author would reverse the commission's decision and remand the case with directions to grant Emerson the tax refunds it seeks. The author believes the result the Court reaches is inconsistent with the integrated plant doctrine developed in Floyd Charcoal Company, Inc., and its progeny. The author would find that, although motors for sale to Emerson's customers are not produced at its motor technology center, all three disputed machines perform product design, perfection and testing functions that are essential to and integral in Emerson's continuing process of manufacturing the motors, especially the customized motors. The author would find that the motor technology center is a manufacturing plant because necessary steps in producing motors offered for sale to customers are performed there. The author notes that the Court's distinction between "upstream" design and development and "downstream" manufacturing is not supported by the language or purpose of the statutory exemption or by this Court's previous holdings. Citation: Opinion Author: Ronnie L. White, Judge Opinion Vote: AFFIRMED. Wolff, C.J., Stith, Limbaugh and Russell, JJ., concur; Blackmar, Sr.J., dissents in separate opinion filed; Teitelman, J., concurs in opinion of Blackmar, Sr.J. Price, J., not participating. Opinion: This slip opinion is subject to modification until the Court has ruled on the parties' motions for rehearing, if any, and will become final only after the Court issues its mandate. To see when the Court issues its mandate, please check the docket entries for the case on Case.net. I. Introduction Emerson Electric Co. challenged the Director of Revenue's assessment of use tax paid on machinery used to design, prototype, and test new motors. The Administrative Hearing Commission (AHC) ruled that the assessment was proper and denied Emerson a refund. Emerson seeks review of the AHC's decision. The parties' central issue is
whether the equipment is "used directly in manufacturing" to qualify for the sales/use tax exemption as contemplated in section 144.030.2(5).
(FN1) The Court declines to extend the integrated plant doctrine to these preliminary stages of production. The decision of the AHC is affirmed. II. Facts and Procedural History Emerson filed claims for refunds of use tax remitted on three machines purchased between 1994 and 1998. The AHC consolidated the cases, conducted a hearing on all three, and made the following findings of fact. Emerson's Motor Technology Center Emerson is a Missouri corporation engaged in the business of manufacturing electric motors. Its corporate headquarters in St. Louis consists of several buildings, among them the motor technology center (MTC), which is one of three advanced technology centers comprising a research and development network for the company's global operations. The MTC is a state-of-the-art research and development facility and home to Emerson's engineering group. It supports Emerson's affiliates and divisions and their customers in developing advanced motors and electronic controls. The three machines in question are located in the MTC. The MTC occasionally undertakes co-development projects where Emerson and a customer work together, pursuant to a written "development agreement," to create a specific product. Co-development often requires considerable sampling and testing. Once the final sample is approved, the MTC engineers send the design and material specifications to the manufacturing plants to build the motors. The MTC also designs platforms, which are generic motors for general application. Emerson uses the same process of making sample motors for co- development projects that it uses for its own products. The MTC also provides support to U.S. Electrical Motors, which is an Emerson division that supplies standard platform motors that customers can purchase from its catalogue. The MTC assists Emerson and customers with modification projects when customers request minor changes to standard motors. In this context, the MTC engineers
use the CAD system to design the custom-modified motors and send the designs to the plants to build them. The majority of the MTC's work involves engineering support for plants and their customers. Co-development represents about 30% and the remainder consists of innovation and platform design. The Equipment The CAD system enables engineers to produce three-dimensional designs - a blueprint in 3-D. Prior to its purchase of the 3-D CAD system for which it claims a tax exemption in this case, Emerson used a two-dimension CAD system. There is no indication in the record that Emerson claimed a refund for the 2-D system or any other low- tech predecessors previously used to create blueprint drawings. Emerson's internal documents state that the driving forces behind the acquisition of the CAD system were the acceleration of new product development, improvement of engineering and product quality, and increased engineering productivity. The CAD equipment is used 70% of the time for custom modification projects, 20% for developing platform designs, and 10% for co-development projects. The stereolithography machine is a tool for developing mechanical parts. It reads design