case for further proceedings.
1
The legislature renumbered § 42-1409(B)(1) as § 42-
5159(B)(1) in 1997, see 1997 Ariz. Sess. Laws, ch. 150, §§ 107,
110, but made no substantive change to its language. Because
there was no substantive change, this opinion refers to the
current citation.
2
BACKGROUND AND PROCEDURAL HISTORY
¶2 Capitol Castings manufactured grinding balls and
custom-cast items used in mining and other industries.2
Manufacturing these items entailed pouring molten metals and
alloys into molds to form the desired shapes. Capitol
constructed its molds using metal, silica sand, chemical
binders, exothermic sleeves, mold cores, mold wash, and hot
topping.
¶3 The molds for custom castings consisted almost
entirely of sand. For some of the custom molds, Capitol would
ram the sand for each half of the mold into a steel flat
containing a wood pattern of the desired shape. For other
custom molds, Capitol would pour sand treated with chemical
binders over wood patterns. The binders helped the sand retain
its form. Capitol would then insert into one of the custom
casting mold’s halves an exothermic sleeve, a round tube that
protruded from the mold like an exhaust pipe and retained excess
molten metal that became part of the casting as the metal inside
cooled and contracted. Capitol used “hot topping,” a powder, to
cover the end of the exothermic sleeve to keep the molten metal
in the sleeve from cooling. After removing the wood patterns
from the molds, Capitol sprayed the cavity left by the pattern
2
Capitol no longer owns the foundry facilities discussed in
this opinion.
3
in the mold with a mold wash to prevent the sand from sticking
to the casting. Capitol sometimes used mold cores, also made of
sand, to form cavities in the molds. Once the halves of each
custom casting mold were complete, Capitol put the halves
together to form a single mold.
¶4 Capitol’s molds were destroyed during the
manufacturing process. The chemical binder and mold wash were
completely consumed and the exothermic sleeves and hot topping
were rendered unusable each time Capitol used a mold, but
Capitol was able to salvage the metal and sand for use in future
molds.
¶5 The Arizona Department of Revenue (“ADOR”) did not
contest the exemption for the metal molds, thus impliedly
conceding that the metal molds are exempt from use tax, but it
contends that the other materials — silica sand, chemical
binders, hot topping, mold wash, mold cores, and exothermic
sleeves — are not exempt.
¶6 ADOR also contests the exemption for the cement and
lime Capitol used at its Chandler facility to detoxify dust
created by the arc furnaces used in the casting process. Like
the chemical binders and hot topping, the cement and lime could
not be reused after they were injected into the toxic dust.
¶7 Finally, ADOR contests the exemption for refractory
materials, such as coxy sand and cerwool blankets, used to
4
protect Capitol’s machinery and equipment from the extreme heat
generated by its manufacturing processes. The manufacturing
process destroyed the refractory materials, requiring Capitol to
replace them periodically.
¶8 This case has an extensive procedural history,
including two tax court proceedings, two published court of
appeals opinions, and a legislative amendment to the exclusions
from the exemptions afforded by A.R.S. § 42-5159(B). We will
explain the history as it becomes pertinent to the analysis.
DISCUSSION
A. Standard of Review
¶9 This case involves the interpretation of statutory
provisions, matters that we review de novo. See Bilke v. State,
___ Ariz. , , ¶ 11, 80 P.3d 269, 271 (2003) (citing Canon
Sch. Dist. No. 50 v. W.E.S. Constr. Co., 177 Ariz. 526, 529, 869
P.2d 500, 503 (1994)). When interpreting statutes, we strive to
“discern and give effect to legislative intent.” People’s
Choice TV Corp. v. City of Tucson, 202 Ariz. 401, 403, ¶ 7, 46
P.3d 412, 414 (2002). We “construe the statute as a whole, and
consider its context, language, subject matter, historical
background, effects and consequences, [as well as] its spirit
and purpose.” Id. (quoting State ex rel. Ariz. Dep’t of Revenue
v. Phoenix Lodge No. 708, Loyal Order of Moose, Inc., 187 Ariz.
242, 247, 928 P.2d 666, 671 (App. 1996)).
