DS Waters of America, Inc. v. Commonwealth of PA , 2016 Pa. Commw. LEXIS 513 ( 2016 )

IN THE COMMONWEALTH COURT OF PENNSYLVANIA
DS Waters of America, Inc., :
Petitioner
:
:
v. :
:
Commonwealth of Pennsylvania, : No. 370 F.R. 2013
Respondent : Argued: October 20, 2016
BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge
HONORABLE P. KEVIN BROBSON, Judge
HONORABLE DAN PELLEGRINI, Senior Judge
OPINION BY
SENIOR JUDGE PELLEGRINI FILED: November 30, 2016
DS Waters of America, Inc. (DS Waters) seeks review of an order of the
Board of Finance and Revenue (Board) denying sales and use tax relief for equipment
utilized at its two water processing facilities in Pennsylvania for the period of January
1, 2007, through March 31, 2010, because DS Waters failed to qualify for the
manufacturing exclusion under the Tax Reform Code of 1971 (Tax Code).1 For the
reasons that follow, we affirm.
I.
Section 202 of the Tax Code imposes a tax on “each separate sale at
retail of tangible personal property,” 72 P.S. § 7202(a), as well as a tax “upon the use
1
Act of March 4, 1971, P.L. 6, as amended, 72 P.S. §§ 7101-10004.
. . . within this Commonwealth of tangible personal property purchased at retail. . . .”
72 P.S. § 7202(b). However, the Tax Code excludes the manufacture of tangible
personal property from sales and use tax as such manufacture is specifically excluded
from the definitions of both “sale at retail” and “use.”2 The Department of Revenue’s
(Department) regulations also provide that “[t]he purchase or use of tangible personal
property or services performed thereon by a person engaged in the business of
manufacturing or processing shall be exempt from tax if such property is
predominantly used directly by him in manufacturing or processing operations.” 61
Pa. Code § 32.32.
Section 201(c) of the Tax Code specifically defines the term
“manufacture” as “[t]he performance of manufacturing, fabricating, compounding,
processing or other operations, engaged in as a business, which place any tangible
personal property in a form, composition or character different from that in which it
is acquired whether for sale or use by the manufacturer….” 72 P.S. § 7201(c). This
provision is applicable to all taxes levied under the Tax Code.
2
See Section 201 of the Tax Code, 72 P.S. §§ 7201(k), (o). The definition of “sale at retail”
provides, in pertinent part:
The term “sale at retail” shall not include . . . (ii) such rendition of
services or the transfer of tangible personal property including, but
not limited to, machinery and equipment and parts therefor and
supplies to be used or construed by the purchaser directly in the
operations of—
(A) The manufacture of tangible personal property.
72 P.S. § 7201(k)(8)(A). The definition of “use” provides a similar exclusion for the use of tangible
personal property, including machinery and equipment. See 72 P.S. § 7201(o)(4)(B).
2
The Department’s regulations define the term “manufacturing” as:
The performance as a business of an integrated series of
operations which places personal property in a form,
composition or character different from that which it was
acquired whether for sale or use by the manufacturer. The
change in form, composition or character shall result in a
different product having a distinctive name, character and
use. Operations such as compounding, fabricating or
processing are illustrative of the types of operation which
may result in a change although any operation which has
that result may be manufacturing. Mere changes in
chemical composition or slight changes in physical
properties are not sufficient.
61 Pa. Code § 32.1. Notably, the Department’s regulatory definition goes on to
provide the following example:
the C Company, as its business operation, takes coffee
beans and thereafter, by mechanical and hand labor cleans
them, removes the outer skins and roasts the beans. The
roasted coffee, resulting from the C Company’s activities, is
not a manufactured product, notwithstanding the fact that
there has been a change in color, weight and size of bean.
Id.As our Supreme Court has noted, the definition of manufacture
emphasizes two separate criteria – the type of activity at issue and the result of that
activity:
To constitute ‘manufacture,’ first, the type of the activity
must fall into one or more categories, i.e. ‘manufacturing,
3
fabricating, compounding, processing or other operations
and second, as a result of one or more types of the
prescribed activities, the personal property must be placed
‘in a form, composition or character different from that in
which [such personal property]’ was acquired.
