Century Aluminum of Kentucky, Gp v. Department of Revenue, Finance and Administration Cabinet Commonwealth of Kentucky ( 2021 )

RENDERED: JULY 9, 2021; 10:00 A.M.
NOT TO BE PUBLISHED
Commonwealth of Kentucky
Court of Appeals
NO. 2020-CA-0301-MR
CENTURY ALUMINUM OF KENTUCKY, GP APPELLANT
APPEAL FROM FRANKLIN CIRCUIT COURT
v. HONORABLE THOMAS D. WINGATE, JUDGE
ACTION NO. 19-CI-00424
DEPARTMENT OF REVENUE,
FINANCE AND ADMINISTRATION CABINET
COMMONWEALTH OF KENTUCKY APPELLEE
OPINION
AFFIRMING
** ** ** ** **
BEFORE: JONES, MAZE, AND TAYLOR, JUDGES.
MAZE, JUDGE: Appellant, Century Aluminum of Kentucky, GP (“Century”),
appeals the Franklin Circuit Court’s order holding certain items are subject to sales
and use tax under KRS1 139.470(9).2 For the following reasons, we affirm.
1
Kentucky Revised Statutes.
2
On April 27, 2018, KRS 139.470(10) was amended and renumbered as KRS 139.470(9). The
amendment does not affect the issues in this case.
BACKGROUND
Century manufactures aluminum in its facility in Hawesville,
Kentucky. For its manufacturing process, Century purchased anode stubs,
Inductotherm lining, thermocouples and tube assemblies, welding wire, and
industrial gases (collectively, the “items”) from Kentucky vendors. The vendors
charged tax on these items, which was then paid to Appellee, Commonwealth of
Kentucky, Finance and Administration Cabinet, Department of Revenue (the
“Department”).
Initially, Century paid the six percent (6%) sales and use tax to the
vendors, who then remitted the tax to the Department. Because Century believed
the items were exempt from the sales and use tax, the vendors, on Century’s
behalf, filed refund requests pursuant to KRS 139.770. The refund requests
covered the items purchased from November 2010 to May 2015. The Department
denied the refund requests for each item stating the items were “repair,
replacement, or spare parts,” which are not exempt from sales and use tax under
KRS 139.470(9).
The vendors entered into agreements assigning their rights to the
refunds to Century. See KRS 134.580(2). Then, Century, as assignee, requested
final rulings from the Department for the items in question. See KRS 131.110(4).
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The Department issued seven separate final rulings denying the refund claims. See
KRS 131.110(3).
Century appealed the seven final rulings with the Kentucky Claims
Commission (the “Commission”). See KRS 49.220(3). The Commission
consolidated the seven appeals and an evidentiary hearing was held in September
2018. The hearing officer recommended that Century’s refund requests be paid
because the items were exempt supplies under KRS 139.470(9). The Commission
subsequently adopted the hearing officer’s recommendation and issued a final
order on March 27, 2019.
The Department appealed the Commission’s final order to the
Franklin Circuit Court, pursuant to KRS Chapter 13B and KRS 49.250. On
February 3, 2020, the circuit court reversed the Commission’s final order, finding
the items were not exempt from the sales and use tax under KRS 139.470(9)
because the items were “repair, replacement, or spare parts,” which are taxable.
This appeal, pursuant to KRS 13B.160, followed. Additional facts will be
developed as necessary.
STANDARD OF REVIEW
Pursuant to KRS 13B.150(2), a circuit court shall not substitute its
judgment for that of the Commission “as to the weight of the evidence on
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questions of fact.” However, the circuit court may reverse the Commission’s final
order if it finds the order is:
(a) In violation of constitutional or statutory provisions;
(b) In excess of the statutory authority of the agency;
(c) Without support of substantial evidence on the whole
record;
(d) Arbitrary, capricious, or characterized by abuse of
discretion;
(e) Based on an ex parte communication which
substantially prejudiced the rights of any party and likely
affected the outcome of the hearing;
(f) Prejudiced by a failure of the person conducting a
proceeding to be disqualified pursuant to KRS
13B.040(2); or
(g) Deficient as otherwise provided by law.
KRS 13B.150(2).
Here, the parties do not dispute that the findings of facts were
supported by substantial evidence in the record. Instead, Century disputes the
circuit court’s interpretation of the relevant statutes: KRS 139.470(9) and KRS
139.010(34).3 We review statutory interpretation cases as a matter of law de novo.
