On June 14, 2018, Governor John Kasich signed into law two pieces of tax-related legislation. Sub. H.B. No. 292 (HB 292) modifies procedures under which an individual can establish that he or she was a nonresident for income tax purposes and also restores the right of direct appeal of Board of Tax Appeals' (BTA) decisions to the Supreme Court of Ohio (Court) for tax matters administered by the Ohio Department of Taxation (Department) and local income tax review boards. Sub. H.B. No. 430 (HB 430) clarifies Ohio's sales/use tax exemption relating to the production of oil and gas by listing certain items of tangible personal property and services deemed to be directly used in production.

The Court also issued a decision applying the manufacturing exemption for sales/use taxes in the context of slag processing that provides guidance to taxpayers as to when the manufacturing process begins.

These developments are discussed below.

Ohio individual income tax — procedures related to nonresident affidavit

Ohio Rev. Code Section 5747.24(B)(1) provides that an individual who has no more than 212 contact periods¹ with Ohio is presumed to be a nonresident. Under this provision an individual may file an affidavit of nonresidency (Ohio Form IT DA) with the Department. The affidavit requires the individual to represent, under penalties of perjury that he or she was not domiciled in Ohio during the preceding tax year, had a place of abode outside Ohio, and had no more than 212 contact periods with Ohio. If timely filed, and truthful, the affidavit creates an irrebuttable presumption of residency.

The foregoing provisions were reviewed by the Court in Cunningham v. Testa, Slip Opinion No. 2015-Ohio-2744 (July 8, 2015). In that case, an individual filed such an affidavit in which he represented that he was not domiciled in Ohio at any time during the tax year at issue. The Department took the position that the affidavit contained a false statement regarding the taxpayer's domicile because, among other facts, the taxpayer claimed a real estate tax homestead exemption, which can generally only be claimed by residents of Ohio.² The Court upheld the Department's position, which created uncertainty as to the efficacy of filing the nonresident affidavit.

For tax years beginning on or after January 1, 2018, HB 292 modifies Ohio Rev. Code Section 5747.24(B) by adding the following requirements that must be met and represented on the nonresident affidavit:

— Individual has no more than 212 contact periods with Ohio.

— The individual has at least one abode outside Ohio for the entire tax year for which no federal depreciation deduction was claimed.

— The individual did not hold a valid Ohio driver license or identification card³ at any time during the tax year.

— The individual did not claim a homestead exemption for the tax year.

— If the individual attended or was enrolled in a state college or university, he or she did not receive the benefit of the resident tuition charge.

If the individual timely files the Ohio Form IT DA and the representations made thereon are truthful, the presumption of nonresidency is irrebuttable.⁴

Restoration of right of direct appeal of certain BTA decisions to the Court

In 2017, as part of Ohio's last biennial budget bill, Am. Sub. H.B. 49 eliminated the right of taxpayers and tax authorities to appeal decisions of the BTA to the Court. This right had existed since the late 1930s (see Tax Alert 2017-1042). HB 292 restores the right of direct appeal for appeals from final determinations, assessments, findings, valuations, determinations or orders issued by the Ohio Tax Commissioner and final determinations from local income tax boards of review. Appeals of BTA decisions related to real property tax valuations will continue to be ineligible for the right of direct appeal to the Court and instead can be directly appealed only to the applicable county court of appeals as prescribed in amended Ohio Rev. Code Section 5717.04.

Ohio sales/use tax — clarification for exemption for oil and gas production property

Ohio Rev. Code Section 5739.02(B)(42)(a) provided an exemption from Ohio sales/use tax for purchases of tangible personal property directly used in the production of oil and gas. HB 430 creates a new provision, Ohio Rev. Code Section 5739.02(B)(42)(q), that retains the direct use requirement and specifies that persons engaged in rendering production services for others are deemed engaged in the production of oil and gas. HB 430 defines the term "production" to mean operations to expose and evaluate an underground reservoir that may contain hydrocarbon resources, prepare the wellbore for production, and lift and control all substances yielded by the reservoir to the surface of the earth. HB 430 also provides that tangible personal property qualifying for the exemption includes, but is not limited to, the following:

— Services provided in the construction of permanent access roads, services provided in the construction of the well side, and services provided in the construction of temporary impoundments

— Equipment and rigging used for the specific purpose of creating a wellbore pathway to underground reservoirs

— Drilling and workover services used to work within a subsurface wellbore and tangible personal property used in performing such services

— Casings, tubulars, and float and centralizing equipment

— Trailers to which production equipment is attached

— Well completion services including the cementing of casings and tangible personal property used in performing such services

— Wireline evaluation, mud logging, and perforation services and tangible personal property used in performing such services

— Reservoir stimulation, hydraulic fracturing and acidizing services and tangible personal property used to provide such services

— Pressure pumping equipment

— Artificial lift systems equipment

— Wellhead equipment and well site equipment used to separate, stabilize, and control hydrocarbon phases and produced water

— Tangible personal property directly used to control production equipment

HB 430 also specifies that the exemption does not cover the following property:

— Tangible personal property primarily used in storing, holding, or delivering solutions or chemicals used in well stimulation

— Tangible personal property primarily used in preparing, installing, or reclaiming foundations for drilling equipment, pumping equipment, or well stimulation material tanks

— Tangible personal property primarily used to transport, deliver, or remove equipment to or from the well site or storing such equipment before its use at the well site

— Tangible personal property primarily used in gathering operations occurring off the well site, including gathering pipelines transporting hydrocarbon gas or liquids away from a crude oil or natural gas production facility.