Commonwealth v. Sitkin’s Junk Co., 194 A.2d 199, 202 (Pa. 1963) (emphasis and
alteration in original). The burden is on the taxpayer to prove that the transaction
sought to be taxed is either not within the Tax Code or is subject to an exemption. Id.
at 204. Furthermore, the manufacturing provision at issue here “must be strictly
construed against the taxing authority, not the taxpayer, since the statute provides for
an exclusion from taxation, not an exemption.” Commonwealth v. Air Products &
Chemicals, Inc., 380 A.2d 741, 743 (Pa. 1977) (citing Sitkin’s Junk Co., 194 A.2d at
204; Statutory Construction Act of 1972, 1 Pa.C.S. § 1928(b)(3)).
Against this backdrop, we turn to the specific facts of this case.
II.
Suntory Water Group, Inc. (Suntory Water) was a Delaware corporation
registered to conduct business in Pennsylvania. It maintained several locations
throughout Pennsylvania, including a water processing facility in Carnegie. Suntory
Water previously appealed to the Board a Pennsylvania tax assessment for the period
of January 1, 1990, through June 30, 1993, asserting that it was entitled to the
manufacturing exclusion to the sales and use tax for capital purchases and utilities
consumed in its operations. In a decision dated March 1, 1995, the Board concluded
that equipment used by Suntory Water to transform source water into purified water
and distilled water qualified for the manufacturing exclusion, explaining:
4
Although the resulting form of the finished product is
essentially the same as the source product, the composition
and character of the finished product is technically very
different from that in which it was acquired. Unlike the
freezing of ice, which does not constitute manufacturing,
the above processing of water results in a permanent
chemical change which enables the different uses of the end
product. . . . Moreover, the resulting water product, once
distilled or made into drinking water, does not eventually
“revert” back to its original state (as does ice), but is
permanently altered until it is used. Additionally, bottled
water, whether it is distilled or otherwise transformed from
tap water into drinking water, is federally regulated as a
food product by the U.S. Food and Drug Administration
(FDA), and must meet specific standards to be labeled as
such.
(Exhibit 17 to Stipulation of Facts, at p. 4) (emphasis in original).
In 1998, the Board of Appeals again ruled favorably to Suntory Water.
Citing to the Board’s 1995 decision, the Board of Appeals held that various steps of
Suntory Water’s production process qualified as manufacturing, including filling,
capping, coding and dating of bottles, as well as loading the bottles onto racks for
labeling and distribution.
III.
Through various mergers, acquisitions, conversions and name changes,
Suntory Water is now DS Waters. DS Waters operates water processing facilities in
Carnegie and Ephrata, Pennsylvania, in which it takes water from municipalities3 and
3
Municipal source water is regulated by the Environmental Protection Agency (EPA) and
must be kept separate from spring water at all times. Bottled water is regulated by the FDA and
must comply with the Federal Food, Drug, and Cosmetic Act as well as federal regulations.
5
converts it to purified water, and then takes purified water and heats and condenses it
to make distilled water (collectively, water products).
To produce purified and distilled water, DS Waters uses stainless steel
tanks with various levels of quartz, rocks, media and sand to filter out the turbidity
and various particles, suspended material and impurities in the source water. It then
softens the source water with filters so that the hardness does not scale up its pipes
and machinery. Additional filters are used to remove a variety of chemicals typically
present in source water that affect its flavor, including chlorine and chloramines. The
source water then goes through a final polishing filter, an ultraviolet sterilizer and the
reverse osmosis process. At this point, the source water qualifies as “purified water.”
To produce distilled water, the source water is further treated through steam
distillation to remove any remaining substances, chemicals, metals, bacteria, etc.
This involves heating the water until it reaches a gaseous state and then condensing
the water vapor back into a liquid form.