specifications transferred electronically from the CAD system and uses a laser and liquid polymer to make three-dimensional molded plastic sample parts. The sample parts can be used for fitting (i.e., to see if the part fits into an appliance) or for mechanical testing. These samples are not strong enough for performance testing or use in a real machine, and they are not sold to customers. Emerson's internal documents state that the stereolithography machine was purchased to provide research and development (R&D) services to various Emerson divisions, to increase the production of sample parts, to provide rapid prototyping technology to the divisions, and to ultimately increase engineering productivity. These internal documents also state that the machines would allow inexpensive experimentation of new part designs and manufacturing processes. Approximately 50 to 75% of co-development projects involve parts developed using this machine. The dynamometer is used to test motors for compliance with industry and customer standards regarding horsepower, efficiency, speed, and torque. It tests samples for development purposes as well as real motors for quality control. This particular machine can also calibrate other dynamometers used in Emerson's manufacturing
plants. Its accuracy enables engineers to test and evaluate new design solutions and improvements in manufacturing processes. Emerson's internal documents state that the dynamometer was purchased to provide a testing facility to certify compliance with industry guidelines, permit engineers to conduct accurate developmental tests, and provide future motor designs. The dynamometer is used approximately 15% of the time for modifying existing platform motors. The director conducted an audit and concluded that the MTC is an R&D facility that is not engaged in manufacturing. After hearing, the AHC concluded that the three machines were purchased and used for engineering design, prototyping, and sample testing, which are R&D functions distinguishable from manufacturing within the meaning of section 144.030.2(5). As such, the director's assessment was proper. III. Jurisdiction and Standard of Review This Court has jurisdiction pursuant to Mo. Const. art. V, section 3 and reviews de novo the AHC's interpretation of revenue law.(FN2) The AHC's factual determinations are upheld if they are supported by the law and, after reviewing the whole record, there is substantial evidence to support them.(FN3) A taxpayer bears the burden of showing they are entitled to an exemption.(FN4) Exemptions from taxation are to be strictly construed against the taxpayer, and any doubt is resolved in favor of application of the tax.(FN5) IV. Applicable Law Section 144.030.2(5) provides sales and use tax exemption for: Machinery and equipment, and the materials and supplies solely required for the installation or construction of such machinery and equipment, purchased and used to establish new or to expand existing manufacturing, mining or fabricating plants in the state if such machinery and equipment is used directly in manufacturing, mining or fabricating a product which is intended to be sold ultimately for final use or consumption.(FN6)
This Court first considered the scope of this exemption in Floyd Charcoal Co. v. Director of Revenue,(FN7) where it adopted the "integrated plant doctrine" for determining what is "directly used" in manufacturing. "The basic questions are the following: (1) Is the disputed item necessary to production? (2) How close, physically and causally, is the disputed item to the finished product? (3) Does the disputed item operate harmoniously with the admittedly exempt machinery to make an integrated and synchronized system?"(FN8) In Floyd, we concluded that a system of conveyors and storage bins that removed starch from railroad cars and conveyed it to a processing area was "used directly in manufacturing." This Court also applied the integrated plant theory in Noranda Aluminum, Inc. v. Missouri Department of Revenue. (FN9) There, machines used to produce anodes, which in turn were used on an aluminum production line, were "essential to and comprise an integral part of Noranda's manufacturing process."(FN10) In addition, laboratory equipment used to test the aluminum for impurities was "essential to and a part of the manufacturing process."(FN11) In Concord Publishing House, Inc. v. Director of Revenue,(FN12) this Court concluded that computer equipment used by journalists and editors to compose and format newspaper content was "directly used" to manufacture the newspaper. Similarly, in DST Systems v. Director of Revenue,(FN13) the Court allowed the exemption for computer equipment used to process and store financial information and produce printed reports for consumers. In Concord Publishing, DST Systems, and more recently in Southwestern Bell Telephone Company v. Director of Revenue,(FN14) the Court clarified that the physical distance between disputed equipment and exempt equipment was not determinative. V. Discussion Emerson asserts that the AHC erred in ruling that the CAD system, stereolithography machine, and dynamometer are not exempt under section 144.030.2(5). Both parties focus primarily on the second part of the statute regarding what constitutes "direct use in manufacturing." However, Emerson's failure to establish the key element of the first part of the statute, largely overlooked by the parties but central to its legislative purpose, is at least equally sufficient to