— Tangible personal property to be incorporated into real property.

— Well site fencing, lighting or security systems

— Communication devices or services

— Office supplies

— Trailers used as offices or lodging

— Motor vehicles of any kind

— Tangible personal property primarily used for storing drilling byproducts and fuel not used for production

— Safety devices

— Data collection or monitoring devices

— Access ladders, stairs or platforms attached to storage tanks.

HB 430 was likely adopted in response to Department audit activity in this area and is intended to be a remedial measure to clarify existing law. The provisions apply to all cases pending on a petition for reassessment, further appeal, or transactions subject to an audit by the Department on or after May 18, 2018.⁵

LaFarge N. Am., Inc. v. Testa, Slip Opinion No. 2018-Ohio-2047

The LaFarge ruling by the Ohio Supreme Court (Court) addressed the application of Ohio's sales/use tax exemption for manufacturing, specifically with respect to when the manufacturing process begins. The taxpayer manufactured pelletized slag at a facility in Ohio. At issue was the application of tax to fuel and repair parts for equipment used to break up and transport solidified slag from a "slag mountain."⁶ The Department audited the taxpayer and assessed tax for the items in question concluding that the manufacturing process did not begin until the slag reached equipment that screened and sorted the slag by size.

The slag mountain, because it consists of solidified slag, did not consist of manageable sized pieces of slag that can be processed. The taxpayer used a specially-fitted bulldozer to rip the slag in a grid pattern breaking up the slag mountain and then crushing the slag as it ran it over. The bulldozer then pushed the slag into a surge pile where front-end loaders transferred the slag to a dump truck that, in turn, took the slag to a screening plant for sorting. The Department concluded that the bulldozer and dump trucks were not part of the manufacturing process. In so doing, the Department reasoned that the items were used to excavate slag prior to the start of the manufacturing process likening it to moving raw materials from initial storage.

Ohio Rev. Code Section 5739.02(B)(42)(g) exempts from tax tangible personal property primarily used to manufacture tangible personal property for sale. Ohio Rev. Code Section 5739.01(S) defines a "manufacturing operation" as a process by which materials are changed, converted, or transformed into a different state or form from which they previously existed. The Department's administrative rule, Ohio Admin. Code 5703-9-21(B)(1), further provides that the manufacturing process begins when raw materials are committed to the manufacturing process, which is the earlier of when initial raw material storage has ceased or where materials are mixed, measured, blended, heated, cleaned, or otherwise prepared for the manufacturing process.

The Court focused on two questions: When is the slag changed, converted or transformed into a different state or form from which it previously existed? And when is the slag committed to the manufacturing process? The Court concluded that the bulldozers were not simply facilitating the movement of the slag from initial storage to the screening plant, but were crushing the slag during the separation process. The Court indicated that this resulted in the requisite change in form to conclude that the manufacturing process began at that point. The manufacturing process then continued with the front-end loader loading the slag into dump trucks for transport to the screening plant. Thus, the Court held that the property at issue was used in manufacturing and, as such, the purchases of fuel and repairs for those items were exempt from Ohio sales tax.⁷

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ENDNOTES

¹ An individual has one contact period with Ohio when he or she is away overnight from his or her abode located outside Ohio and spends any part, however minimal, of two successive days in Ohio. Ohio Rev. Code Section 5747.24(A).

² The application for this exemption requires the homeowner, under penalties of perjury, to declare that the home is his or her principal residence.

³ The individual must surrender his or her Ohio driver license or identification card before the beginning of the tax year for which nonresident status will be represented.

⁴ If an individual does not exceed 212 contact periods with Ohio during the tax year and does not file the affidavit, Ohio Rev. Code Section 5747.24(C) provides that the individual is presumed to be an Ohio resident. The presumption can be rebutted by a preponderance of the evidence.

⁵ Section 3, uncodified law.

⁶ The slag at issue was a by-product that separates from molten iron ore during the steelmaking process that solidifies after cooling. A slag mountain consists of a large slag mass that accumulates over a long period of time.

⁷ The Court had previously issued a decision (Sims Bros., Inc. v. Tracy, 83 Ohio St.3d 162 (1998)) in which it held that a scrap yard crane used to pick scrap metal off the ground to load into a baling box was not exempt under the manufacturing exemption. In Sims Bros., the taxpayer had argued that the crane was "mixing" the scrap by picking up predetermined amounts of scrap from different piles into a single pile where it was then compressed by a baler. However, the Court disagreed holding that the selection of scrap and its removal from storage is not an exempt use. Interestingly, the LaFarge Court did not discuss the Sims Bros. case. It appears that LaFarge is distinguishable from Sims Bros. based on its facts as the requisite change in form was not found to occur in the earlier case.