The Kentucky Supreme Court held that certain items purchased by Century Aluminum and consumed in its manufacturing process were tax-exempt supplies, not taxable repair, replacement or spare parts. Century Aluminum of Kentucky, GP v. Department of Revenue, 2021-SC-0300-DG (Ky. December 15, 2022) (designated to be published). ). In holding for the taxpayer, the Court reversed the Court of Appeals’ opinion affirming the Franklin Circuit Court and remanded the case to the Kentucky Claims Commission (“KCC”), now the Board of Tax Appeals, for reinstatement of its Final Order. Century is an aluminum manufacturer in Hawesville, Hancock County, Kentucky.
From November 2010 to May 2015, as part of its aluminum manufacturing business, “Century purchased anode stubs, Inductotherm lining, thermocouples and tube assemblies, and welding wire and industrial gases from Kentucky vendors in the relevant time period.” Id. at 2. Although vendors initially collected sales tax from Century on the items and remitted the tax to the Department, Century subsequently concluded these items were properly characterized as tax-exempt supplies, not taxable repair, replacement or spare parts, and filed refund requests for these purchases. Id. The Department denied the refund requests and issued a Final Ruling Letter for each vendor, which Century (as assignee of the vendors rights in the refund requests) appealed to the KCC. Id. at 2-3.
At the KCC, Century argued that each item was necessary to the manufacturing process and had a limited useful life. The Department argued that if items which meet the qualification of a tax-exempt supply also meet the definition of a taxable part, then they will be held taxable. Id. at 2-6. Both parties produced witnesses to support their claims. Id. at 3.
The KCC determined that the anode stubs, Inductotherm lining, thermocouples and tube assemblies, and welding wire and industrial gases used for welding are tax-exempt supplies under KRS 139.470(10)(a)2.b. Id. at 6-7. The KCC rejected the Department’s interpretation, which would allow most tangible personal property meeting the criteria for a tax-exempt supply to be also categorized as a taxable part, and concluded that the test for final categorization is whether the item is intended to be used up in the manufacturing process or simply wears out. Id. at 6. Under this test, the KCC determined that the items at issue would be categorized as tax-exempt. Id. at 7. The Department appealed.
On appeal, the Franklin County Circuit Court reversed the KCC, and was affirmed by the Kentucky Court of Appeals. The circuit court agreed with the Department finding the items were introduced to maintain, restore, mend, or repair machinery or equipment used at Century’s facility, and were therefore taxable under KRS 139.470(10). Id. at 9-10. The Court of Appeals, like the circuit court, concluded that KRS 139.470(10) and KRS 139.010(26) are not in conflict and do not need to be harmonized, making Century’s proposed test unnecessary. Id. at 10-11. In addition to the two parties’ merit briefs, amici curiae Kentucky Association of Manufacturers and Kentucky Chamber of Commerce filed briefs with the Kentucky Supreme Court as well.
The Court acknowledged that “[c]ategorization of an item as a supply is…at the heart of this dispute.” Id. at 15. In reversing the Court of Appeals, the Kentucky Supreme Court agreed with the KCC’s “ultimate conclusion that a distinguishing difference between a tax-exempt supply and a taxable part is whether the tangible personal property is consumed in the manufacturing process and has a useful life less than one year,” [id. at 12-13], noting that its decision was “based upon the plain language of the statutes.” Id. at 12. The Court explained that in order to be categorized as a supply, an item must be (i) tangible personal property that is (ii) consumed when used in the manufacturing or industrial processing and is directly used in such processing, and (iii) having a useful life of less than one year. Id. at 15-16 (citing KRS 139.470(10)). The Court explained that, “upon consideration of the statutory language as a whole, that plain language incorporates the principles expressed in Mansbach and Century Indemnity.” Id. at 20 (citing Mansbach Metal Co. v. Dep’t of Revenue, 521 S.W.2d 85, 87 (Ky. 1975), and Century Indemnity Co. of Chicago, Ill. v. Shunk Mfg. Co., 68 S.W.2d 772, 774 (Ky. 1934). Among these principles, the Court included one that was referenced in the Amic Curiae Brief filed by the Kentucky Association of Manufacturers and joined by the Kentucky Chamber of Commerce, that “a distinction could be drawn between materials and supplies and parts, that distinction being that materials and supplies are designed and intended to be used up in the manufacturing process and parts simply wear out.” Century Aluminum, supra, at 18, (citing Mansbach, 521 S.W.2d at 86-87) (emphasis added); see also Amici Curiae Brief, at 10, n.5. The Court therefore agreed with the KCC’s ultimate finding that the items were categorized as tax exempt because all items at issue were tangible personal property that had direct use in manufacturing in a manufacturing facility and had a useful life of less than one year.
This decision impacts all Kentucky manufacturers. As explained in the Amici Curiae Brief , manufacturing is undisputedly the “economic engine” of Kentucky, accounting for 17.8% of the total output in the state and employing 13.29% of the workforce; the total output from manufacturing in Kentucky was $38.33 billion in 2019. Amic Curiae Brief, supra, at 1. Every manufacturer with a plant in Kentucky purchases supplies used in their manufacturing operations to which the manufacturing supplies exemption of KRS 139.470(9)(b)2.b may apply to exempt such supplies for sales and use tax purposes. Accordingly, this particular exemption is of widespread application and importance to many Kentucky taxpayers. Now, those taxpayers have clarity on the supply exemption’s scope.
The authors, Mark A. Loyd, Bailey Roese, Stephanie Bruns and Collier Clay, and their law firm, represent Amic , Kentucky Association of Manufacturers and the Kentucky Chamber of Commerce.
December 29, 2022