Title: Am. Natl. Can Co. v. Tracy

State: ohio

Issuer: Ohio Supreme Court

Document:

OPINIONS OF THE SUPREME COURT OF OHIO                               
     The full texts of the opinions of the Supreme Court of                      
Ohio are being transmitted electronically beginning May 27,                      
1992, pursuant to a pilot project implemented by Chief Justice                   
Thomas J. Moyer.                                                                 
     Please call any errors to the attention of the Reporter's                   
Office of the Supreme Court of Ohio.  Attention:  Walter S.                      
Kobalka, Reporter, or Deborah J. Barrett, Administrative                         
Assistant.  Tel.:  (614) 466-4961; in Ohio 1-800-826-9010.                       
Your comments on this pilot project are also welcome.                            
     NOTE:  Corrections may be made by the Supreme Court to the                  
full texts of the opinions after they have been released                         
electronically to the public.  The reader is therefore advised                   
to check the bound volumes of Ohio St.3d published by West                       
Publishing Company for the final versions of these opinions.                     
The advance sheets to Ohio St.3d will also contain the volume                    
and page numbers where the opinions will be found in the bound                   
volumes of the Ohio Official Reports.                                            
                                                                                 
American National Can Company, Appellee v. Tracy, Tax Commr.,                    
Appellant.                                                                       
[Cite as Am. Natl. Can Co. v. Tracy (1995),      Ohio                            
St.3d      .]                                                                    
Taxation -- Sales and use taxes -- Production and sales of                       
     plastic bottles -- Machine hoppers that hold raw material                   
     are preliminary to manufacturing and are subject to tax --                  
     Case erectors which produce cardboard containers are                        
     subject to tax -- Water cooling system which cools                          
     equipment during processing are not subject to tax due to                   
     its adjunctive use -- Electrical transforming substation                    
     not affixed to concrete slab upon which it rested and                       
     which could be moved with a crane is not real property and                  
     thus is subject to tax.                                                     
     (No. 94-595 -- Submitted November 4, 1994 --                                
Decided May 10, 1995.)                                                           
     Appeal from the Board of Tax Appeals, No. 91-Z-718.                         
     The Tax Commissioner appeals the decision of the Board of                   
Tax Appeals ("BTA") exempting from Ohio sales and use taxes the                  
machine hoppers, case erectors, water chiller cooling system,                    
and electrical transforming substation purchased and used by                     
appellee, American National Can Company ("Am-Nat") at its                        
Bellevue, Ohio plant, during the audit period October 1, 1985                    
through December 31, 1987.                                                       
     Am-Nat produces and sells plastic bottles which are packed                  
in cardboard containers for shipment to its customers.  A                        
separate extruder is used to produce each of the six layers of                   
the plastic bottles.  Five layers are made of polyproplyene,                     
adhesive, or ethyl vinyl alcohol.  The sixth is made of                          
"regrind."  The basic material for each layer is resin, which                    
is pumped from storage tanks into machine hoppers located at,                    
and above, the extruders.  As raw material is needed for                         
production of plastic bottles, it  is gravity-fed into an                        
extruder.   The raw material is heated to four hundred degrees                   
within the extruder and becomes molten.  It then flows through                   
a two-foot flow-tube to the extruder head and  is formed into                    
six-layer "straws."  The straws are introduced into rotating                     
molds, where inserted needles inject compressed air, shaping                     
the bottles.  Am-Nat's water cooling system circulates water                     
through the molds to cool the bottles and produce the necessary                  
crystallization process.  Excess material, "regrind," is then                    
trimmed from the bases and the necks of the bottles and                          
recirculated into production to become one of the six layers.                    
      The case erectors, carton-forming machines, produce                        
cardboard containers.  After forming, the containers are                         
conveyed to the "pack station," where the bottles are placed                     
manually into them.                                                              
      Am-Nat's electrical transforming substation consists of a                  
seven foot by seven foot by nine foot electrical transformer                     
resting on a seven foot by nine foot by two foot thick concrete                  
slab, buried in the ground; two forty-two foot tall telephones                   
poles and two twenty-foot tall telephone poles sunk seven to                     
nine feet into the ground; three tiers of wood cross-members                     
attached to the telephone poles by bolts; electrical equipment,                  
including insulators, fuses and capacitors bolted to the                         
cross-members and connected to the transformer by wiring; and a                  
chain-link fence surrounding the concrete slab.                                  
     The commissioner assessed sales and use taxes on Am-Nat's                   
purchases and use of the machine hoppers, case erectors, water                   
chiller cooling system, and electrical transforming substation.                  
     Upon appeal, the BTA reversed the order of the                              
commissioner as to each of these items.                                          
     The cause is now before this court upon an appeal as of                     
right.                                                                           
                                                                                 
     Bricker & Eckler and Mark A. Engel, for appellees.                          
     Betty D. Montgomery, Attorney General, and Lawrence D.                      
Pratt, Assistant Attorney General, for appellant.                                
                                                                                 
