Missouri Court Applies Integrated Plant Doctrine to Manufacturing Exemption

States typically provide exemptions for manufacturing machinery and equipment, include repair and replacement parts, but the breadth of those exemptions varies by state based on a variety of factors. As this Missouri case illustrates, each item purchased must be analyzed independently.

By:  Tina M. Chunn, SALT Senior Manager

Most states provide some form of sales tax exemption for manufacturing machinery and equipment, including replacement and repair parts. However, states vary in application of their exemptions due to different interpretations of several issues, such as defining what constitutes “manufacturing” and determining when the manufacturing process starts and ends.

Within the manufacturing process itself, some states limit the exemption to the machines/equipment that specifically transform the raw materials into the final product, while others apply a broader  “integrated plant doctrine” that recognizes manufacturing as a continuous process involving machines that are essential to the process, even though they may not physically change the raw materials. On June 16, 2020, the Supreme Court of Missouri issued an opinion in which it applied the integrated plant doctrine to the taxpayer’s purchase of replacement parts.[1]

In this case, B&B Timber Company, a sawmill that manufactures a variety of timber-related products, hired Dreyer Electric Co., LLC to install a new electrical system in one of its manufacturing buildings following a fire. Ultimately, Dreyer sought a refund of approximately $6,400 in sales taxes it paid on the purchase of all electrical items installed in B&B’s facility. These items included: soft starters to avoid power surges that could disrupt service for other electric customers; circuit breakers to stop electricity from flowing to various machines in the event of a malfunction; overload relays to stop machinery that overheats; as well as conduits, connectors, couplings, wires and other equipment (collectively referred to as the “disputed items”).

The Director of Revenue denied the refund claim and Dreyer appealed to the Administrative Hearing Commission (AHC). The AHC found the disputed items constituted replacement equipment used directly in the manufacturing process, and therefore approved the full refund for all electrical items purchased by Dreyer. The Director appealed, arguing that the exemption should only apply to replacement equipment used to transform raw materials into a finished product.

The Court rejected the Director’s argument, explaining that although the state’s manufacturing exemption applies to “replacement machinery, equipment, and parts . . . used directly in manufacturing,” prior cases have applied a three-factor integrated plant test to determine if such items are “used directly in manufacturing.” The three-factor test considers the following questions:

• Is the item necessary to production?
• How close, physically and casually, is the item to the finished product?
• Does the item operate harmoniously with the admittedly exempt machinery to make an integrated and synchronized system?

The Court agreed that AHC correctly applied the integrated plant test to exempt the soft starters, circuit breakers and overload relays, which are necessary to operate the sawmill machinery safely and without overloading the electrical system. In addition, the AHC properly exempted the starters, connectors and disconnectors, and power and control wires that were necessary to power the manufacturing equipment.

However, the Court disagreed with the AHC’s determination that all the electrical equipment was exempt (based on AHC’s assumption that because the major equipment described above was exempt, every item was exempt). For example, the Court agreed with the Director that electric outlets, lights, and lamps that are of general use do not meet the integrated plant test because they are not necessary to operate the equipment – therefore, the Court remanded the case to AHC to consider each specific item in the refund claim applying the integrated plant test.

When reviewing purchases for a manufacturing exemption, it is important to identify how each item purchased falls within the state’s requirements. Even though machinery may not physically act on the raw material to change its composition in some way, this does not mean the machinery won’t qualify for the exemption. For example, some states may exempt material handling and testing equipment.

Aprio’s SALT team is experienced with state manufacturing exemptions and can assist you in correctly applying these exemptions to your purchases. In addition, we can conduct “reverse audits” to determine if you are entitled to refunds of sales tax paid on any machinery and equipment previously purchased that should have been exempt, and we will prosecute those refund claims on your behalf. 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 Tina Chunn, SALT Senior Manager  at tina.chunn@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 July 2020 SALT Newsletter.

[1] Dryer Electric Co., LLC v. Director of Revenue, No. SC98007 (Supreme Court of Missouri, June 16, 2020).