3
KRS 139.010(34), effective June 27, 2019, was previously numbered KRS 139.010(35) and,
before that, KRS 139.010(26). The renumbering of this statute does not affect the issues in this
case.
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Louisville Edible Oil Prod., Inc. v. Revenue Cabinet Kentucky, 957 S.W.2d 272,
274 (Ky. App. 1997) (citations omitted).
ANALYSIS
For its appeal, Century argues that the circuit court erred by not
harmonizing KRS 139.470(9)(b)2., which states that certain items are tax-exempt,
with KRS 139.010(34), which is the definition statute for KRS Chapter 139.
Specifically, Century claims the two statutes conflict by exempting certain items
from the sales and use tax while also defining certain items as subject to the sales
and use tax.
Because this appeal involves the construction and application of the
sales and use tax exemption, we begin our analysis with the observation that “tax
exemptions are disfavored and will be narrowly or strictly construed, with all
doubts resolved against the exemption’s application . . . .” Popplewell’s Alligator
Dock No. 1, Inc. v. Revenue Cabinet, 133 S.W.3d 456, 461 (Ky. 2004).
Accordingly, we resolve close questions concerning statutory exemptions against
awarding an exemption. We now turn to the statutes at issue.
According to KRS 139.470(9), certain items are exempt from taxes,
including:
(a) Gross receipts derived from the sale of tangible
personal property, as provided in paragraph (b) of this
subsection, to a manufacturer or industrial processor if
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the property is to be directly used in the manufacturing or
industrial processing process of:
1. Tangible personal property at a plant facility;
....
(b) The following tangible personal property shall qualify
for exemption under this subsection:
1. Materials which enter into and become an
ingredient or component part of the manufactured
product;
2. Other tangible personal property which is
directly used in the manufacturing or industrial
processing process, if the property has a useful life
of less than one (1) year. Specifically these items
are categorized as follows:
a. Materials. This refers to the raw
materials which become an ingredient or
component part of supplies or industrial
tools exempt under subdivisions b. and c.
below;
b. Supplies. This category includes
supplies such as lubricating and
compounding oils, grease, machine waste,
abrasives, chemicals, solvents, fluxes,
anodes, filtering materials, fire brick,
catalysts, dyes, refrigerants, and explosives.
The supplies indicated above need not come
in direct contact with a manufactured
product to be exempt. “Supplies” does not
include repair, replacement, or spare
parts of any kind; and
c. Industrial tools. This group is limited to
hand tools such as jigs, dies, drills, cutters,
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rolls, reamers, chucks, saws, and spray guns
and to tools attached to a machine such as
molds, grinding balls, grinding wheels, dies,
bits, and cutting blades. Normally, for
industrial tools to be considered directly
used in the manufacturing or industrial
processing process, they shall come into
direct contact with the product being
manufactured or processed; and
3. Materials and supplies that are not reusable in the
same manufacturing or industrial processing process
at the completion of a single manufacturing or
processing cycle. A single manufacturing cycle
shall be considered to be the period elapsing from
the time the raw materials enter into the
manufacturing process until the finished product
emerges at the end of the manufacturing process.
(c) The property described in paragraph (b) of this
subsection shall be regarded as having been purchased
for resale.
(d) For purposes of this subsection, a manufacturer or
industrial processor includes an individual or business
entity that performs only part of the manufacturing or
industrial processing activity, and the person or business
entity need not take title to tangible personal property
that is incorporated into, or becomes the product of, the
activity.
(e) The exemption provided in this subsection does
not include repair, replacement, or spare parts[.]
(Emphasis added). The phrase “repair, replacement, or spare parts,” as used in the
statute, is defined in KRS 139.010(34)(a)-(b) as “any tangible personal property
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used to maintain, restore, mend, or repair machinery or equipment” and “does not
include machine oils, grease, or industrial tools[.]”
Century contends that these two statutes conflict because almost all
items that qualify for a tax-exemption under KRS 139.470(9)(b)2.b. are also used
to “maintain, restore, mend, or repair machinery or equipment” and, thus, not
exempt under KRS 139.010(34)(a)-(b). If these two statutes are not harmonized,
Century claims that KRS 139.470(9) is meaningless and null.