5
¶10 In the tax field, we liberally construe statutes
imposing taxes in favor of taxpayers and against the government,
Ariz. Tax Comm’n v. Dairy & Consumers Co-op Ass’n, 70 Ariz. 7,
18, 215 P.2d 235, 242-43 (1950), but strictly construe tax
exemptions because they violate the policy that all taxpayers
should share the common burden of taxation. See Tucson Transit
Auth., Inc. v. Nelson, 107 Ariz. 246, 252, 485 P.2d 816, 822
(1971); 71 Am. Jur. 2d State and Local Taxation §§ 232, 233
(2001). Nevertheless, an exemption should “not be so strictly
construed as to defeat or destroy the [legislative] intent and
purpose.”3 W.E. Shipley, Annotation, Items or Materials Exempt
from Use Tax as Used in Manufacturing, Processing, or the Like,
30 A.L.R.2d 1439, 1442 (1953). Bearing these principles in
mind, we turn to the issue raised by the parties.
B. Machinery or Equipment
¶11 Our analysis begins with the text of A.R.S. § 42-
5159(B)(1), which exempts “[m]achinery, or equipment, used
directly in manufacturing, processing, fabricating, job
printing, refining or metallurgical operations.” The statute
3
Citing People’s Choice TV Corp., 202 Ariz. at 403, ¶ 7, 46
P.3d at 414, Capitol argues that we should construe the
exemption at issue in this case liberally. As the court of
appeals below correctly pointed out, People’s Choice TV Corp.
interpreted a statute prohibiting the imposition of a tax, not a
provision exempting an otherwise taxable item. See Capitol II,
205 Ariz. at 263-64, ¶ 23, 69 P.3d at 34-35. Capitol’s reliance
on People’s Choice TV Corp. is therefore misplaced.
6
requires that the “terms ‘manufacturing,’ ‘processing,’
‘fabricating,’ ‘job printing,’ ‘refining’ and ‘metallurgical’”
be interpreted to include “those operations commonly understood
within their ordinary meaning.” Id. No one disputes that
Capitol’s casting processes were of the type contemplated by the
statute.
¶12 The statute does not define the terms “machinery or
equipment.” Generally accepted definitions of “machinery”
indicate that it may be “an assemblage of machines,” “the parts
of a machine collectively,” or “a system by which action is
maintained or by which some result is obtained.” Webster’s
College Dictionary 788 (2d ed. 1997). The definition includes
“an apparatus consisting of interrelated parts with separate
functions, used in the performance of some kind of work,” or “a
device that transmits or modifies force or motion.” Id. at 787.
“Equipment” includes “the articles, implements, etc., used or
needed for a specific purpose or activity.” Id. at 442.
¶13 Despite the lack of definitional specificity in the
statute, there is no dispute about its underlying purpose. The
legislature enacted A.R.S. § 42-5159(B)(1) to stimulate business
investment in Arizona in order to improve the state’s economy
and increase revenue from other taxes, such as income and
property taxes. See Ariz. Dep’t of Revenue v. Blue Line
Distrib., Inc., 202 Ariz. 266, 268, ¶ 11, 43 P.3d 214, 216 (App.
7
2002) (describing the policy supporting the “machinery or
equipment” exemption from the transaction privilege tax and
citing 71 Am. Jur. 2d State and Local Taxation § 288 (2001));
Duval Sierrita Corp. v. Ariz. Dep’t of Revenue, 116 Ariz. 200,
204, 568 P.2d 1098, 2002 (App. 1977) (same). Our interpretation
of the statute therefore should further, not frustrate, the
policy of encouraging investment and spurring economic
development.
¶14 Although the text of the statute may not clearly
reveal the legislature’s intent, the procedural history of this
case provides significant evidence of the legislature’s intended
definition and its purpose in exempting machinery and equipment
used in industrial processes from the use tax. In Arizona
Department of Revenue v. Capitol Castings, Inc., 193 Ariz. 89,
970 P.2d 443 (App. 1998) (“Capitol I”), which addressed the
issue presented in this case before the legislature amended §
41-5159(C)(1), the court of appeals held that the items at issue
did not qualify for the use tax exemption afforded by § 42-
5159(B)(1) because they were expended or consumed in the
production process. Id. at 95, ¶ 26, 970 P.2d at 449. The
court also found that the items at issue did not qualify as
machinery or equipment, but determined that this conclusion was
“moot” in light of its holding that the items fell within § 42-
5159(C)(1), which excluded “expendable materials” from the use
8
tax exemption contained in § 42-5159(B)(1). Id. at 93-95, ¶¶
14-26, 970 P.2d at 447-49.
¶15 In the course of its “machinery or equipment”
discussion, the court overruled the tax court’s opinion in
Arizona Department of Revenue v. Cyprus Sierrita Corp., 177
Ariz. 301, 303, 867 P.2d 871, 873 (Tax 1994) (“Cyprus
Sierrita”), which had held that chemicals expended during the
ore leaching process nonetheless qualified as “machinery or
equipment” for purposes of the exemption because they functioned
as machinery might in an ore leaching process and they were “an
integral part of a complicated process.” The court of appeals
also distinguished its own opinion in Duval Sierrita Corp. v.
