Title: DOLESE BROS. CO. v. STATE EX REL. OKLAHOMA TAX COMM.

State: oklahoma

Issuer: Oklahoma Supreme Court

Document:

DOLESE BROS. CO. v. STATE EX REL. OKLAHOMA TAX COMM.  DOLESE BROS. CO. v. STATE EX REL. OKLAHOMA TAX COMM. 2003 OK 4 64 P.3d 1093 Case Number: 96267 Decided: 01/21/2003 THE SUPREME COURT OF THE STATE OF OKLAHOMA [64 P.3d 1093] DOLESE BROS. CO. AND ROGER M. DOLESE AND BRYAN ARNN, AS OFFICERS OF DOLESE BROS. CO. AND AS INDIVIDUALS, Protestants/Appellants, v. STATE OF OKLAHOMA ex rel. OKLAHOMA TAX COMMISSION, Respondent/Appellee. ON APPEAL FROM THE OKLAHOMA TAX COMMISSION ¶0 The Oklahoma Tax Commission assessed additional sales and use tax against Dolese Bros. Co and two of its officers in connection with purchases and sales made by the company. Taxpayers timely protested the assessments. Dolese Bros. Co. subsequently filed a claim for a refund of certain sales tax previously paid. The protest and claim for refund were consolidated for hearing before an administrative law judge, who recommended that both be denied. The Oklahoma Tax Commission adopted the recommendation and taxpayers appealed. Their appeal stands retained for this court's disposition. THE OKLAHOMA TAX COMMISSION'S ORDER IS AFFIRMED IN PART AND REVERSED IN PART; CAUSE REMANDED FOR IMPLEMENTATION OF TODAY'S OPINION BY AN ORDER CONFORMING TO THE COURT'S PRONOUNCEMENT Robert D. Tomlinson and H. Craig Pitts, McKINNEY & STRINGER, P.C., Oklahoma City, Oklahoma, and Robert O. O'Bannon, PHILLIPS McFALL McCAFFREY McVAY & MURRAH, P.C., Oklahoma City, Oklahoma, for Appellants. Douglas B. Allen and Marjorie L. Welch, OKLAHOMA TAX COMMISSION, Oklahoma City, Oklahoma, for Appellee. OPALA, V.C.J. ¶1 Three issues are pressed on appeal: (1) Does the manufacturer's exemption from sales and use tax apply to purchases of equipment and property used to remove the [64 P.3d 1094]overburden and to place and detonate explosives at appellants' stone manufacturing plants? (2) Does the corporate appellant's method of producing sand constitute manufacturing and if so, does the process of manufacturing sand begin with the removal of the overburden? and (3) Is there record proof that appellants stand relieved of liability for sales tax on transactions that appellants characterize as exempt agricultural sales? We answer the first and second questions in the affirmative and the third in the negative. I ANATOMY OF LITIGATION ¶2 The audit division of the Oklahoma Tax Commission (the Commission) conducted an audit of the books and records of Dolese Bros. Co. (Dolese or the company), an Oklahoma corporation, for the period beginning 1 January 1993 and ending 31 December 1995 (the audit period). Based on the audit, a proposed assessment was issued against Dolese and two of its officers, Roger M. Dolese and Bryan Arnn, individually and in their corporate capacity (collectively taxpayers), for additional sales tax, interest, and penalty in the amount of $271,912.98. A portion of this assessment was attributable to purchases of equipment and property by Dolese on which it paid no sales tax. The remainder was attributable to sales tax that Dolese neither collected nor remitted on certain of its sales. The Commission also proposed to assess taxpayers the sum of $148,424.73 in additional use tax, interest, and penalty on equipment and property purchased outside the state and brought into the state for Dolese's use or consumption. ¶3 Taxpayers timely protested the proposed assessments, contending that (a) the purchases made by Dolese on which the Commission based its assessments are exempt from sales tax under the provisions of the manufacturer's exemption, ¶4 Several months later, Dolese initiated a proceeding in the Commission to recover the sum of $1,237,368.00 in sales tax paid between 1 January 1993 and 31 December 1996 (the refund-claim period). Dolese claims the tax it seeks to recover was mistakenly paid on purchases that were exempt from taxation under the terms of the manufacturer's exemption. Dolese later reduced the refund claim to the sum of $818,489.00. ¶5 The protest and claim for refund were consolidated for adjudication by the Commission and heard by an administrative law judge on 30-31 October 1997. At the conclusion of the hearing, the judge agreed to keep the record open for the parties' post-hearing submission of findings, conclusions, and recommendations and for the receipt of revised exhibits delineating the amounts remaining at issue. Those exhibits show that there remains in controversy (a) the sum of $35,052 with respect to the proposed assessments of sales and use tax ¶6 On 29 January 2001 an administrative law judge submitted to the Commission findings of fact, conclusions of law, and a recommendation for the disposition