Ruling 94-8, Sales and Use Taxes / Motor Vehicle Fuels Tax / Scrap Metal Processing / Manufacturing
FACTS:
A company ("the Company") operates an automobile junkyard and scrap recycling business. The Company purchases junked motor vehicles and a variety of other scrap items, such as refrigerators and other appliances, old bicycles, lawnmowers, metal fencing, re-bar and I-beams, and gas and oil tanks. In some cases, the motor vehicles are stripped for usable parts, which the Company sells. Some vehicles are not used for parts but are immediately processed into scrap metal; eventually, all the vehicles are so processed.
The Company uses three machines to process scrap metal. The first, called a "pulverizer" or more commonly a "shredder," is powered by a 2000 horsepower diesel engine. The shredder takes whole motor vehicles, refrigerators, and other large items and pulverizes and shreds these items into many small pieces, a few inches across. These pieces emerge onto a conveyor belt which leads to a shaker table and a magnetic separator, which separate the material into ferrous metal (known as "frag") and non-ferrous metals and non-metallic materials, such as glass, fabric and plastic (known as "shredder non-ferrous"). Conveyors take the materials to separate storage locations.
The second machine is an electric hydraulic baler. The baler takes whole metal items such as fencing, re-bar, gas tanks and appliances, and squeezes them into two foot by four foot cubes, known as "bales" or "bundles," weighing between 1000 and 1500 pounds. These cubes are not graded or sorted.
The third machine is an electric hydraulic cutter, known as a "shear." Heavy gauge metal material is squeezed, flattened, and then cut, or sheared, into different lengths. The materials most commonly placed in the shear are I-beams, truck frames and large oil tanks.
The metals, whether shredded, baled or sheared, are generally sold to steel mills, and the non-metals from the shredder are generally discarded. Diesel-powered cranes are used to lift the materials into the machines, and diesel-powered payloaders are used to transport the materials to and from the machines.
Approximately 90% of the Company's scrap metal output is processed through the shredder, and approximately 10% using the other two machines. Approximately 60% of the area of the Company's facility is devoted to scrap metal processing, and approximately 80% of the Company's revenues are from scrap metal processing.
ISSUES:
Whether any of the Company's scrap metal recycling machines are exempt from sales and use taxes as machinery used directly in a manufacturing process, under Conn. Gen. Stat. §12-412(34).
Whether materials, tools and fuel used by the Company in its scrap metal recycling operations are exempt from sales and use taxes under Conn. Gen. Stat. §12-412(18) as materials, tools and fuel used in an industrial plant in the actual fabrication of a finished product to be sold, or used directly in the furnishing of power to an industrial manufacturing plant.
Whether gas or electricity used by the Company in its scrap metal recycling operations is exempt from sales and use taxes under Conn.Gen. Stat. §12-412(3) as fuel used directly in the fabrication of a finished product to be sold or in an industrial manufacturing plant.
Whether the diesel fuel used by the Company to power the shredder, the cranes and the payloaders used in its scrap metal recycling operations is exempt from motor vehicle fuels tax under Conn. Gen. Stat. §12-458(a)(8).
DISCUSSION:
Before applying the statutes and regulations involved to the facts in this matter, it is necessary to note the interpretative framework within which the discussion must occur. It is well established, and the Connecticut Supreme Court has consistently held, that statutes which grant exemptions from taxes must be strictly construed against the taxpayer, and any ambiguities in such statutes must be resolved in favor of the Department. See, e.g.,United Illuminating Co. v. Groppo, 220 Conn. 749, 752-53, 601 A.2d 1005 (1992).
Conn. Gen. Stat. §12-412(34) exempts from sales and use taxes
[s]ales of and the storage, use or other consumption of machinery used directly in a manufacturing production process. The word "machinery" as used in this subsection means the basic machine itself, including all of its component parts and contrivances, such as belts, pulleys, shafts, moving parts, operating structures and all equipment or devices used or required to control, regulate or operate the machinery ....