Arizona Department of Revenue, 116 Ariz. 200, 568 P.2d 1098
(App. 1977), which had adopted two tests — the ultimate function
and integrated rule tests — for determining whether items were
machinery or equipment “used directly” in qualifying operations
under § 42-5159(B)(1).
¶16 In response to Capitol I, the legislature amended §
42-5159(C)(1), which excludes expendable materials from the
(B)(1) use tax exemption, to provide that “expendable materials
do not include any of the categories of tangible personal
property specified in subsection B of [§ 42-5159] regardless of
the cost or useful life of that property.” See 1999 Ariz. Sess.
Laws, ch. 153, § 2 (emphasis added). The amendment plainly was
9
designed to avoid the interpretation given to the prior version
of subsection (C)(1) in Capitol I. As evidenced by the parties’
arguments, however, there remains a question whether the
amendment of the (C)(1) exclusion also affects the analysis in
Capitol I of § 42-5159(B)(1), the provision exempting certain
machinery or equipment from the use tax. In Capitol II, the
court of appeals held that the amendment did not affect the
machinery or equipment analysis under subsection (B)(1). 205
Ariz. at 266, ¶ 33, 69 P.3d at 37.
¶17 The court of appeals reasoned in Capitol II that its
opinion in Capitol I contained two parts: one that “rejected
the broad interpretation of ‘machinery or equipment,’” id. at
264, ¶ 24, 69 P.3d at 35, and a second that analyzed whether the
materials at issue were expendable. Id. ¶ 25. The court
concluded that the 1999 amendment affected only the expendable
materials discussion in Capitol I, but did not affect its
discussion of what constitutes machinery or equipment. Id. at
265-66, ¶¶ 29-34, 69 P.3d at 36-37. We disagree and conclude
that this narrow interpretation of the legislative amendment
fails to give full effect to the legislature’s intent.
¶18 Several factors demonstrate that, in amending A.R.S. §
42-5159(C)(1), the legislature meant to alter the specific
result reached by the court of appeals in Capitol I, not just
the conclusion that the materials at issue were expendable and
10
therefore excluded from the exemption. First is the language of
the amendment itself. The conclusion in Capitol I that the
items at issue did not qualify as machinery or equipment was
ultimately grounded on the fact that the items were expended in
the casting process. 193 Ariz. at 95, ¶ 26, 970 P.2d at 449
(describing the question whether the items qualified as
machinery or equipment as “moot” in light of their
expendability). The legislature then promptly removed an item’s
expendability as an impediment to qualification for the use tax
exemption, thus making plain that expendable materials can
function as machinery or equipment.
¶19 Second, the legislative history of the amendment
reveals that the legislature meant to change the result of
Capitol I. Minutes of Senate Committee on Finance, 44th Leg.,
1st Reg. Sess. (Feb. 22, 1999) (discussing the case law
addressing the exemption for machinery or equipment and the
exclusion for expendable materials); Senate Fact Sheet for H.B.
2395, 44th Leg., 1st Reg. Sess. (Feb. 18, 1999) (same); Minutes
of House of Representatives Committee on Ways and Means, 44th
Leg., 1st Reg. Sess. (Jan. 26, 1999) (same); House of
Representatives Abstract for H.B. 2395, 44th Leg., 1st Reg.
Sess. (1999) (same). We are therefore reluctant to read the
amendment as leaving unaltered the ultimate result in Capitol I.
¶20 Finally, the legislature made the amendment
11
retroactive to May 19, 1977, see 1999 Ariz. Sess. Laws, ch. 153,
§ 3(A), the same day the court of appeals issued its opinion in
Duval Sierrita, which had applied broader, function-based tests
to determine whether items used in mining processes were exempt
from use tax – an opinion distinguished in Capitol I. See 193
Ariz. at 94-95, ¶¶ 21-25, 970 P.2d at 448-49. The unusual
retroactive effective date suggests three things. First, it
implies that the legislature intended to return the
interpretation of the statute to its pre-Capitol I status.
