Arkansas Issues Guidance on the Scope of Manufacturing

Manufacturers are often exempt from sales and use tax on machinery they purchase, but the definition of “manufacturing” isn’t always clearly defined in state regulations.

By Jeff Glickman, SALT partner

Most states exempt manufacturers from paying sales and use taxes on machinery and equipment they purchase to manufacture the goods that they sell. However, in order to take advantage of that exemption, the taxpayer must be viewed as a “manufacturer,” which means that it must be engaged in “manufacturing” something. Unfortunately, what constitutes “manufacturing” is not always clearly defined in the state statutes or regulations. Recently, the Arkansas Supreme Court (the “Court) issued an opinion on the scope of manufacturing. [1] The state Department of Finance and Administration (“DFA”) then issued a Revenue Legal Counsel Opinion regarding the application of the manufacturing exemption in response to the Court’s decision. [2]

In the case before the Court, the taxpayer operated a water treatment plant which turns raw water into potable drinking water and asserted that it was entitled to an exemption on its purchases of property used in the plant because it was engaged in manufacturing. Specifically, the taxpayer described an extensive three-stage mechanical and chemical process that occurs at the plant. First, raw surface water undergoes a pretreatment process known as “trash or debris removal,” in which large items are screened and removed and certain chemicals are injected to remove contaminants that could affect the taste and odor of the water. Next, the water undergoes the flocculation process, where additional chemical applications are added that “settle out microscopic particles” and clarify the water. Finally, the water is exposed to chemicals such as chlorine and fluoride before it passes through a “Backwash Tank” and into the “Final Filter Tanks.”

Under Arkansas law, there is not a specific definition of “manufacturing.” All the statute says is that “manufacturing . . . refer[s] to and include[s] those operations commonly understood within [its] ordinary meaning.” [3] The DFA argued that the exemptions should not apply because the plant only cleans the water and does not manufacture it. Relying on a prior case, the Court noted that:

Manufacture implies a change, but every change is not manufacture, and yet every change in an article is the result of treatment, labor, and manipulation. But something more is necessary…There must be a transformation; a new and different article must emerge, having a distinctive name, character or use. [4]

Based on this guidance, the Court held that the taxpayer did not engage in manufacturing, stating that “It was water in the beginning, and it was water in the end.”

In the Revenue Legal Counsel Opinion, the DFA addressed the applicability of the manufacturing equipment exemption to a taxpayer that operated a roofing rock granule processing facility. Essentially, the taxpayer takes crushed rock and heats, dyes and further crushes the rock into its marketable form. Relying on the Court’s decision, the DFA concluded that the taxpayer is not entitled to an exemption because it is not engaged in manufacturing, stating that “[I]t is rock in the beginning, and it is rock in the end.”

Taxpayers need to be aware of whether their operations qualify as manufacturing in order to purchase equipment and machinery without paying sales/use tax. In the Arkansas case, it seems as if the Court took a very simplistic view of the operations – treating it plainly as “water in, water out.” Alternatively, the Court could have viewed the operation as “raw water in, drinking water out,” which might have satisfied the Court’s own guidance that the new article that emerges have a distinctive name, character or use. Under that view, would the fact that the treated water is suitable to drink qualify as a new use?

Aprio has experience assisting taxpayers with understanding how their operations will be viewed for sales tax purposes (despite how the taxpayer views itself) and how that classification will impact their sales and use tax obligations. These issues are vitally important in order to ensure that you remain in compliance and minimize your risk of sales and use tax exposure.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the August 2016 SALT Newsletter. To view the newsletter, click here.

[1] Walther v. Carrothers Construction Company of Arkansas, LLC, 2016 Ark. 209 (May 19, 2016).

[2] Arkansas Revenue Legal Counsel Opinion No. 20140817S (June 21, 2016).

[3] Ark. Code § 26-52-402(b).

[4] Ragland v. Arkansas Valley Coal Services, 275 Ark. 108, 109 (1982).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.