Following an audit, the Department issued a sales and use tax
assessment to DS Waters for the period of January 1, 2007, through March 31, 2010,
in the amount of $412,597.06, including penalties and interest.4 The Department
4
The assessment was broken down as follows:
State Sales Tax Deficiency: $83,019.21
Allegheny County Sales Tax Deficiency: 5,031.66
State Use Tax Capital Deficiency: 173,868.87
Allegheny County Use Tax Deficiency: 7,556.18
State Use Tax Expense Deficiency: 62,838.07
Allegheny Use Tax Expense Deficiency: 5,050.57
Penalties: 29,669.23
(Footnote continued on next page…)
6
determined that DS Waters did not qualify for the manufacturing exclusion and,
therefore, assessed a use tax deficiency for certain equipment and supplies purchased
and used at both facilities during the audit period, including: plastic bottles and
associated freight; bottle racks, tiers, pallets, stackers, destackers and material
handling equipment; municipal water equipment, compressors, line reactors, mixers,
vent lines, clamps and hoses; and labor charges. Stipulation of Facts, ¶ 8.
DS Waters paid the full amount of the assessment on or about July 6,
2011. It then appealed, and on September 12, 2012, the Board of Appeals revised the
audit assessment liability to $332,816.93 plus interest.
DS Waters then appealed to the Board, conceding the State Sales Tax
Deficiency and the Allegheny County Sales Tax Deficiency, but continuing to
challenge the entire Use Tax Deficiency. By decision dated March 29, 2013, the
Board denied the petition for review, concluding that DS Waters failed to
demonstrate that its activities in producing purified and distilled water products5
(continued…)
Interest: 45,563.27
Total: $412,597.06
5
The initial audit determined and the Board agreed that DS Waters’ operations of collecting
water from springs qualified for the mining exemption to the Tax Code. Pursuant to the
Department’s regulations, “mining” is defined as:
Commercial mining both deep and strip mining, quarrying, gas and
oil drilling, and other commercial removal of natural resources,
minerals or mineral aggregates from the earth or from waste or stock
piles or from pits or banks including blast furnace slag. Water well
(Footnote continued on next page…)
7
qualified for the manufacturing exclusion pursuant to Section 201(c) of the Tax Code,
72 P.S. § 7201(c). The Board agreed with the Department that DS Waters’
operations failed to place the water in a form, composition or character different from
that in which the water was acquired, and that the water essentially retained the same
identity after going through the various processes at DS Waters’ facilities. In
addition, the Board held that DS Waters failed to establish that the Department was
estopped from assessing tax on the items in question due to the Board’s 1995 decision
with respect to Suntory Water.
DS Waters then appealed to this Court seeking a refund of $244,766.06
in use tax,6 as well as a refund of $33,140.01 in interest paid and statutory interest.
(continued…)
drillers shall be considered to be engaged in mining and shall be
entitled to the mining exemption.
61 Pa. Code § 32.1. The Commonwealth conceded this determination in its brief to this Court and
during oral argument. As such, DS Waters’ spring water products are not at issue in this appeal.
6
The specific assessed taxes being appealed are as follows:
State Use Tax Capital Deficiency: $173,868.87
Allegheny County Use Tax Deficiency: 7,556.18
State Use Tax Expense Deficiency: 58,903.25
Allegheny Use Tax Expense Deficiency: 4,437.76
Total: $244,766.06
8
IV.
A.
On appeal,7 DS Waters first argues that it qualifies for the manufacturing
exclusion because the processing and manufacturing of its purified and distilled water
products causes a permanent change in the composition and character of the source
water. In support of this argument, DS Waters relies primarily on two cases –
Sitkin’s Junk Co. and Air Products & Chemicals, Inc.
The taxpayer in Sitkin’s Junk Co. was engaged in the scrap business
wherein it bought mixed and unsorted scrap, removed the unusable and unsalable
portions, sorted the remaining scrap, cut the scrap into convenient lengths or baled it,
and sold it to steel mills. The mixed, unsorted scrap that the taxpayer started with had
little, if any, commercial value; yet after the handling and preparation by the
taxpayer, the scrap became a component highly useful in the production of steel. The
Supreme Court found that the taxpayer in Sitkin’s Junk Co. was entitled to the
manufacturing exclusion8 because, as a result of the above process, the scrap was in
“a form, composition and character” different from the scrap which it had originally
7
In appeals from decisions of the Board of Finance and Revenue, our review is de novo
because we function as a trial court even though such cases are heard in our appellate jurisdiction.
Glatfelter Pulpwood Company v. Commonwealth of Pennsylvania, 19 A.3d 572, 576 n.3 (Pa.
Cmwlth. 2011) (en banc), aff’d, 61 A.3d 993 (Pa. 2013).