affirm. Are the disputed machines directly used in manufacturing the product intended for sale? First, Emerson contends that the machines were used directly in manufacturing a product intended for sale in that Emerson used the machines for designing, prototyping, and testing, and such activities are essential and integral parts of the manufacturing process. The parties agree that that the functions of the disputed machines are design and development. They disagree, however, as to whether these functions are part of the manufacturing process. The director asserts, and the AHC held, that design and development – though necessary to production - are separate from and preliminary to manufacturing. None of this Court's precedent supports Emerson's position that design and development are integral parts of manufacturing. Emerson claims that the machines are exempt under the integrated plant doctrine. The Court disagrees. Applying the three prongs of Floyd, first, design and development equipment is necessary to production. Second, regarding the physical and causal proximity of the equipment to the finished product, they are distant. The physical distance between the equipment and the actual manufacturing plants is not fatal alone but compounds the problem when coupled with stretched causality. While there is close causality between the disputed equipment and the initial designs, prototypes, and test results that they generate, the distance between this equipment and the finished product off the assembly line – a real motor for retail sale – is much farther removed. Again, design and development are necessary to production, but they are "upstream" stages separate and distinct from "downstream" manufacturing. This distinction becomes sharply apparent when applying the third prong. The disputed items do not operate "harmoniously" with exempt machinery but rather they perform the "prelude." The disputed equipment does not operate with the exempt machines in a "synchronized" system; the operations of the former must precede the work of the latter. In Mid-America Dairymen, Inc. v. Payne, the court of appeals considered whether a product development facility separate from and supportive to other facilities is "directly engaged in ... manufacturing..."(FN15) There, the court
acknowledged the integrated plant analysis of Floyd and concluded that the separate facility was not "used for ... manufacturing" and, therefore, did not qualify for the claimed tax treatment. Though that case involved a VAT abatement under a different statute, the court's reasoning is instructive for purposes of distinguishing product development from manufacturing. In Concord Publishing and DST Systems, where the disputed computers were used to compile, process, and edit information contained in newspapers and reports printed and sent to customers, the information itself was the ultimate product. The product being manufactured contained the information. Here, conversely, the information generated by Emerson's design equipment is not the finished product. Emerson is not selling the blueprints, samples, or test results generated by the CAD, stereolithograph, or dynamometer. The product intended for sale is the motor. Moreover, in Concord Publishing this Court expressly limited its holding to computers used for newspaper publication. (FN16) Emerson describes its co-development and customization projects in great detail and asserts that its development of custom products for specific buyers is not research and development in the general, experimental sense, but rather an integral part of manufacturing. Customization is not relevant to the analysis. Application of Floyd in this context yields the same result. Design and development is preliminary to manufacturing, not part of it. Therefore, Emerson's claim fails without regard to the percentage of use of the equipment for custom projects or the certainty of the sale of the ultimate product. In sum, to the extent the equipment was used for design, prototyping, and developmental testing, the equipment is not used directly in manufacturing the product intended for sale. The mixed use of the dynamometer merits further discussion. The AHC found that Emerson used this machine primarily for R&D, but also 15% of the time on existing platform motors plus an unquantified but "incidental" amount of time for testing actual motors and calibrating dynamometers from the plants. In Noranda, an exemption for laboratory machines used to test molten aluminum samples(FN17) was allowed in order to monitor quality control during the manufacturing process. Moreover, the director's own regulations suggest that Emerson's partial use of the machines for testing existing motors and dynamometers would normally qualify the machine for exemption.(FN18) The