Conn. Agencies Regs. §12-412(34)-1 further defines the exemption and its scope. Subsection (c) of the regulation defines the term "manufacturing" to mean
an operation or an integrated series of operations that substantially transform, by physical, chemical or other means, the form, composition or character of raw or finished materials into a product possessing a new name, nature and use which is intended for sale .... If the transformation is not substantial, the process may only constitute fabrication.... In determining whether a process constitutes manufacturing, the commissioner will examine the facts and circumstances of each case, using the following principles as guidelines:
(1) The process must occur at a manufacturing plant.
(2) ... the mere sorting of recyclable materials is not manufacturing, while using heat and chemicals to eliminate impurities, increase density and change the composition of recyclable materials so that they will meet certain metallurgical or chemical tolerances is manufacturing. ...
Subsection (d) of the regulation defines "manufacturing production process" to mean
the activities or series of activities of which manufacturing consists, beginning with the movement of materials, after their receipt, inspection and storage, to the first production machine and ending with the packaging of the manufactured product for its sale to the ultimate consumer. ...
Subsection (e) of the regulation defines "manufacturing plant" to mean "an establishment that has manufacturing as its predominant purpose and that is generally regarded as such." (Subsection (a) of the regulation defines "predominantly" to means more than fifty percent.) The regulation indicates that, in considering whether an establishment is a "manufacturing plant," consideration will be given to such things as whether the floor space is predominantly devoted to manufacturing, whether a predominant number of the employees are working in manufacturing, and whether the operating costs and the revenues of the establishment are predominantly attributable to manufacturing.
Conn. Agencies Regs. §12-412(34)-1(f) requires that the Department will consider machinery to be "used directly" in a manufacturing production process if it is
(1) Machinery that directly transforms, or has a direct effect upon, the form, composition or character of raw materials being manufactured into a product possessing a new name, nature and use ...
(2) ... machinery such as a forklift, crane or hoist that is used more than fifty percent of the time to move the materials being manufactured between machinery described in subdivision
(1) of this subsection ....
The Company's shredder and separators take raw materials (automobiles, large appliances, etc.) and, by shredding them into small bits, substantially transform the form, character and composition of such materials into products possessing new names (such as "frag"), new natures (small bits of metal and plastic which have been separated from the raw materials and from each other) and new uses (raw materials for steel mills), intended for sale. Therefore the shredder, including the components used to sort and separate the shredded products, is a manufacturing machine. Since shredding produces 90% of the Company's output, occupies over 50% of the Company's yard area that is devoted to processing of scrap metals, and accounts for over 50% of the Company's revenues, the Company's predominant purpose is manufacturing, and therefore the Company's establishment qualifies as a manufacturing plant. To the extent that the Company's cranes and loaders are used more than 50% of the time to carry materials during the manufacturing process (that is, from the loading of the raw materials into the shredder to the loading of the manufactured materials into trucks for transportation), they also are manufacturing machines. Any sorting that is done to materials prior to their movement to the first production machine (the shredder) is not part of the manufacturing process. Repair or replacement parts purchased by the Company for such qualifying manufacturing machines are taxed at a reduced rate of five and one-half percent, pursuant to Conn. Gen. Stat. §12-408(1)(A), and also qualify for partial exemption under the Manufacturing Recovery Act of 1992; Conn. Gen. Stat. §12-412i (see below).
The company's baler and shear, however, do not perform manufacturing and are not exempt machines. Although they achieve some change in the size and shape of scrap metal items by squeezing, compressing and cutting them, they do not substantially transform scrap metal into a new product. The fact that the Company chooses to call the baled and sheared metal something different (such as "#2 bundles") after the metal emerges from the process, does not automatically mean that it has acquired a "new name," as the regulation requires, since what goes into the baler and shear is items of scrap metal, sometimes in combination with other materials, and what emerges from them is those same items, merely compacted and changed in size and shape, so that they may be more easily handled by the Company and delivered to its customers. Moreover, to qualify as "manufacturing," it must be established that the process meets all the elements of the applicable definitions, not merely some of them, and as previously noted, all ambiguities or doubts must be resolved in favor of the Department. See Connecticut Water Co. v. Barbato, 206Conn. 337, 343-44, 537 A.2d 490 (1988).