of the proceeding. II STATUTORY PROVISIONS IN EFFECT AT THE TIME OF THE TRANSACTIONS IN QUESTION, AND NOT SUBSEQUENT AMENDMENTS, APPLY TO TAXPAYERS' PROTEST AND DOLESE'S REFUND CLAIM ¶7 The decisions to be made in this case require the application of several provisions of the Oklahoma Sales Tax Code (Sales Tax Code ), ¶8 As a general rule, statutes and statutory amendments will be construed as operating prospectively unless by express declaration or necessary implication from the language used the Legislature clearly demonstrates a contrary intent. ¶9 The same rules of construction apply to administrative rules and regulations as to statutes. III CRUSHED STONE IS PRODUCED IN AN INTEGRATED MANUFACTURING PROCESS THAT INCLUDES THE REMOVAL OF THE OVERBURDEN AND THE PLACEMENT AND DETONATION OF EXPLOSIVES ¶10 The Sales Tax Code imposes a tax on non-exempt sales of tangible and intangible personal property and on specified services. ¶11 Dolese operates eight rock quarries in Oklahoma that manufacture crushed stone for use in the construction industry. In Tulsa Machinery Company v. Oklahoma Tax Commission, ¶12 Overburden removal is the first procedure performed on a rock formation from which crushed stone will be produced. The overburden is the layer of earth above the formation consisting of dirt, clay, vegetation, and other extraneous materials. The overburden must be removed in the manufacture of crushed stone in order to prevent contamination of the finished product and interference with the operation of the stone crushing machinery. Removal is accomplished by using bulldozers, front-end loaders, trucks, and chain saws. ¶13 After the overburden is removed, holes are drilled in the exposed rock formation and explosives are inserted. The optimum placement of the drill hole, its size, and the amount of explosives to be used are determined according to complex formulas depending upon the type of fragmentation desired. Each hole is detonated separately and sequentially using blasting caps that contain delay elements. The explosives break apart the stone formation creating "shot-down rock," some of which is sold "as is" and some of which undergoes, before being sold, additional crushing procedures.[64 P.3d 1099] ¶14 Citing Tulsa Machinery, the Commission ruled in this case that it was precluded from extending the manufacturer's exemption to activities that take place before the stone reaches the primary crusher. The Commission urges the court to reaffirm that holding today, pointing out that the Commission has viewed quarrying activities to be outside the scope of the manufacturer's exemption since 1947, shortly after the manufacturer's exemption was enacted.24 The Commission also reminds us to heed the rule of statutory construction that tax exemptions are to be strictly construed against the claimant.25 ¶15 Taxpayers, on the other hand, contend that the holding of Tulsa Machinery should be revisited in light of recent developments in Oklahoma jurisprudence that enlarge the range of activities deemed to fall within the terms of the manufacturer's exemption. ¶16 We first considered the meaning of the term manufacturing in the 1935 case of Cain's Coffee Company v. City of Muskogee. "[T]he word 'manufacture' is not to be given its technical meaning. The Century Dictionary defines it as 'the production of articles for use from raw or prepared materials by giving these materials new forms, qualities, properties, or combinations, whether by hand labor or machine.'" Because the case dealt with licensing under a city ordinance, it was not necessary for the court to address where the manufacturing process began or ended. The significance of Cain's Coffee is that it defined manufacturing in terms of an activity's transformative effect upon raw or prepared materials in the course of producing a new article for use. ¶17 Then in Tulsa Machinery, the court held on the authority of Cain's Coffee that the transformation of rock into crushed stone constitutes manufacturing, but that equipment which was not used directly in changing the form of the rocks was not exempt from sales tax.28 Tulsa Machinery hence stands for the proposition that manufacturing begins with the first action that has a direct transformative effect upon the raw or prepared materials. ¶18 We next considered the meaning of manufacturing in Curry Materials Company v. Oklahoma Tax Commission.29 The court again applied the transformative concept of manufacturing, holding that the processes employed by Curry Materials Company in the production of sand were not manufacturing because they did not effect any change in the physical properties of the raw materials but merely altered their location.30 ¶19 The court's first departure from the transformative