Did Taxpayer create a new product when it flattened slabs of raw steel, aluminum, and paper pulp?

Indiana allows an exemption from sales and use tax for items directly used or consumed in the direct production of tangible personal property.  The Indiana Tax Court last month concluded that a Taxpayer’s grinding and calibrating of work rolls used by mills was manufacturing – not simply repair work.  In Hoosier Roll Shop Services, LLC v. Indiana Department of Revenue, Cause No. 49T10-1104-TA-29 (May 14, 2014), the Court analyzed four questions in reaching this decision and reversing the Department’s assessment of sales and use tax for Taxpayer’s purchases of items used in its remanufacturing process.  Slip. Op. at 11-12.

Customers demanded precision rolling.  Mills use large work rolls to flatten slabs of raw steel, aluminum, and paper pulp into sheets of finished products.  The process is high-tech and precise.  The rolls “operate like giant rolling pins to create the proper thickness, flatness, surface texture, and luster of the sheet product as it passes between them.”  Slip op. at 2-3 (footnotes omitted).  The rolling process must be accurate.  Even minuscule errors could turn the rolled product into scrap.  The surfaces of the work rolls, therefore, must be ground and calibrated to exact specifications.  On average, each work roll is ground and calibrated 40 times to produce different sheet products over its usable life.

Four questions.  Indiana’s industrial exemptions for sales and use tax require the production of other tangible personal property.  Slip op. at 8 (citations omitted).  The parties agreed on the issue before the Court:  whether Taxpayer produced a new good in grinding and calibrating the work rolls.  Taxpayer argued that it created entirely new tools for new uses in modifying the rolls.  The Department responded that, instead, Taxpayer merely provided a repair service designed to perpetuate the work roll’s usable life.  To analyze the issue, the Court turned to four questions first articulated in its 1998 decision, Rotation Products Corp. v. Department of State Revenue.

1.  What is the substantiality and complexity of the work done on the existing article and what are the physical changes to the existing article, including the addition of new parts?

The Court found that Taxpayer made substantial physical changes to its customers’ work rolls.  Whether new and blank or previously ground and calibrated, the work rolls “must be physically altered before [they] can be used to produce a specified sheet product.”  Slip op. at 9.  Taxpayer “convincingly explained” that it created “an entirely new tool for a different use.”  Id.  Taxpayer did not, as asserted by the Department, merely begin and end with a “giant rolling pin that is used to flatten things.”  Id.  That analysis was woefully simplistic, failing to recognize that the intended use of the remanufactured rolling pin was “very different from the use and form of the work roll when the customer first delivered it to” Taxpayer.  Id.

2.  How does the article’s value before and after the work compare?

The Court found that Taxpayer’s grinding and calibration process adds value to a work roll.  Slip op. at 9.  The Court explained:  “This is evidenced by the fact that at the time a customer brings its work rolls to [Taxpayer], it can no longer use them for their specified purposes.”  Slip op at 9-10.  Once remanufactured, each work roll is “transformed into a new tool.”  Slip op. at 10.  The Department argued that Taxpayer’s process resulted only in “use value” to customers, which failed to increase the value or marketability of the work rolls.  The Court noted, however, that it has previously “rejected the notion that the term ‘value’ does not encompass use value.”  Slip op. at 10 (citing Rotation Products Corp., 690 N.E.2d at 802).

3.  How favorably does the performance of the “remanufactured” article compare with the performance of newly manufactured articles of its kind?

It was undisputed that “each time a work roll is ground and calibrated to certain specifications, its performance as a work roll is no less favorable than its performance as a work roll with the previously ground and calibrated specifications.”  Slip op. at 10.

4.  Was the work performed contemplated as a normal part of the life cycle of the existing article?

The Court concluded that Taxpayer’s grinding and calibration process was not “contemplated as a normal part of a work rolls’ life cycle.”  Slip op. at 11.  It was not “routine maintenance.”  Id.  Taxpayer transformed the work rolls “into entirely new and different tools that are used by its customers to create entirely new and different sheet products.”  Id.

The answer to each of the four questions favored Taxpayer, which the Court held “produces other tangible personal property when it grinds and calibrates its customers’ work rolls.”  Slip op. at 12.