Tennessee Rules that the Manufacturing Sales Tax Exemption Does Not Require Production of a New Product

By: Tina M. Chunn, SALT Senior Manager

At a glance

• The main takeaway: A Tennessee court ruled in favor of a taxpayer’s sales tax exemption claim for manufacturing machinery and equipment used in processing their products, even if it does not produce a new or substantially different product.
• Assess the impact: It’s worth noting that while the court agreed with the taxpayer, other state’s definitions of “manufacturing” or “processing” may require that the end-product be new or substantially different.
• Take the next step: Aprio’s State and Local Tax (SALT) team can help your business identify exemptions and successfully obtain refunds of sales tax paid on manufacturing equipment and other inputs. 

Schedule a free consultation today to learn more!

The full story:

Many states provide manufacturers and/or processers of tangible personal property with sales tax exemptions that can cover a wide range of inputs, such as machinery, equipment and materials.  However, the scope of those exemptions differs among states due to different statutory language and the interpretation of that language. For example, one common issue is whether a particular activity actually constitutes manufacturing or processing. This was the issue addressed by a recent Tennessee Court of Appeals opinion.¹

A closer look at the case

The taxpayer leases hygienically clean textiles to customers for a single use in a variety of industries, including food and beverage, healthcare, and hospitality and lodging. These leases include such items as sheets, towels, napkins, tablecloths, and uniforms and can be new or used. If the items are new, the taxpayer first sanitizes them before they are leased to customers. Once used, they are often heavily soiled and must be sanitized again before provided for lease to the next customer.

The Tennessee Department of Revenue (Department) initially provided the taxpayer with sales and use tax certificates that granted an industrial machinery exemption for its Tennessee facilities. However, a month later, those certificates of exemption were revoked after the Department concluded that the taxpayer’s business did not qualify for the industrial manufacturing exemption. 

Tennessee defines industrial machinery as “machinery apparatus and equipment and all associated parts . . . that is necessary to, and primarily for, the fabrication or processing of tangible personal property for resale and consumption off premises . . . by one who engages in such fabrication or processing as one’s principal business.”² Since there was no dispute that the tangible personal property is consumed off the taxpayer’s premises and that the taxpayer’s activity is its principal business, the focus of this case was whether the taxpayer’s operations should be treated as “processing.”

The road to define “processing”

The Court noted first that Tennessee statutes do not define the term processing. However, Tennessee courts have looked to other jurisdictions in prior rulings to provide guidance on the definition of processing as applied to sales tax exemptions. Specifically, in Beare Co v. Tennessee Department of Revenue,³ the court was asked to address whether the taxpayer’s two methods of preserving food products constituted “processing.”⁴ The first process included blast freezing of fresh or raw food products, and the second was the preservation of already frozen foods to keep them in a frozen state. 

Without guidance in Tennessee, the court in Beare looked to the definition of processing from Ohio courts which concluded that “processing” is “essentially a transformation or conversion of materials or things into a different state or form from that in which they originally existed – the actual operation incident to changing them into marketable products.” Applying that definition, the court concluded that the blast freezing caused the food products to undergo certain chemical changes while the preservation storage merely maintained the product in the same form. Accordingly, the court ruled that the blast freezing met the definition of processing while the preservation operation did not. 

Breaking down the ruling

In the case, the taxpayer argued that its sanitation operations meet the definition of processing. Specifically, the sanitization process requires the application of a chemical process to the textiles to break the bond between the contaminants and the fibers and chemically changes those soils to remove the contaminants to make the textiles fit for consumption. In addition, the sanitization process similarly removes oils and other waxes from new textiles. Prior to the process, the product was not absorbent or safe, and after the process, the product has been altered and can be used safely and effectively by the taxpayer’s customers. 

The Department disagreed, arguing that the items are the same before and after going through the taxpayer’s sanitation process (i.e., uniforms in, uniforms out) and that the process does not result in a new or substantively different product. 

The Court agreed with the taxpayer. It noted that Tennessee’s adopted definition of “processing” does not require a new or substantively different product, but rather that the end-product be in “a different state or form from that in which [it] originally existed”⁵ The Court went even further, stating that, “We find nothing in the Beare decision indicating that the change in state or form cannot be to a state or form the textile has been in at some point in the past. All that is required is that each time the articles or materials are submitted to a taxpayer’s operations, they must be in a state or form different than the state or form they were in prior to undergoing the process.”

The bottom line

Aprio’s SALT team has experience with sales tax exemptions for manufacturers and processors. We have assisted companies with identifying exemptions and successfully obtaining refunds of sales tax paid on manufacturing equipment and other inputs. 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.

This article was featured in the October 2023 SALT newsletter.

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¹ Alsco, Inc. v Tennessee Department of Revenue, M2022-01019-COA-R3-CV, 09/06/2023.

² Tenn. Code Ann.  Sec. 67-6-102(46)(A)(i).

³ 858 S.W.2d 906, 908-09 (Tenn. 1993).

⁴ This would allow the taxpayer in that case a reduced sales and use tax rate.

⁵ It is worth noting that other states’ definitions of “manufacturing” or “processing” may require that the end-product of the operation be a new or substantively different product.