concept of manufacturing occurred in Oklahoma Tax Commission v. Oklahoma Coca-Cola Bottling Company, ¶20 The Oklahoma Legislature enacted in 1981a definition of manufacturing. "'Manufacturing' means and includes every operation commencing with the first production stage of any article of tangible personal property and ending with the completion of tangible personal property having the physical properties which it has when transferred by the manufacturer to another." Implicit in this definition is the requirement that for manufacturing to have occurred there must be some change at the end of the production process in one or more of the properties of the original materials. It is thus consistent with the definition of manufacturing first adopted in Cain's Coffee. The definition also identifies the commencement point of manufacturing as "the first production stage of tangible personal property," but leaves the meaning of that phrase indefinite. What qualifies as the first production stage of a manufacturing operation is precisely the point here at issue. ¶21 The court next addressed the scope of the manufacturer's exemption in Schulte Oil Company, Inc. v. Oklahoma Tax Commission, "The §1359 sales tax exemption should receive a practical construction - one that would not allow a manufacturing operation that is in fact but one continuous and integrated production process to be chopped up into distinct and discrete segments. To confine the tax exemption to equipment which actually causes some [64 P.3d 1101] physical change in the manufactured product would impose a restriction not warranted by the language of the statute. We hence hold that within the meaning of §1359 machinery which is synchronized into the manufacturing operation in a manner that makes it necessary to the production of the finished product is 'directly used in' the manufacturing process." ¶22 Most recently, we applied this concept in United Design Corporation v. State ex rel. Oklahoma Tax Commission, ¶23 Giving due consideration to the points raised by the Commission, we nevertheless agree with taxpayers that Tulsa Machinery construes too narrowly the manufacturer's exemption as it applies to the process of manufacturing crushed stone. The record supports Dolese's contention that it employs an integrated manufacturing process at its stone plants, in which the equipment and other property used in the removal of the overburden and in the placement and detonation of explosives play a necessary part. ¶24 The Commission argues that even if the equipment and other property at issue are used in an integrated manufacturing process, taxpayers should not prevail because they have failed to prove that overburden removal and the use of explosives to break rock are "generally recognized" as manufacturing. We disagree. The pertinent provisions of §1359(C) exempts machinery and equipment used in the operation of a manufacturing plant. Manufacturing plants are defined as "those establishments primarily engaged in manufacturing or processing operations, and generally recognized as such." ¶25 We hence hold that any goods, wares, merchandise, or property used or consumed in overburden removal or explosive placement and detonation at Dolese's stone plants are exempt from sales tax under §1359(A) and any equipment or machinery so employed are "directly used" in the manufacturing process and are exempt from sales tax under §1359(C). The corresponding section of the Use Tax Code exempts the items from use tax as well. IV THE PRODUCTION OF SAND AT DOLESE'S PLANTS CONSTITUTES MANUFACTURING AND THE OPERATION IS AN INTEGRATED MANUFACTURING PROCESS THAT BEGINS WITH THE REMOVAL OF THE OVERBURDEN ¶26 Dolese owns and operates four sand plants in Oklahoma that produce blended sand for use in making concrete. As with stone production, the first process in the production of sand is the removal of the overburden from above a sand deposit. If not removed, the overburden will interfere with later stages of the production process and can contaminate the finished product. A lake or pit with the sand deposit beneath it is then created and a floating dredge suctions slurry, a mixture of sand suspended in water, from the pit. The slurry flows through a pipeline into the processing plant where scalping screens remove extraneous materials. The slurry is then discharged at a high velocity into classifying tanks. As it enters the tanks the slurry hits a large body of stationary water and slows down almost to a stop. Suspended sand particles begin to fall out, the heaviest at the input end of the tank, intermediate sized particles in the middle, and the lightest at the discharge end of the tanks. The different sized particles come to rest in separate blending