The Company's baling and shearing operations, while not manufacturing, do qualify as "fabrication," as that term is defined in Conn. Agencies Regs. §12-412(18)-1. Subsection (f) of the regulation defines "fabrication" as "an operation or integrated series of operations that alter or modify a manufactured product or raw materials, whether or not a change in the identity of the product or materials occurs." Fabrication includes manufacturing, as well as such processes as assembling, cutting and perforating. Conn. Gen. Stat. § 12-412(18) exempts from sales and use taxes "materials ... tools and fuel ... which become an ingredient or component part of tangible personal property to be sold or which are used directly in ... an industrial plant in ... actual fabrication ...."
Since the Company's establishment is an "industrial plant," as that term is defined in subsection (e) of the regulation, all materials (such as lubricants, chemicals and solvents), tools and fuel (such as diesel fuel) that are used directly in the manufacturing or fabricating processes of the Company are exempt from sales and use taxes under Conn. Gen. Stat. § 12-412(18).
The Company may also qualify to purchase some of its gas or electricity exempt from sales and use taxes under Conn. Gen. Stat. §12-412(3). That statute, in pertinent part, provides an exemption for
gas, including bottled gas, and electricity when delivered to consumers ... for use ... directly in ... fabrication of a finished product to be sold or an industrial manufacturing plant, provided the exemption ... shall only be allowed with respect to a metered building, location or premise at which not less than seventy-five percent of the gas, including bottled gas, or electricity consumed ... is used for the purpose of such ... fabrication or manufacturing.
The Company will qualify to purchase the diesel fuel used to operate its shredder and its cranes and loaders exempt from motor vehicle fuels tax pursuant to Conn. Gen. Stat. §12-458(a)(8), which provides that "[s]aid tax shall not be payable on such fuel as may have been ... sold exclusively to furnish power for an industrial plant in the actual fabrication of finished products to be sold." Since the terms "industrial plant" and "fabrication" encompass both the Company's manufacturing (shredding) processes and its nonmanufacturing (baling and shearing) processes, all the diesel fuel purchased by the company for the shredder and for the cranes and payloaders is exempt, as long as the vehicles are used only to transport materials to and from the recycling machines. However, the diesel fuel used in the trucks which bring raw materials into the Company's industrial manufacturing plant or transport processed materials out of it is not exempt.
Finally, it should be noted that the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i (the "MRA"), provides a progressively phased-in partial exemption for materials, tools, fuels, machinery and equipment used in "manufacturing, processing or fabricating," as those terms are more expansively defined for purposes of the MRA only. The Company's baler and shear would qualify as "machinery" for purposes of the MRA partial exemption, although they do not so qualify for purposes of Conn. Gen. Stat. §12-412(34). See Special Notice 93(1.1) for full details.
RULING:
The Company's shredder and its cranes and payloaders qualify for exemption from sales and use taxes as machinery used directly in a manufacturing process, under Conn. Gen. Stat. §12-412(34). The Company's baler and shear do not so qualify.
The materials, tools and fuel used by the Company directly in its scrap metal recycling operations (including shredding, baling and shearing) qualify for exemption from sales and use taxes under Conn. Gen. Stat. §12-412(18).
The gas or electricity used by the Company in its scrap metal recycling operations qualifies for exemption from sales and use taxes under Conn. Gen. Stat. §12-412(3), provided not less than 75% of such gas or electricity consumed at a metered location is used directly in fabrication or in an industrial manufacturing plant.
The diesel fuel used by the Company to power the shredder, cranes and payloaders used in its scrap metal operations qualifies for the exemption from motor vehicle fuels tax under Conn. Gen. Stat. §12-458(a)(8).
This Ruling supersedes Ruling No. 90-72.
LEGAL DIVISION
MAY 4, 1994