In response, the Department argues that harmonization of KRS
139.470(9)(b)2.b. with KRS 139.010(34) is unnecessary because the two statutes
do not conflict. The Department notes that KRS 139.470(9) provides examples of
exempt items and KRS 139.010(34) merely defines “repair, replacement, or spare
parts” as used in KRS 139.470(9).
At the September 2018 hearing of this matter, three witnesses testified
regarding the items at issue. William Morgan, a technical manager for Century
with thirty years of experience in the aluminum industry, testified that each item
had a useful life of less than one year, was used directly in manufacturing, at a
manufacturing facility, and was tangible personal property. These are criteria
outlined in KRS 139.470(9). Mr. Morgan also testified that, at the end of each
item’s useful life, the items had no value or were scrap. Additionally, Century had
Robert C. Clark, a certified public accountant and retiree from the Department,
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testify regarding the statutes at issue. Mr. Clark testified that the items were tax-
exempt and the two governing statutes conflict. Finally, Richard Dobson, an
executive director with the Department, testified that the sales and use tax
exemption was not applicable to the items. Thus, Mr. Dobson testified that the
Department correctly denied Century’s refund request.
After the hearing, the Commission concluded that the items at issue
were not “repair, replacement, or spare parts” and, thus, were tax-exempt. The
Commission, relying on Mansbach Metal Co. v. Department of Revenue, 521
S.W.2d 85, 87 (Ky. 1975), held that a distinction must be drawn between items that
are used up and items that simply wear out to determine if the items are tax-
exempt. Based on Mr. Dobson’s testimony that the Department does not consider
this distinction, the Commission held that the Department erroneously interpreted
KRS 139.470(9) and KRS 139.010(34) because “[a]lmost all exempt supplies” also
fit the definition of non-exempt supplies. To harmonize these statutes, the
Commission adopted Century’s proposed four-part test4 to conclude that the items
4
Century’s four-part proposed test is: (1) Determine the useful life of the tangible personal
property at issue if the machine or equipment that the tangible personal property allegedly
maintains, restores, mends, or repairs is operating without the introduction of the product being
manufactured. (2) Determine the useful life of the tangible personal property at issue if the
machine or equipment that the tangible personal property allegedly maintains, restores, mends,
or repairs is operating with the introduction of the product being manufactured. (3) If there is a
difference in the useful lives of the tangible personal property between (1) and (2), then the
tangible personal property is being consumed in the manufacturing process and is exempt from
tax. (4) If there is no difference in the useful life of the tangible personal property between (1)
and (2), then the tangible personal property is a taxable repair, replacement, or spare part.
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at issue were designed to be used up in the manufacturing process and, thus, were
tax-exempt.
On appeal, the circuit court reversed the Commission’s final order and
held that the two relevant statutes do not conflict. The circuit court held that KRS
139.470(9) provides examples of tax-exempt items, but also makes clear that if the
items are purchased as “repair, replacement, or spare parts,” then they are not tax-
exempt. The circuit court then found that each item was used as “repair,
replacement, or spare parts” and, thus, were taxable as discussed below.
First, the circuit court addressed the anode stubs used in Century’s
manufacturing process. The anode stubs are part of the larger anode assembly
consisting of the anode rod and a “yolk,” to which the anode stubs are welded
using the welding wire and industrial gases. Century’s witness, Mr. Morgan,
testified that the anode stubs are used to “maintain” the anode assembly and that
replacing the anode assembly is necessary to maintain the entire manufacturing
process. Because “repair, replacement, or spare parts” is defined as “any tangible
personal property used to maintain, restore, mend, or repair machinery or
equipment,” the circuit court concluded that anode stubs were not tax-exempt
under the statutes.
Second, the circuit court addressed the welding wire and industrial
gases, which Mr. Morgan testified were necessary to join the anode stub to the
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yoke. Based on Mr. Morgan’s testimony that the welding wire and industrial gas
must be used to “restore” the anode assembly, the circuit court held that these
items met the definition of “repair, replacement, or spare parts” and, thus, were not
tax-exempt.
Third, the circuit court addressed the thermocouples and tube
assemblies, which Mr. Morgan testified act as a thermometer and need regular
replacing due to metal fatigue from the high temperature baths in the
manufacturing process. Because Mr. Morgan testified that the thermocouples and
tube assemblies were purchased to “replace” existing ones, the circuit court held
that they qualify as replacement parts and were not tax-exempt.