cells, which fill at nonuniform rates depending on the amount of each particle size entering the classifying tanks. The amount of sand in each blending cell is monitored by a computer, which releases the precise quantity of each sand particle size required for the sand blends produced at the plant. The blended sand is then released into a blade mill for additional cleaning. The blade mill churns the sand in water, rubbing the particles against each other, breaking them down into finer particles, and removing residual mud. The sand is next discharged into dewatering screws, auger-like devices that remove most of the water. From the dewatering screws the sand is deposited onto a conveyor belt, which moves it to a stockpile from which it is sold. ¶27 Citing the court's decision in Curry Materials that sand production is not manufacturing, "[T]here is no crushing and fracturing . . . . Nor, is there claimed to be any blending of the gravel and sand, or earth conglomerate, with other, or additional, materials as might reasonably be expected to occur in the preparation of coffee, or spices, for human consumption. Instead of there being any change in the form of the gravel and materials saved from the earth by said company, the only change effected by its processing may be regarded merely as a change in the material's surroundings, or locale. . . . [They] are the same materials they originally were, while a part of the earth, ground, and before their extraction by said company." ¶28 Taxpayers argue that Curry Materials, decided in 1957, is outdated. They contend that because today's sand production techniques are more complex than they were in the 1950's, sand production has now become a manufacturing operation. They point specifically to the use of computers to monitor the blending process as an example of that complexity. They also point out that the specifications for sand used in concrete today are very different from what they were when Curry Materials was decided. The sand produced by the taxpayer in Curry Materials would not meet today's specifications and could not be used in modern-day construction projects. Taxpayers contend that while natural sand was the beginning and end product in Curry Materials, the blended sand Dolese [64 P.3d 1103]produces is distinguishable in form and composition from the raw material coming out of the lake. The Commission maintains that what Dolese does today differs in no material respect from what Curry Materials did a half-century ago. In both instances, the Commission argues, sand goes in and sand comes out and no manufacturing takes place. ¶29 We agree with taxpayers that Dolese's sand plants are engaged in manufacturing. "The salient point in each of these cases is that a product was changed into one that became marketable or more usable. Here, the process of rebuilding damaged oilfield pipe transforms a virtually unusable and nonmarketable product into serviceable and saleable merchandise. While it is true that after the remanufacturing process is accomplished the end product is still used oilfield pipe, the remanufactured article is nonetheless new and different from the form of the material used in making it." ¶30 Although natural and blended sand are both sand in their essential properties, the procedures applied by Dolese to the natural form of the material produce tangible personal property - blended sand - that is substantially new and different from that which originally existed. Natural sand is "a virtually unusable and nonmarketable product" in today's construction industry. Blended sand, although composed of the same materials as natural sand, is "nonetheless new and different from the form of the material used in making it." ¶31 The Commission argues that the manufacturer's exemption does not apply to the manufacture of sand because the facility at which sand is produced is not a "manufacturing plant" as defined by §1359(C). ¶32 Taxpayers urge the court to view its sand production operation as an integrated manufacturing process that begins with the removal of the overburden and ends when the product is sold. We agree and hold that any goods, wares, merchandise or property used or consumed in the integrated process of manufacturing sand are exempt from sales tax under §1359(A) and any equipment or machinery employed at the company's sand plants in these processes are "directly used" in the manufacturing process [64 P.3d 1104]and are exempt from sales tax under §1359(C). The corresponding section of the Use Tax Code exempts the items from use tax as well. V TAXPAYERS FAILED TO PROVE THAT THEY WERE RELIEVED OF LIABILITY FOR UNCOLLECTED SALES TAX ¶33 The provisions of 68 O.S. 1991, §1361 require sellers to collect and remit sales tax on all