Indiana Department of Revenue v. Interstate Warehousing, Inc.

Citations: 783 N.E.2d 248; 2003 Ind. LEXIS 117Docket: 49S10-0205-TA-266

Court: Indiana Supreme Court; February 14, 2003; Indiana; State Supreme Court

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Interstate Warehousing, Inc. operates refrigerated warehouses in Indiana, using electricity to liquify ammonia for chilling purposes. The company sought to avoid sales and use taxes on its electricity purchases, claiming a statutory exemption. However, the Indiana Supreme Court ruled that Interstate does not qualify for this exemption, as its use of ammonia does not constitute the 'production of other tangible personal property' and it is not classified as being in the 'business of processing.' The Indiana Tax Court had previously granted Interstate a refund for sales and use taxes totaling $91,566.85 paid from 1993 to 1996, but this decision was overturned on appeal. The statutory exemption applies only to tangible personal property acquired for direct consumption in the production of other tangible personal property within specific industries, which does not apply to Interstate's operations.

Tangible personal property includes 'electrical energy.' Interstate claims its electricity purchases qualify for a sales and use tax exemption, asserting entitlement to a refund. Exemption statutes are strictly construed against taxpayers unless legislative intent is compromised. Therefore, Interstate bears the burden to prove its eligibility for the exemption. The court found that Interstate failed to meet the criteria for the exemption in two ways: it is not engaged in the 'production of other tangible personal property' and does not operate in recognized business activities such as manufacturing or agriculture. 

Specifically, while Interstate uses electricity to convert gaseous ammonia to liquid for cooling purposes, this transformation does not meet the statute's definition of 'production.' For the exemption, the electricity must be used to create a distinct marketable good, which does not occur as the liquid ammonia is not marketed. The Tax Court has previously clarified that byproducts must have market value to qualify as 'production,' as demonstrated in related cases. Therefore, Interstate's activities do not satisfy the statutory requirements for the exemption.

The taxpayer was found not to be engaged in the production of textiles but rather perpetuating textiles made by others. In the case of Faris Mailing, the Tax Court determined that the taxpayer, which processed mailing items, did not qualify for a sales and use tax exemption as it was not producing tangible property; the items involved did not transform the customer’s package into a new product. In Indianapolis Fruit Co. v. Department of State Revenue, the court distinguished between the active transformation of bananas through ethylene gas, which constituted production, and the passive ripening of tomatoes, which did not. The common element in these cases is that the Tax Court ruled that if a taxpayer does not transform property into a distinct marketable product, it is not engaged in production. 

Applying this reasoning to Interstate’s liquefaction of ammonia, while it may meet the transformation requirement, it fails to produce a distinct marketable good since the liquefied ammonia is not sold to its customers. Moreover, to qualify for the exemption, a business must be involved in manufacturing or processing as defined by the Indiana Administrative Code, which requires substantial change through an integrated series of operations. Interstate claims it processes chilled ammonia to produce conditioned air, but the analysis suggests that it does not create a transformed end product for its customers, indicating it does not meet the processing requirement.

Interstate is not classified as engaging in the "business of processing" because the cool air it provides merely maintains previously manufactured goods without altering their form, composition, or character. The Tax Court's ruling favored Interstate, heavily referencing the case of Mid-America Energy Resources, Inc. v. Indiana Dept. of State Revenue. In Mid-America, the taxpayer provided chilled water for air conditioning, which was processed and sold as a distinct marketable product, thereby qualifying for a tax exemption on chemicals purchased for this process. While both Interstate and Mid-America utilized similar chilling and distribution systems, the essential difference lies in the nature of their services: Interstate offers storage for frozen goods, not a sale of processed ammonia. Customers of Interstate do not purchase the ammonia nor pay sales tax on it, unlike Mid-America's customers who purchased chilled water. Additionally, Interstate claimed an exemption from sales and use tax for energy purchases, but eligibility for this exemption requires the purchase to be for the production of tangible personal property, which has been determined not applicable to Interstate's operations.

The Indiana Tax Court's judgment is reversed, affirming the Indiana Department of Revenue's denial of Interstate's exemption from sales and use tax under Ind. Code. 6-2.5-5-5.1. The relevant statutory language remained unchanged during the tax years in question. The Tax Court has previously addressed the issue of 'tax pyramiding'—where a taxpayer pays sales tax on production inputs and transfers this cost to customers, resulting in multiple tax burdens. Although the Tax Court suggests that certain economic activities should only be taxed once at the final retail sale, it recognizes that such determinations are better suited for legislative action. The denial of the exemption in this case, as in the White River case, is attributed to the absence of a product subject to sales or use tax at the customer level.