In Bridges v. Nelson Industrial Steam Co., the Louisiana Supreme Court (Court) reversed a lower court ruling, and held that a power plant operator's limestone purchases are excluded from sales and use tax under the "further processing exclusion" because the use of limestone in the power generation process creates ash as a by-product that is sold at retail.¹ The Louisiana Department of Revenue (Department), however, has filed a petition asking the Court to reconsider its decision, arguing that the Court's adoption of a "dual or multiple purpose test" for the exclusion will give taxpayers the opportunity to seek to exempt their entire purchases from taxation by "claiming innovative, miniscule residual purposes" for their purchases.²

Court's reasoning

The taxpayer, Nelson Industrial Steam Co. (Nelson), is in the business of generating electric power and sells multiple products, including steam, electricity and ash. Nelson purchases and uses limestone for the dual purpose of inhibiting sulfur in the production of electricity and producing ash. Nelson asserts that its purchase of limestone, with respect to its production of ash, is subject to the "further processing exclusion" and, therefore, not subject to sales and use tax. While the Louisiana Department of Revenue and the Calcasieu Parish School System did not tax the purchase of limestone for many years, they now argue that such purchases are subject to tax and not subject to any exclusion. The trial court and court of appeal both ruled in favor of the tax collectors. On appeal, the Court reversed, ruling that the "further processing exclusion" applied to the limestone at issue.

In reaching this conclusion, the Court first determined that ash is the appropriate end product to analyze for purposes of Nelson's limestone purchases (as opposed to electricity), finding that the lower courts erred in narrowing the analysis solely to the end product of electricity. In doing so, the lower courts interjected a "primary product" test or "business purpose" test not rooted in any statutory, regulatory or jurisprudential authority.

Moreover, International Paper³ expressly rejected a "primary purpose" test, favoring instead a dual-purpose or multi-purpose test, so long as one of those purposes was "inclusion in the end product." The Court then applied International Paper's three-part test in determining the "further processing exclusion's" applicability to raw material, finding that, under the third prong of the test (the first two prongs were stipulated to having been met) the limestone raw materials are materials for further processing and, therefore, are purchased with the purpose of inclusion in the end products.⁴ This is evidenced by the operator's choice of manufacturing process and technology, its contractual language utilized in its purchasing of the limestone, and its subsequent marketing and sale of the ash.

Lastly, the Court noted that it will continue to adhere to the exclusive three-prong test set forth by the courts until the legislature chooses to narrow the "further processing exclusion" by way of requiring a profit or writing into law a new test that embodies a "primary product" or "primary purpose" factor.

Department's reasoning for seeking review

The Department argued in its review petition that the Court's decision to exclude energy companies' purchases of limestone from sales and use tax essentially interpreted a statute aimed at avoiding double taxation to apply in a way that would allow companies to avoid all taxation on limestone use. According to the Department's attorney, pending refund claims filed after the Court's decision could exceed $100 million.⁵

The Department's arguments are similar to Justice Knoll's dissent in this case, in which she argued that the majority's holding opens the door to exempting from sales tax all purchases for consumption where the purchaser's process results in an incidental by-product that is salvageable and saleable. She further noted that the "purpose test" "unnecessarily forecloses consideration of relevant evidence and is highly likely to invite taxpayer abuse," which will damage Louisiana's already-suffering public fisc.

Implications

The Court's decision provides taxpayers with potential refund opportunities for sales and use tax paid on items purchased and used for further processing in manufacturing. Louisiana, however, faces a $750 million budget shortfall, which the Governor has called a special session of the state legislature to address. Earlier in 2016, the legislature cut many sales tax exemptions and exclusions in an effort to raise revenue, and the Governor has called for a second special session beginning on June 6, 2016. Included in the Governor's summary of the call for the second special session was a bullet point to "Address the 'primary use test' as applied to Louisiana's 'further processing' exclusion (Item 48)."

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ENDNOTES

¹ Bridges v. Nelson Industrial Steam Co.,No. 2015-C-1439 (La. S. Ct. May 3, 2016).

² Yauch, Eric, "DOR Asks Court to Reconsider Sales Tax Exclusion Decision," 80 State Tax Notes 611, Tax Analysts (May 18, 2016).

³ International Paper, Inc. v. Bridges, 972 So.2d 1121 (La. S. Ct. 2008).

⁴ The first two prongs of the International Paper test are: (1) the raw materials become recognizable and identifiable components of the end products, and (2) the raw materials are beneficial to the end products.

⁵ Yauch, Eric, "DOR Asks Court to Reconsider Sales Tax Exclusion Decision," 80 State Tax Notes 611, Tax Analysts (May 18, 2016).