Second, because Duval Sierrita addressed only the § 42-
5159(B)(1) exemption, not the (C)(1) exclusion that was the
subject of the amendment, the retroactive date also shows the
legislature’s intent that the (C)(1) exclusion be construed to
act upon the definitions in subsection (B)(1) in a functional
way, exempting from the use tax items that would qualify under
(B)(1) even if they are expended in the manufacturing or
fabricating process. Finally, the effective date suggests the
legislature’s approval of the “ultimate function” and
“integrated rule” tests used in Duval Sierrita for determining
whether items should be exempt from use tax under § 42-
5159(B)(1).
¶21 Although the items for which exemption was sought in
Duval Sierrita differ from those at issue in this case, the
approaches developed in that case provide a useful framework for
12
analyzing whether an item is exempt under § 42-5159(B)(1). In
Duval Sierrita, the court addressed whether two types of
property qualified for the § 42-5159(B)(1) use tax exemption:
(1) spare or replacement parts for items conceded to be
machinery or equipment, 116 Ariz. at 203, 568 P.2d at 1101, and
(2) water booster pumps and steel water pipes used in Duval
Sierrita’s mining operations, id. at 202, 568 P.2d at 1100. The
answers to both questions turned on the statutory requirement
that the machinery or equipment be “used directly” in the
qualifying operations. Id. at 203, 568 P.2d at 1101. The court
concluded that rather than view each item at a fixed point in
time, without reference to its function, it should apply the
“ultimate function” test: that is, it should examine how the
item functions in the industrial process at issue to see whether
the item qualifies for the § 42-5159(B)(1) exemption. Id. at
204, 568 P.2d at 1102. For the specific items already in
service, the court adopted an “integrated approach” that
addresses how the item is used in the industrial processes
described in A.R.S. § 42-5159(B)(1) and considers the item’s
necessity to the process. Id. at 205, 568 P.2d at 1103. The
integrated approach exempts only those items that are “essential
to [the] operation and which make it an integrated system.” Id.
at 206, 568 P.2d at 1104. The Duval Sierrita approaches allow
some items that would not ordinarily be considered “machinery”
13
or “equipment” to qualify for the § 42-5159(B)(1) exemption if
they function as a necessary part of an integrated process.
Such a result furthers the legislative goal of encouraging
investment and spurring economic development.
¶22 While § 42-5159(B)(1), by its terms, applies only to
“machinery” or “equipment” that is “used directly in
manufacturing . . . operations,” Duval Sierrita clarifies that
whether an item qualifies as “machinery or equipment” must be
considered in light of the second element of the exemption, that
it be “used directly” in a manufacturing or other qualifying
process. For example, a computer used in a business is
“machinery” or “equipment.” A computer used purely for
administrative purposes, however, may not qualify for the
exemption because it is not “used directly in manufacturing . .
. operations.” But if the computer is used to manage and
control specific tasks conducted on an automated assembly line,
the computer may well qualify for the exemption as it is “used
directly in manufacturing . . . operations.” Similarly, certain
items not traditionally considered to be machinery or equipment
may qualify as such depending on their function in the process.
For example, in Cyprus Sierrita, the tax court found that three
chemicals, “sulfuric acid, LIX, and Orfom 7,” qualified as
machinery or equipment. 177 Ariz. at 302, 304, 867 P.2d at 872,
874. Although the chemicals did not fall within the commonly
14
held notions of machinery or equipment, the court found that
they functioned as such in the processes of extracting copper
from ore. Because the chemicals functioned like items
traditionally thought to be machinery or equipment, they were
exempt from use tax. Id. at 304, 867 P.2d at 874.
¶23 As these examples show, a functional approach requires
consideration of both of the exemption’s elements, as neither
element standing alone may be dispositive. By embracing Duval
Sierrita and its ultimate function and integrated rule tests,
the legislature expressed its intent to extend the exemption for
machinery or equipment beyond the narrow confines created by
Capitol I.
¶24 From this evidence, we conclude that the 1999
amendment was specifically intended to overrule Capitol I and to
reinstate the Duval Sierrita tests. Thus, in analyzing whether
an item is exempt from use tax under § 42-5159(B)(1), a court
should consider a number of factors to determine whether the
item qualifies as “[m]achinery, or equipment, used directly in
manufacturing . . . operations.” First, a court must apply
flexible and commonly used definitions of machinery and
equipment within the relevant industry. See supra ¶ 12. In
determining whether the items at issue here were machinery or
equipment, the court of appeals in Capitol I relied upon the
concept of “fixed assets,” which it defined as “physical
15
resources” such as “machinery or tools” other than land and
buildings. 193 Ariz. at 94, ¶ 19, 970 P.2d at 448. The court
in Capitol II relied upon the definition set forth in Capitol I,
finding no legislative intent to change it in the 1999 amendment
to § 42-5159(C)(1). 205 Ariz. at 266, ¶ 32, 69 P.3d at 37. In
light of the legislature’s implicit approval of Duval Sierrita’s
broader, more flexible approach, however, we find the analogy to
“fixed assets” too narrow and therefore unhelpful in determining
what constitutes machinery or equipment, especially in light of
the legislature’s disavowal of “cost or useful life” in the
expendable materials exclusion from the exemption. See A.R.S. §
42-5159(C)(1). Applying the more expansive definition of
machinery or equipment better serves the legislative goal than
does applying accounting terminology used for balance sheet and
income statement purposes.
