Minnesota Tax Court Denies Sales Tax Exemption for Purchase of Capital Equipment

When interpreting sales tax exemptions with ambiguous language, courts generally construe the language narrowly, as was the case in this Minnesota Tax Court decision addressing a sales tax exemption for certain capital equipment purchases.

By Alissa Graffius, SALT Senior Associate

It is not uncommon for a state to provide dozens of exemptions from sales tax, some of which are broad (e.g., manufacturing machinery) and some very narrow (e.g., Georgia currently provides an exemption for the sale of tangible personal property used in the renovation and expansion of the Georgia Aquarium).  It is important to identify the specific requirements of an exemption, and to understand that to the extent the statutory language is ambiguous, courts will generally resolve such ambiguity in favor of the state.  On Sept. 14, 2018, the Minnesota Tax Court issued an opinion in which it addressed the applicability of an exemption for capital equipment purchased and used by a taxpayer that provides an online e-discovery document retrieval system.[1]

Kroll Ontrack, LLC (“Kroll”), the taxpayer, provides technology-driven data recovery, document review and electronic discovery services primarily to law firms, corporate law departments, and governmental entities. Kroll’s e-discovery and document review system relies on two programs – Advanceview and Inview – that work together to sort, search and select relevant documents from large databases.

To use the system, Kroll’s client must upload documents to Advanceview along with keywords. The keywords allow the system to associate the documents with relevant searches. When a search is run, relevant documents appear and are transferred to a second database which is accessible using Kroll’s Inview program. The Inview program distributes selected documents to reviewers for further review. After the documents are distributed among reviewers, Kroll’s Inview program allows users to categorize and prioritize the documents. As reviewers are categorizing and prioritizing the documents, Kroll’s Inview program will suggest appropriate categorizations. Finally, the system allows the client to prepare documents for production in discovery. Clients log onto Kroll’s servers using secure credentials in order to access such information; however, only the client’s specific documents can be accessed.

In order to support and expand its system, Kroll purchased equipment for which it paid sales tax. Kroll subsequently filed for a refund of sales tax on the equipment purchased. The Minnesota Department of Revenue denied the refunds, and Kroll appeal to the Minnesota Tax Court.

Minnesota has a sales tax exemption for the purchase of “capital equipment,” which is defined to include “machinery and equipment used primarily to electronically transmit results retrieved by a customer of an online computerized data retrieval system.”[2] The statute defined “online computerized data retrieval system” to mean “a system whose cumulation of information is equally available and accessible to all its customers.”[3]

Initially, the Minnesota Tax Court looked to the plain language of the exemption statute and explained that in order for the purchased machinery and equipment to qualify for the exemption, the system of which they are a part (1) must be online, (2) must be computerized, and (3) must retrieve data. Additionally, the machinery and equipment’s primary use must be to electronically transmit results from the system to the customer. Kroll’s system is online, is computerized, retrieves data, and the machinery/equipment electronically transmits the results to its customers. Thus, the system appears to meet the exemption definition.

However, the Court then noted that the statue provides a specific definition of an “online data retrieval system.” In addressing its interpretation of this definition, the Court noted that since the statute provides an exemption from tax, the language must be construed narrowly.  Kroll argued that its system met the definition because it is not the information that must be equally available and accessible to all customers; rather, it is enough that the tools used to search the system and retrieve information from it (i.e., Advanceview and Inview) are equally available and accessible.

The Court disagreed, and read the statute as requiring that the information itself be equally available and accessible to all customers.  In this case, since each customer can only access the specific documents that it has uploaded (i.e., documents uploaded by other customers are not accessible).  Therefore, the Court concluded that Kroll’s system does not meet this requirement, and accordingly, the purchased machinery and equipment does not qualify for the exemption.

This ruling demonstrates that the plain language in tax statutes is often open to multiple interpretations, and that when it comes to tax exemptions, Courts will often side with an interpretation that results in a narrow application of the exemption.  Taxpayers should be aware of this as they evaluate the potential applicability of a specific exemption to their business.

Aprio’s SALT team can assist taxpayers with determining how a particular tax exemption may apply to their business considering all available guidance and we will make sure that you properly claim all applicable exemptions.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Alissa Graffius, SALT senior associate at alissa.graffius@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the October 2018 SALT Newsletter.

[1] Kroll Ontrack, LLC v. Commissioner of Revenue, Docket No. 8977-R, (Minn. Tax Court, Sept. 14, 2018).

[2] Minn. Stat. § 297A.68, subd. 5(a).

[3] Minn. Stat. § 297A.68, subd. 5(d)(8).

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.

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