In Quality Driven Copack, Inc. v. Commonwealth of Pennsylvania, No. 879 F.R. 2013 (decided December 29, 2021) (opinion not reported), the Pennsylvania Commonwealth Court (the “Commonwealth Court”) held that for the Taxpayer to qualify under the manufacturing exclusion for sales and use tax purposes, there must be a physical change in form to the product or products. The Commonwealth Court also reversed the Board of Finance and Revenue’s (the “BFR”) determination that sales and use tax was properly assessed on the Taxpayer relative to the use of help supply services and subsequently remanded the matter back to the BFR.
The Taxpayer is a Pennsylvania corporation engaged in the business of assembling pre-cooked frozen ingredients into frozen sandwiches and other entrees to be sold at wholesale. To create its finished product, the Taxpayer would purchase the food components, blend them together, and then freeze them to be sold as frozen meals. The Taxpayer claimed that it was engaged in manufacturing and processing for sales and use tax purposes in Pennsylvania as is defined under 72 P.S. § Section 201(c) and (d) and 61 Pa. Code § 32.1.
Taxpayer vehemently argued that the materials utilized in its manufacturing process, while initially various food items, were transformed by its manufacturing process into a full meal, ready for quick preparation and consumption by the ultimate consumer. Taxpayer referenced the case of Edwin Bell Cooperage Co v. Pittsburgh, 112 A.2d 662 (Pa. Super. 1955), stating that the assembly of kegs and barrels from existing parts was determined to be manufacturing because the finished keg is a permanent structure with parts which are not interchangeable and cannot be taken apart and reassembled – thus a new product is made out of materials which in combination create an article with distinctive character and use.
The Commonwealth Court disagreed, finding the Taxpayer’s comparison to the Edwin Bell Cooperage Co. case unconvincing. The Taxpayer was met with staunch disagreement from the Commonwealth Court, which argued that a physical change in form, composition or character is missing from the Taxpayer’s packaging operation. The Commonwealth Court instead paralleled the Taxpayer’s operations to that in Commonwealth v. Tetley Tea Co., 220 A.2d 832 (Pa. 1966), in which the separation of tea from foreign matter, blending it, and placing precise amounts in specifically designed bags was not manufacturing because the entire process started and ended with tea. The Commonwealth Court emphasized that merely assembling pre-cooked frozen food ingredients in a package is not manufacturing under the strict and limited definition in the Tax Code.
In addition to its manufacturing arguments, the Taxpayer also claimed that use tax was erroneously assessed on expense transactions including certain services that it claims were erroneously characterized as help supply services. The Commonwealth Court argued that the services provided by the staffing contractors hired by the Taxpayer are taxable help supply services because the Taxpayer retained control over the production operation and employed a plant manager to oversee all activities of the plant. The Commonwealth Court looked closely at the degree of ground-level direction provided by the contractor versus that retained by the Taxpayer. The Commonwealth Court concluded that evidence presented by the Taxpayer, including affidavits from a supervisor for one of the vendors that provided labor to the Taxpayer and the vice president of Taxpayer’s company, showed that the contractors worked independently on the plant floor with very little oversight by the Taxpayer and therefore, the Commonwealth Court could not say that the Taxpayer provided the requisite level of direction for the third party labor services to be considered taxable help supply services.
Ultimately, the Commonwealth Court reversed the BFR’s decision that sales and use tax was properly assessed on the Taxpayer relative to the use of help supply services but remanded the matter back to the BFR to determine what amount, if any, the Taxpayer was assessed in sales and use tax as it relates to the help supply services. The Commonwealth did affirm the Orders of the BFR relative to whether the Taxpayer was engaged in manufacturing for purposes of a sales and use tax exclusion.
Many taxpayers are quick to jump on this manufacturing exclusion from sales and use tax – but as seen here, it is not an easy argument to make – the taxpayer must be able to meet the threshold set in the Tax Code calling for a physical change in form rather than a mere assembly of individual items into packaging and calling it manufacturing.