sales of tangible and intangible personal property as well as on specified services unless the transaction is exempt. ¶34 The burden of proving that a transaction qualifies for an exemption is on the seller. "If a vendor, in good faith, timely accepts from a consumer properly completed documentation certified by the Oklahoma Tax Commission that such consumer is exempt from the taxes levied by the Oklahoma Sales Tax Code, the vendor shall be relieved of any liability for any sales tax or the duty to collect any sales tax imposed by the provisions of Section 1361 of this title upon such vendor with respect to such sale." Compliance with this statute and with the Commission rule implementing it provides a safe harbor for a seller who claims an exemption by affording categorical relief from sales tax liability even if it turns out that the underlying transaction is not exempt. ¶35 The Commission has promulgated a rule, OAC 710:65-7-6, to implement this stat-[64 P.3d 1105]ute. ¶36 The Commission argues that taxpayers failed to present any proof that the product sold in the challenged transactions was directly used on a farm or ranch in agricultural production. Taxpayers argue that if the Commission's argument is sustained, it will be tantamount to imposing a duty upon sellers to follow every purchaser home to make sure the purchased product is put to an exempt use. We disagree. The Commission appears to us to be saying no more than that the product sold must be one that can be used for an exempt purpose and that the seller must comply with the statutory and regulatory documentation requirements in order to qualify for relief under §1361.1 and the Commission's rule. It is unnecessary for us to determine whether the product sold by Dolese in the questioned transactions can be used for an exempt agricultural purpose because taxpayers' failure to show proof of compliance with the documentation requirements of OAC 710:65-7-6 is sufficient to uphold the assessment. ¶37 The Commission admits that Dolese obtained for each of the challenged sales a copy of the purchaser's agricultural exemption permit card as required by OAC 710:65-7-6(c)(3)(A), ¶38 Dolese admits that none of the invoices bearing the allegedly-missing information is included in the record ¶39 Taxpayers also rely on two exhibits which they claim provide record support for their assertion that the requisite documentation was obtained. First, they direct our attention to the work papers prepared by the Commission's auditor, in which the letters "SG", "SIG", "SIGN", "SIGND", or "SIGNED" appear next to an abbreviated description of the articles sold. ¶40 Taxpayers also rely on the following testimony of the Commission's auditor with respect to his receipt of documentation: ". . . as I was able to validate the farm card number and the customer had signed for agricultural use, then I removed those items from the work papers." We fail to see how this supports taxpayers' contention since the witness appears to be saying that he removed from the assessment sales for which he was given evidence that the purchaser had signed for agricultural use. ¶41 Without record support of its compliance with the documentation required by statute and Commission rule, taxpayers' protest of the assessment on its sales was properly denied. We hence affirm that portion of the Commission's order. VI SUMMARY ¶42 The manufacture of crushed stone is an integrated manufacturing process that includes the removal of the overburden and the placement and detonation of explosives. Property used in these processes qualifies for the manufacturer's exemption from sales and use tax and we reverse the Commission's order denying taxpayers' protest and Dolese's refund claim insofar as it relates to these activities. Dolese's production of blended sand constitutes manufacturing and the manufacture of sand is an integrated manufacturing process, which begins with the removal of the overburden above a sand deposit. Property used in the manufacture of sand qualifies for the manufacturer's exemption from sales and use tax and we reverse the Commission's order denying taxpayers' protest and Dolese's refund claim insofar as it relates to the production of sand at Dolese's plants. Taxpayers failed to prove that Dolese complied with the documentation requirements imposed by statute and by the Commission's rule on sales claimed to qualify for the agricultural exemption. We hence affirm the Commission's denial of that portion of taxpayers' protest. ¶43 THE OKLAHOMA TAX COMMISSION'S ORDER IS AFFIRMED IN PART AND REVERSED IN PART; CAUSE REMANDED FOR IMPLEMENTATION OF [64 P.3d 1107]TODAY'S OPINION BY AN ORDER CONFORMING TO THE COURT'S PRONOUNCEMENT ¶44 ALL JUSTICES CONCUR. [ 64 P.3d 1108 ] FOOT