8
The statute at issue in Sitkin’s Junk Co. was the Selective Sales and Use Tax Act of 1956
(Act of 1956), Act of March 6, 1956, P.L. (1955) 1228, as amended, 72 P.S. § 3403-1 – 3403-605,
repealed by the Act of March 4, 1971, P.L. 6. The definition of manufacture under the Act of 1956
was identical to that currently contained in Section 201(c) of the Tax Code, except the Act of 1956
omitted the word “tangible.”
9
acquired – “that which was useless ha[d] been rendered useful.” Sitkin’s Junk Co.,
194 A.2d at 204.
Air Products & Chemicals, Inc. involved a taxpayer engaged in the
making and selling of medical and industrial gases such as nitrogen, oxygen and
argon. The processes taxpayer utilized to make these gases included compressing
and purifying atmospheric air, cooling the air to a point where it would pass to a
liquid state, distilling the liquid into its constituent elements, and then vaporizing the
elements into separate gases. At issue was the taxpayer’s use of equipment at
“customer stations” wherein it would install complex equipment at a buyer’s location
to hold and maintain the products in their liquid form prior to conversion to gas.
Again, the Supreme Court held that the taxpayer was entitled to the manufacturing
exclusion9 because “the result of the process which the liquid product undergoes in
the customer station is to place it in a form, composition or character different from
that in which it is acquired.” Air Products & Chemicals, Inc., 380 A.2d at 744
(citation omitted).
DS Waters argues that, similar to these two cases, it takes municipal
source water, puts it through various complicated processes to remove impurities, and
9
Air Products & Chemicals, Inc. involved the manufacturing exclusion to the use tax
imposed by the Tax Act of 1963 for Education, Act of May 29, 1963, P.L. 49, 72 P.S. § 3403-1 –
3403-605. This act was repealed by the Tax Code, and reenacted in large part by Article II of the
Tax Code. See 72 P.S. § 7201 et seq. The Tax Act of 1963 for Education defined the term
“manufacture” as “[t]he performance of manufacturing, fabricating, compounding, processing or
other operations, engaged in as a business, which place any personal property in a form,
composition or character different from that in which it is acquired whether for sale or use by the
manufacturer. . . .” 72 P.S. § 3403-2(c).
10
transforms it into completely different products. According to DS Waters, if this
production merely resulted in a “superficial change” to the source water, the
specialized equipment, FDA regulations and strict requirements for chemical
composition would all be unnecessary.
However, those cases are not factually similar. The processes involved
in sorting, cutting and baling scrap and making industrial gases is not at all similar to
the filtration process DS Waters utilizes to “convert” municipal water into purified
and distilled water. Further, we note that the Commonwealth in Air Products &
Chemicals, Inc. conceded that the taxpayer’s processes amounted to manufacturing.
The issue in that case was when did that particular manufacturing process end, and
whether the final step of the process at taxpayer’s customer stations involved actual
manufacturing or merely storage. Therefore, Air Products & Chemicals, Inc. and
Sitkin’s Junk Co. are inapposite and DS Waters’ reliance upon them is misplaced.
More analogous is the long line of cases involving the filtration and
pasteurization of other products holding that activity did not justify a manufacturing
exclusion. For example, in Stewart Honeybee Products, Inc. v. Commonwealth, 579
A.2d 872 (Pa. 1990), the taxpayer’s business involved “processing raw honey in such
a way that it [was] transformed from a crystalline mass into a liquid which has been
pasteurized and filtered to remove impurities.” Id. at 873. The honey was also
blended for flavor, heated and cooled to various temperatures to kill bacteria, and
packaged in containers of various sizes. The Supreme Court held that the taxpayer
was not entitled to the manufacturing exemption because, despite these filtration and
pasteurization processes, the basic substance was “not substantially changed, and
11
[was] not, therefore, a new, different and useful item.” Id. at 874 (emphasis in
original). Similar results were reached in Commonwealth v. Tetley Tea Company,
Inc., 220 A.2d 832, 834 (Pa. 1966) (holding that the procedures involved in
processing and packaging loose tea into specially designed bags did not make it a
new and different product as “[t]he process starts and ends with tea.”); Rieck-
McJunkin Dairy Co. v. School District of Pittsburgh, 66 A.2d 295 (Pa. 1949),
(holding that pasteurization of milk and certain milk products did not qualify as
manufacturing); Commonwealth v. Lowry-Rodgers Co., 123 A. 855 (Pa. 1924)
(holding that cleaning coffee beans, removing their outer skins and roasting them was
not manufacturing); and Commonwealth v. Glendora Products Co., 146 A. 896 (Pa.
1929) (roasting coffee was not manufacturing).
Moreover, Commonwealth v. Sunbeam Water Co., 130 A. 405 (Pa.
1925), dealt with whether the manufacturing exclusion should apply to the production
of distilled water. There was no specific definition of the term “manufacture” in
1925 when Sunbeam was decided. Rather, the courts generally went by the premise
that the Legislature intended the word be taken in its ordinary and general meaning.
As for the wording of the Act of July 22, 1913, P.L. 903 regarding the capital stock
tax, it exempted from taxation only so much of the capital stock of a corporation “as
may be invested in any property or business not strictly incident or appurtenant to its .
. . manufacturing business . . . it being the object of this proviso to relieve from State
taxation only so much of the capital stock as is invested purely in the . . .
manufacturing plant and business.”
12
Our Supreme Court in Sunbeam rejected the taxpayer’s argument that
the process of distilling water brought about significant chemical changes in the
source of water, and instead held that the process did not result in a change in the
form, composition or character of the water. It also said, by way of analogy, that
purified water was not manufacturing. As the court explained:
the boiling and consequent cleaning of water does not make
the resulting water a manufacture thereof. It would hardly
be contended that, if water were put through a sand or
charcoal filter for the purpose of cleansing it of impurities,
that this would constitute manufacture of the cleansed
water, and we fail to see in essentials how the process used
by [taxpayer] is different.
Id. at 406.
Even though distilled water is sometimes used differently than purified
water does not necessarily mean that distilled water is entitled to the manufacturing
exclusion. Ice is used by hospitals to “ice wounds,” make ice balls, keep beverages
cold, etc. However, in Marweg v. Commonwealth, 513 A.2d 525 (Pa. Cmwlth.
1986), we held that the making of ice did not qualify for the manufacturing exclusion
to the Tax Code. Moreover, DS Waters is not entitled to the manufacturing exclusion
just because there might be a specialized market for some of its distilled water
products, including laboratories, food manufacturers, hospitals and medical settings.
As noted in the above cases, the focus of the manufacturing determination is not upon
the ultimate use of the product, but whether the process utilized by the taxpayer
brings about a change in the form, composition or character of the original substance.
The fact that the taxpayer’s end product may potentially be put to a different use than
13
the original substance is not, in and of itself, dispositive of the issue of
manufacturing. If it were, then processing honey from a crystalline mass into a liquid
that can be readily consumed by the general public would constitute manufacturing,
see Stewart Honeybee; filtering and pasteurizing milk into sour cream and condensed
milk would constitute manufacturing, see Rieck-McJunkin; cleaning, skinning and
roasting coffee beans would constitute manufacturing as the beans could now be used
to make coffee, see Lowry-Rodgers and Glendora Products; etc. Moreover, we note
that the stipulation of facts in this case fails to contain any information regarding DS
Waters’ distilled water products, let alone to what “new” uses such products may be
put.
It is true that several of the above cases denying application of the
manufacturing exclusion involved taxes other than the sales and use tax now
contained within the Tax Code. Specifically, Sunbeam Water Co. and Stewart
Honeybee involved the manufacturing exemption to various versions of the capital
stock tax. Again, those cases focused on the end product and whether the processes
utilized by the taxpayers brought about a change in the form or condition of the basic
substance, which is essentially the same definition of manufacture currently found in
the Tax Code. In addition, in determining that the filtration of honey did not
constitute manufacturing for purposes of the capital stock tax, our Supreme Court
looked to its determination in Ski Roundtop v. Commonwealth, 553 A.2d 928 (Pa.
1989) for guidance, a case involving the manufacturing exclusion to the use tax in the
Tax Code and not the capital stock tax. See Stewart Honeybee, 579 A.2d at 872-73.