appropriations request on which the AHC relied cited three objectives: to provide a testing facility that would be able to certify a motor's compliance with industry guidelines, to permit engineers to conduct accurate developmental tests, and to improve the efficiency of future motor designs. While the second and third objectives are non-exempt R&D functions, the first objective, as described in detail in the appropriations request, relates to direct testing of existing motors. But even if this Court disagrees with the AHC about Emerson's intent to use the machine, at least in part, for testing that would be considered part of the manufacturing process under the aforementioned regulations, Emerson still cannot claim the exemption because it failed to prove that the machine was purchased and used to expand manufacturing plants in Missouri. Were the machines purchased and used to expand Emerson's manufacturing plant(s) in the state? In its second point, Emerson asserts that the AHC erred in denying the exemption because the machines were purchased and used to expand Emerson's manufacturing plant, of which it claims the MTC is a part, and increase Emerson's production. In Concord Publishing, Concord's computers expanded its existing manufacturing in that they enabled the paper to increase its publication from six days of the week to seven. Here, the CAD system and stereolithograph allow Emerson to improve designs and produce more samples, but, again, the blueprints and samples are not for sale. While the record shows that the disputed equipment increased engineering productivity and the production of more sample parts, it does not show an increase in production of saleable motors coming off assembly lines in the state. (FN19) As already discussed, design and development are not "manufacturing." An increase in Emerson's R&D capabilities at the MTC is not itself plant expansion. The MTC is not an integral part of Emerson's actual manufacturing plants in the state. This Court finds no evidence suggesting that the equipment acquired to expand R&D at the MTC resulted in an expansion of Emerson's manufacturing plants in Missouri. As such, the CAD system and stereolithography machine clearly do not qualify for the exemption. Further, as already noted, even if the AHC had found an intended and material use of the dynamometer for testing actual motors as part of the manufacturing process, Emerson failed to prove any intended or actual manufacturing plant expansion in Missouri. The dynamometer does not qualify for the exemption.
VI. Conclusion The decision of the AHC is affirmed. Footnotes: FN1. All references are to RSMo 2000. FN2. Concord Pub. House, Inc. v. Director of Revenue, 916 S.W.2d 186, 189 (Mo. banc 1996). FN3. DST Systems, Inc. v. Director of Revenue, 43 S.W.3d 799, 800 (Mo. banc 2001); section 621.193. FN4. Branson Props. USA, L.P. v. Dir. of Revenue, 110 S.W.3d 824, 825 (Mo. banc 2003). FN5. Id. FN6. Section 144.030.2(5) (emphasis added). FN7. 599 S.W.2d 173 (Mo. 1980). FN8. Id. at 177 (quoting Niagara Mohawk Power Corp. v. Wanamaker, 144 N.Y.S.2d 458, 461-462 (N.Y.App.Div. 1955), aff'd, 139 N.E.2d 150 (N.Y. 1956)). FN9. 599 S.W.2d 1 (Mo. 1980). FN10. Id at 4. FN11. Id. FN12. 916 S.W.2d 186 (Mo. banc 1996). FN13. 43 S.W.3d 799 (Mo. banc 2001). FN14. 182 S.W.3d 226 (Mo. banc. 2005). FN15. 990 S.W.2d 648 (Mo. App. 1999). FN16. Concord Publishing at 196. FN17. Unlike the prototype samples created by Emerson's stereolithograph, the aluminum samples in Noranda were pulled directly from the production line and were incorporated into the final product. The equivalent in Emerson's process would be when it randomly pulls real motors from its production line for quality control testing. FN18. Though not in effect when Emerson purchased the dynamometer, the Director's regulations are nonetheless instructive. 12 CSR 10-111.010(4)(F) provides the following examples: A manufacturing company purchases various pieces of testing equipment for different purposes, including: i) to ensure that the seller's product meets the tolerances claimed in its marketing literature, ii) to meet the customer's specification requirements mandated by the sales agreement, and iii) to perform research, and development on
potential future products. The testing equipment for the first two (2) situations are directly used to manufacture a product intended to be sold ultimately for final use or consumption and would qualify for the exemption. The testing equipment for research and development is not directly used in manufacturing a product intended to be sold ultimately at retail and, therefore, would not qualify for the exemption. In addition, 12 CSR 10-111.010(3)(F) states in pertinent part: In order for the machinery and equipment to be exempt from tax it need not be used exclusively or primarily for an exempt purpose. The purchaser must intend at the time of purchase to use and actually make material use of the machinery and equipment in an exempt capacity to qualify. The fact that it may also be used for nonexempt purposes will not prevent the purchase of the item from qualifying for the exemption. FN19. During most of the tax years in question, Emerson had manufacturing plants in Ava and Kennett, Missouri. The Ava plant closed in 1997. Separate Opinion: