In Valley Power Systems v. South Dakota Dept. of Revenue, the South Dakota Supreme Court (Court) ruled that, when evaluating whether contractors are installing fixtures, it will not look to the intended design of the property installed but to the actual use to determine whether mobile power units are fixtures for contractor gross receipts tax and sales and use tax purposes.¹ In so holding, the Court upheld the imposition of both the contractor's gross receipts tax and the sales and use tax on the sale and installation of exhaust manifolds on mobile power units.

Background and procedural history

South Dakota imposes an excise tax on the gross receipts of all contractors and subcontractors engaged in realty improvement contracts if they are classified under the Standard Industrial Classification (SIC) manual in the construction (division c) group or if their work entails the construction, building, installation, or repair of a fixture to realty. Such contractors also may be subject to use tax on the tangible personal property installed unless sales and use tax has already been paid on such property.

The taxpayer, Valley Power Systems, was an out-of-state industrial-engine distributor that entered into a contract with a South Dakota utility to provide and install new exhaust manifolds on the mobile power units at one of the utility's South Dakota plants. The mobile power units in question were used to generate supplemental electricity during peak-load electrical usage. They were large, not bolted to the ground, and connected to a fuel source and the electrical transmission grid. Although each unit could be moved by a crane, they had not been moved since 1965.

When the South Dakota utility company was audited, the state auditor determined that it was entitled to a refund for its transaction with the taxpayer. The South Dakota Department of Revenue (Department) subsequently issued an assessment stating that the taxpayer should have paid contractor gross receipts tax and use tax on the receipts from the sale and installation of the exhaust manifolds. The South Dakota Circuit Court upheld this decision.

Imposition of tax and rationale

When the Department issued its assessment, it relied on the facts that: (1) the utility intended for the units to be permanent fixtures; and (2) the units were stationary, had been there since 1965 and promoted the use of the realty.

The taxpayer in turn argued that it should not be subject to excise or use tax because it was not a contractor whose services involved the repair of a fixture to realty based on the intended purpose for which the units were designed. Specifically, it argued that the power units were designed to be mobile (each unit was self-contained, unbolted to the realty and could be moved), they were not fixtures, and it was irrelevant that the utility did not move the mobile power units.

The Court was not persuaded by this argument. Under earlier case law, whether property is a fixture is not based exclusively on the purposes for which the property was designed. The controlling criterion is the intention of the property owner with regard to making the article a permanent accession to the realty. Historically, the Court had upheld fixture determinations based on the facts of each case, despite the property (e.g., mobile homes) having the ability to be mobile.

Although the mobile power units were not designed to be stationary and permanent, the Court concluded that the Department did not err in finding that the utility intended the mobile power units to be permanently annexed to the real estate for the economic life of the power units. In reaching this conclusion, it noted that units sat in a fenced enclosure, were connected to a fuel source and the electrical transmission grid, and had remained in the same location for nearly 50 years. Further, because the utility's actual use reflected its intention to annex the mobile power units to the land and provided supplemental power, the Department did not err in concluding the taxpayer's provision of installation services constituted a repair of a fixture to realty, thereby subjecting it to both the contractor's gross receipts tax and the use tax on provided property.

Implications

As coal's presence as a fuel source for electric generation continues to decline, natural gas now contributes the largest percentage of the United States' fuel generation mix at 31.9%.² Due to the low prices of natural gas, utilities may continue to invest in mobile power units as coal-fired facilities continue to be retired. Taxpayers that sell, install, or provide repair services on mobile power units or other property that, despite being designed to be mobile, are expected to remain stationary for long periods of time may want to review their treatment of receipts for possible sales and use tax obligations in South Dakota (and in other states that adopt a similar taxing scheme).

Curiously, the units in this case remained fixed to the realty for nearly 50 years. That fact appeared to be a critical determining factor in the Court's decision. As a result, the Court may have had the benefit of hindsight, in evaluating an arguably extreme set of facts. Therefore, taxpayers should be careful in making their own taxability determinations, which could change over time as the intention of the owner evolves.

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ENDNOTES

¹ Valley Power Systems v. South Dakota Dept. of Rev., 2017 S.D. 84 (S.D. S. Ct. Dec. 13, 2017).

² Electric Power Monthly, U.S. Energy Administration (Dec. 22, 2017).