Similarly, Rieck-McJunkin involved mercantile taxes and Tetley Tea involved the
imposition of the franchise tax; however, both cases concentrated on the taxpayers’
14
final products and whether the processes they used created a new and different
product. In Tetley Tea, the Supreme Court acknowledged that it had previously
defined the term “‘manufacturing’ to be the application of skill and labor to materials
so that there results a new, different and useful product,” and that “the manufacturing
process must have substantially transformed the ingredients in form, quality and use”
in order to qualify for the exclusion. Tetley Tea, 220 A.2d at 833-34 (citations
omitted). Again, this definition of the term manufacture and the crux of these cases
are similar to the current manufacturing exclusion found in the Tax Code.
Given all of the above, we find that DS Waters failed to meet its burden
of demonstrating that it is entitled to use tax relief based upon the manufacturing
exclusion to the Tax Code.
B.
DS Waters also argues that because the Board and Board of Appeals
both determined that its predecessor, Suntory Water, qualified for the manufacturing
exclusion in 1990-1993, the Department is collaterally estopped from assessing use
tax on tangible personal property that DS Waters purchased and used to perform
water processing activities at its facilities in Carnegie and Ephrata in 2007-2010.
According to DS Waters, these previous administrative decisions regarding Suntory
Water compel the same result in the current tax appeal. We disagree.
First, we note that DS Waters’ estoppel argument relies, in part, upon an
unpublished panel decision of this Court, Corning Asahi Video Products Co. v.
Commonwealth, (Pa. Cmwlth., No. 5 F.R. 2003, filed April 27, 2005). Pursuant to
15
Section 414 of this Court’s Internal Operating Procedures, as an unpublished
decision, Corning Asahi may only be cited for its persuasive value and not as binding
precedent. Second, we do not find the estoppel argument to be persuasive in this
context. In Commonwealth v. Western Maryland Rail Road Company, 105 A.2d 336,
340 (Pa. 1954), our Supreme Court denied the appellant’s argument that the
Commonwealth was estopped from assessing a tax due to “the failure of officials
who, acting under a mistaken impression of the applicable law, either did not impose
the taxes or compromised them for lesser amounts than were properly due.” In
reviewing the extensive case law in this area, the court stated:
It is a fundamental legal principle that a State or other
sovereignty cannot be estopped by any acts or conduct of its
officers or agents in the performance of a governmental as
distinguished from a proprietary function. No errors or
misinformation of officers or agents can estop the
government from collecting taxes legally due. However
firmly established the rule as to private individuals or
corporations that where a person has been induced to act to
his detriment by the representations of an agent he can hold
the principal on the theory of estoppel, that rule does not
apply when a government is the principal. . . . In
Commonwealth v. Taylor’s Ex’r, [] 147 A. 71, 74 [(Pa.
1929)], it was said: ‘Defendant’s contention is, in effect,
that the letter of the auditor general operated to altogether
estop the commonwealth. No authority is given for this
contention, and we know of none. As a sovereign state we
cannot be thus estopped.’ . . . In Commonwealth v. A.M.
Byers Co., []31 A.2d 530, 532 [(Pa. 1943)], it was said:
‘No administrative officer or body, exercising discretion
conferred by the legislature, is vested with the power to
abrogate the statute law of the Commonwealth, or to grant
to individuals an exemption from the general operation of
the law. . . . It is well settled that no estoppel can be
asserted against the State in the exercise of its taxing
power.’
16
Id. at 340-41. We hold that the Department was not estopped from assessing a use
tax against DS Waters due to a decision of an administrative board issued to a
predecessor in interest regarding its operations during a separate tax year. Moreover,
we note that our review of the decision of the Board is de novo.
Accordingly, the order of the Board is affirmed.
__________________________________
DAN PELLEGRINI, Senior Judge
17
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
DS Waters of America, Inc., :
Petitioner
:
:
v. :
:
Commonwealth of Pennsylvania, :
Respondent : No. 370 F.R. 2013
ORDER
AND NOW, this 30th day of November, 2016, the order of the Board
of Finance and Revenue in the above-captioned matter is affirmed. The parties
have 30 days from the entry of this order in which to file exceptions. Pa. R.A.P.
1571(i).
__________________________________
DAN PELLEGRINI, Senior Judge