Big Thaw: DFA Reverses Opinion and Treats Freezer as Manufacturing

The Department of Finance and Administration (DFA) recently published a letter opinion, no. 20151008-S (Apr. 4, 2016), allowing a poultry blast freezer to obtain the reduced rate of sales tax on electricity used in manufacturing. This letter opinion was a reversal of a previously issued opinion, no. 20151008 (Feb. 9, 2016), which had wrongly denied the low rate on the basis that blast freezing was not actual manufacturing. (See our prior post criticizing the opinion.) This about-face demonstrates a benefit of tax transparency: The taxpayer community can identify erroneous legal interpretations and get them corrected.

In February, the Department of Finance and Administration had issued the initial ruling denying a taxpayer the benefit of the low 0.625% rate of tax for sales of electricity or natural gas to manufacturers for use directly in the manufacturing process.  Instead of looking to the NAICS code as specified by Arkansas Code Annotated section 26-52-319(a)(1), the opinion considered whether the taxpayer was engaged in "actual manufacturing," determined that it was not, and denied the benefit of the low rate. This opinion was erroneous in that it did not focus on NAICS codes, and also in that it did not consider a sales tax regulation, Rule GR-64(d)(2), that treated quick freeze processing as manufacturing.

The new ruling corrects these errors. First it considers NAICS codes, observing that the processes should be categorized under NAICS code 311615, poultry processing, which is within the manufacturing sectors of the NAICS system. Next, the opinion turns to whether the equipment is used "directly" in manufacturing. The fact that Rule GR-64(D)(2) expressly includes "quick freeze" processing in the manufacturing process is controlling.

To cap off the good news for poultry freezers, the opinion also advises that electricity used for the temporary cold storage of frozen items after processing was complete also can qualify for the low rate. Rule 2007-5, which governs the low rate of sales tax on manufacturers' purchases of utilities, has specific language in subparagraph (B)(7)(b) allowing the use of electricity in supporting activities to qualify, including "temporary cooling/chilling areas at the beginning or at the end of the process which are needed to enhance, maintain, and protect the integrity of the product...."

Tax transparency appears to have been the catalyst for the correction of the February opinion. We commented to DFA about the troubling original opinion; others may have done the same. DFA's receptiveness to this input is heartening. Indeed, simultaneous with the revision of this opinion, DFA also revised an earlier opinion dealing with the same issue, no. 20140508-S (Apr. 4, 2016). That original opinion had been issued in December 2014, more than a year before tax transparency took effect at the beginning of 2016. Presumably DFA's error would have languished uncorrected if not for transparency.

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