¶25 Next, bearing in mind these flexible definitions, a
court should examine the nature of the item and its role in the
operations. Items essential or necessary to the completion of
the finished product are more likely to be exempt. See Duval
Sierrita, 116 Ariz. at 205-07, 568 P.2d at 1103-05. The
prominence of an item’s role in maintaining a harmonious
“integrated synchronized system” with the indisputably exempt
items will also directly correlate with the likelihood that the
16
exemption applies.4 Id. at 205, 568 P.2d at 1103. The closer
the nexus between the item at issue and the process of
converting raw materials into finished products, the more likely
the item will be exempt. As part of its analysis, the court
should consider whether the item physically touches the raw
materials or work in process, whether the item manipulates or
affects the raw materials or work in process, or whether the
item adds value to the raw materials or work in process as
opposed to simply reducing costs or relating to post-production
activities. In an environment such as Capitol’s, for example, a
furnace that melts scrap metal into a molten form would be
essential or necessary to enable the scrap metal to be shaped
into grinding balls or custom castings. The furnace also
affects and manipulates the scrap metal when it melts the raw
material into the desired cast shapes. Finally, by transforming
the scrap metal into a molten metal that can be shaped into
usable forms, the furnace increases the value of the scrap
metal. Throughout its analysis, a court must bear in mind that
the goal of the exemption – promoting economic development – must
4
ADOR’s failure to challenge the exemption for the metal
components of the molds suggests that both the metal and the
sand used in the grinding ball molds should qualify for the
exemption, because both the metal and sand components seem to
have performed the same functions. In an “integrated
synchronized system,” it does not seem logical that two items
performing the same function, but composed of different
materials, should be treated differently for purposes of the
exemption afforded by § 42-5159(B)(1).
17
not be frustrated by too narrow an application of § 41-5159(B).5
¶26 Applying these tests to the items at issue in this
case, we conclude that the silica sand, chemical binders,
exothermic sleeves, mold cores, mold wash, and hot topping
qualify for the exemption because they were used directly in and
were an integral part of a qualifying process under A.R.S. § 42-
5159(B)(1). The items functioned the way machinery or equipment
might in an integrated, synchronized system within the industry.
All had a close nexus to the process as they directly touched
the raw materials in the process of converting them into the
finished product. The cement and lime, on the other hand,
appear to have served the ancillary purpose of pollution control
and therefore were not as integrally related to the process. We
conclude, therefore, that the cement and lime do not qualify for
the exemption.
¶27 The record is less clear with respect to the coxy sand
and cerwool blankets that were used as refractory materials. We
remand to the tax court to determine whether these items qualify
for exemption pursuant to A.R.S. § 42-5159(B)(1).
CONCLUSION
¶28 We conclude that the court of appeals interpreted the
5
ADOR’s concession that the molds would have qualified as
machinery or equipment had Capitol purchased them preassembled,
but not if Capitol assembled the molds itself, frustrates the
legislative goal of the exemption and fails to apply Duval
Sierrita’s ultimate function test.
18
amendment to A.R.S. § 42-5159(C)(1) too narrowly and the tax
court similarly erred in its analysis in this case. We vacate
the opinion of the court of appeals, reverse the decision of the
tax court, and remand the case to the tax court for entry of
judgment as to the decided issues and for further proceedings
consistent with this opinion.
__________________________________
Rebecca White Berch, Justice
CONCURRING:
_________________________________________
Charles E. Jones, Chief Justice
_________________________________________
Ruth V. McGregor, Vice Chief Justice
_________________________________________
Michael D. Ryan, Justice
_________________________________________
Andrew D. Hurwitz, Justice
19
State Ex Rel. Department of Revenue v. Capitol Castings, Inc.
Court: Arizona Supreme Court
Date filed: 2004-04-21
Citations: 88 P.3d 159, 207 Ariz. 445
Copy CitationsCombined Opinion