Finally, the circuit court addressed the Inductotherm lining, which Mr.
Morgan testified separates the molten cast iron from the furnace components in the
manufacturing process. Because Mr. Morgan testified that the Inductotherm lining
was used to “maintain” the induction furnaces, the circuit court held that this item
was not tax-exempt.
Because each of the foregoing items were “repair, replacement, or
spare parts,” as defined in KRS 139.010(34), the circuit court concluded that
Century was not entitled to a refund. Furthermore, the circuit court rejected
Century’s proposed four-part test because it “ignore[d] the fact that all tangible
personal property used in the manufacturing process wears down or is used up”
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and this test would only serve to exempt nearly all items from the sales and use tax
in KRS 139.470(9). Instead, the circuit court held that the proper test is whether
items of tangible personal property are introduced into the manufacturing process
“to maintain, restore, mend, or repair machinery or equipment” as set forth in KRS
139.010(34) or whether items of tangible personal property are used up or
consumed because of their involvement in the manufacturing process. If an item is
used “to maintain, restore, mend, or repair machinery or equipment,” then it is
subject to the sales and use tax. However, if the item is used up or consumed
because of its involvement in the manufacturing process, then it is not subject to
the sales and use tax.
After careful review, we conclude that the two statutes at issue are not
in conflict. While KRS 139.470(9) outlines items that are exempt from the sales
and use tax, this statute also clearly excludes items purchased as “repair,
replacement, or spare parts” from the exemption. That exclusion is contained
within KRS 139.470(9). Then, the Legislature defined that exclusion in KRS
139.010(34), which is the definition statute for KRS Chapter 139. Therefore, the
two statutes do not need to be harmonized and we hold that the circuit court
correctly interpreted the statutes at issue.
Also, we agree with the circuit court’s rejection of Century’s proposed
four-part test. In KRS 139.470(9), the Kentucky Legislature set forth the
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parameters for how to classify an item as tax-exempt or taxable. Clearly, the
Legislature intended for certain items in the manufacturing process to be tax-
exempt and for other items to be taxable. In light of the express language of the
statute, the circuit court properly interpreted the statutes and applied the
Legislature’s words as written to evaluate the items at issue. We also agree with
the circuit court’s application of the law to the facts to conclude that the items were
introduced “to maintain, restore, mend, or repair machinery or equipment” and,
therefore, are taxable.
At this point, we recognize Century’s argument that the Department
improperly attached evidence to its appellate brief. Century urges the Court to
disregard the Department’s references to the Legislature’s intent regarding KRS
139.470(9) because those materials were not part of the record below and can only
be introduced when a statute is considered ambiguous.
As a general matter, Century is correct that evidence not offered or
introduced as evidence in the lower court, with exceptions, will not be considered
by an appellate court. However, we also note that we are bound by KRS
446.080(1), which directs that “[a]ll statutes of this state shall be liberally
construed with a view to promote their objects and carry out the intent of the
legislature[.]” Accordingly, “the cardinal rule of statutory construction is that the
intention of the legislature should be ascertained and given effect.” MPM Fin.
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Grp., Inc. v. Morton, 289 S.W.3d 193, 197 (Ky. 2009) (citation omitted). “We also
bear in mind that where the language of a statute is clear and unambiguous on its
face, we are not free to construe it otherwise even though such construction might
be more in keeping with the statute’s apparent purpose.” Id. (citation omitted).
In this case, the language of KRS 139.470(9) and KRS 139.010(34) is
clear and unambiguous. The Court did not need to examine the legislative history
referenced by the Department to interpret the language of the statutes or ascertain
the Legislature’s intent. See Cummings v. Covey, 229 S.W.3d 59, 61 (Ky. App.
2007).
CONCLUSION
In conclusion, the circuit court properly interpreted the statutes and
applied the law to the facts to conclude that the items were taxable as “repair,
replacement, or spare parts” under KRS 139.470(9) and KRS 139.010(34). For the
foregoing reasons, we affirm the circuit court’s order.
JONES, JUDGE, CONCURS.
TAYLOR, JUDGE, DISSENTS AND DOES NOT FILE A
SEPARATE OPINION.
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BRIEFS FOR APPELLANT: BRIEF FOR APPELLEE:
Steven L. Lenarz Richard W. Bertelson, III
Goshen, Kentucky Frankfort, Kentucky
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