The Arkansas Supreme Court upheld the sales and use tax manufacturing exemption for steel grit used to make pipes in Walther v. Welspun Tubular, LLC, 2021 Ark. 90 (Apr. 22, 2021). This case provides significant clarification of (1) the plant expansion exemption, (2) the articles of commerce requirement, and (3) the continuing utility of equipment requirement. As such, it should be of interest to almost all manufacturers. The positions on each of these issues that were upheld by the court are broader than what the Department of Finance and Administration (DFA) generally has allowed. Arkansas manufacturers should consider whether they can benefit from applying these principles to their own tax situations.
Welspun manufactures steel pipe at a facility in Little Rock, Arkansas. Pipe is custom made to a buyer's specifications. Part of the manufacturing process is to blast the pipe with a mix of steel grit and shot to prepare the surface for an epoxy coating.
The question in this case was whether the grit qualified for the manufacturing exemption. Like most states, Arkansas offers a manufacturing machinery and equipment exemption. See Ark. Code Ann. §§ 26-52-402, 26-53-114; Rule GR-55. The Arkansas exemption is relatively narrow and has a number of requirements, several of which were examined in this case.
Plant Expansion: Look to General Expansion
First the court allowed the application of the relatively more favorable plant expansion arm of the the manufacturing exemption. The Arkansas exemption applies more broadly to machinery and equipment purchased and used to create new manufacturing plants or expand existing manufacturing plants, in contrast to the narrower requirement of replacing substantially all of an essential function in an existing, non-expanding facility. So plant expansion is more favorable to the taxpayer if it qualifies.
In its analysis the Arkansas Supreme Court looked at the general facts of Welspun's expansions rather than tying the steel grit to a particular phase of the expansion. The grit was usable over multiple cycles (discussed below), but it was not as though all the grit purchases were specifically associated with the one-time fit-out of the plant expansion. The court specifically found that increasing employment by 50 percent and increasing productivity in the applicable process by two-thirds were sufficient evidence of the expansions. The court did not require a closer connection between the grit and the expansion.
While the distinction between plant expansion versus other replacement of equipment is becoming less important due to the phase in of the manufacturing repair parts and services exemption of Ark. Code Ann. § 26-52-447 (an increasing rebate until full exemption July 1, 2022), manufacturers with growing or modernizing facilities may be able to benefit from this general approach to applying the plant expansion part of the manufacturing exemption.
Articles of Commerce: Custom Sales Can Satisfy
Another requirement of the manufacturing exemption is that the equipment be used to manufacture an article of commerce. Since all of Welspun's production was to buyers' custom specifications as opposed to standard products for sale to the general public, the DFA argued that the produced steel pipe was not an article of commerce and did not qualify.
The Supreme Court rejected this argument, holding that the trial court's findings in support of articles of commerce requirement were not clearly erroneous: that the pipes were sold (1) in the public marketplace in all 50 states and (2) to all the major oil and gas producers and transportation companies.
Taxpayers who face issues about whether their products meet the articles of commerce requirement, such as printers or fabricators, should consider whether the reasoning in Welspun would also apply to their situations.
Continuing Utility: Wearing Out Over Multiple Cycles Can Satisfy
The DFA also disputed whether the grit really was durable equipment that could qualify for this exemption, as opposed to a taxable purchase of a consumable used in production. The court rejected this argument and upheld classification of the grit as equipment. The facts showed that the grit could be reused thousands of times before wearing out to dust.
With the continuing phase-in of the tax exemption for manufacturing repair parts and services (full exemption July 2022), this distinction between equipment and consumables is becoming more and more important. Taxpayers should consider whether purchases that wear out periodically, but are used more than once, can qualify as equipment under Welspun. In many instances the answer may be yes.
Deference to the Trial Court, Not Precedent
The Supreme Court treated the circuit (trial) court's determinations on each of the above issues as findings of fact and applied a clearly erroneous standard in reviewing them. DFA was unable to surmount this heavy burden. Query whether the taxpayer would have prevailed in an appeal if the DFA had won on any of the issues in the trial court.
The Court also notably distinguished prior precedent denying the manufacturing exemption, C&C Machinery, Inc. v. Ragland, 278 Ark. 629 (1983), explaining that the "nearly insurmountable" earlier standard of qualifying for an exemption beyond a reasonable doubt was no longer the law. Perhaps other Arkansas precedents denying exemptions are similarly vulnerable, particularly if the taxpayer can prevail in trial court.
Welspun raises a number of questions and opportunities. It is not yet clear how DFA will respond. Manufacturers should consider their positions and consult with their advisors as to how to proceed. And all Arkansas taxpayers should be aware of the broader trends toward deferring to the trial court and to skepticism over old cases denying exemptions under a beyond a reasonable doubt standard.