     Per Curiam.  The seminal question as to the taxability of                   
the machine hoppers turns on whether this equipment constitutes                  
an "adjunct" to direct use during the manufacturing or                           
processing period and therefore is exempt from taxation under                    
R.C. 5739.01(E)(2) and 5739.01(R).  In Ball Corp, v. Limbach                     
(1992), 62 Ohio St.3d 474, 478, 584 N.E.2d 679, 682, we quoted                   
Canton Malleable Iron Co. v. Porterfield (1972), 30 Ohio St.2d                   
163, 170, 59 O.O.2d 178, 181-182, 283 N.E.2d 434, 439:                           
     "'[M]anufacturing and processing "' * * * imply                             
essentially a transformation or conversion of material or                        
things into a different state or form from that in which they                    
originally existed -- the actual operation incident to changing                  
them into marketable products.'"  * * *'"  We said in Ball, as                   
we say here, that the manufacturer "did not sell" the raw                        
material or "regrind pellets; it sold bottles in partitioned                     
cartons."  Id.                                                                   
     "The test for determining the exemption from taxation of                    
equipment by reason of its status as adjunct under former R.C.                   
5739.01(S), later codified at (R), is * * * '"that the thing                     
sought to be excepted from taxation be (1) an adjunct, (2) used                  
at the same location, and (3) used after the transformation or                   
conversion has commenced.  Subsection (E)(2) adds the                            
additional requirement that the thing be adjunct to direct use                   
or consumption." * * *'"  (Emphasis sic.)  Id. at 478, 584                       
N.E.2d at 682-683.                                                               
     A fact pattern strikingly similar to Ball exists here.                      
Raw material is maintained at locations near the extruders.                      
The actual manufacturing or processing of Am-Nat's product                       
occurs in the extruder when the form or state of the raw                         
material is changed, ultimately resulting in the saleable                        
product.  The machine hoppers that hold the raw material are                     
preliminary to manufacturing and are, thus, not adjuncts, and                    
are subject to tax.  Thus, we reverse the decision of the BTA                    
as to the machine hoppers.                                                       
     Regarding the case erectors, Am-Nat's attempt to extend                     
the scope of the exemption for material used in packaging                        
tangible personal property produced for sale cannot succeed.                     
"We agree with the commissioner's construction of R.C.                           
5739.02(B)(15).  To be excepted from taxation * * *  equipment                   
must be used in placing tangible personal property produced for                  
sale in packages."  Hawthorn Mellody, Inc. v. Lindley (1982),                    
65 Ohio St.2d 47, 52, 19 O.O.3d 234, 238, 417 N.E.2d 1257, 1261.                 
     Am-Nat concedes that the actual placing of the finished                     
product in the shipping containers is done manually.  In Ball,                   
"[t]he Tax Commissioner contest[ed] the exception of the * * *                   
carton-forming system * * *.   R.C. 5739.02(B)(15) provides an                   
exception for machinery and equipment used in 'packaging.'  She                  
urge[d] that exception be denied because only machinery and                      
equipment used 'in placing the item for sale in the packages'                    
qualifies.   She contend[ed] that the BTA erred in extending                     
the exception to machinery or equipment which is neither                         
packaging machinery or equipment, nor an integral part of                        
packaging machinery or equipment."  Id. at 479, 584 N.E.2d at                    
683.  The court held that "[e]xceptions from taxation are to be                  
strictly construed" and that "'[t]o be excepted from taxation                    
under R.C. 5739.02(B)(15), machinery or equipment must be used                   
in placing tangible personal property produced for sale in                       
packages.'" Id.  Thus, we reverse the BTA's decision as to the                   
case erectors.                                                                   
     Although there is a factual dispute regarding the function                  
of Am-Nat's water cooling system, and even as to the number of                   
water cooling systems Am-Nat uses, the BTA found as a fact that                  
"* **  the system should be looked at as a whole, and due to                     
its adjunctive use, not assessed tax.  The two systems work                      
essentially as a single system to accomplish the manufacturing                   
function of cooling equipment during processing."                                
     The BTA is responsible for determining factual issues and,                  
if the record contains reliable and probative support for these                  
BTA determinations, we will affirm. .  R.R.Z. Assoc. v.                          
Cuyahoga Cty. Bd. of Revision (1988), 38 Ohio St.3d 198, 201,                    
527 N.E.2d 874, 877.  Since the record contains such evidence,                   
we affirm the BTA's decision as to the water cooling system.                     
     Finally, regarding the electrical transforming substation,                  
the commissioner contests only the taxability of the                             
transformer.  The test for exemption is to determine whether                     
the transformer is a structure attached to the land.  R.C.                       
5739.01(B)(5).  If it is attached, it becomes real property and                  
is exempt from sales and use taxes; if it is not attached, it                    
remains personal property subject to taxation.                                   
     To qualify for exemption under R.C. 5739.01(B)(5), the                      
transformer must be "'incorporated into a structure or                           
improvement on and becoming  a part of real property.'"   See                    
Rotek, Inc. v. Limbach (1990), 50 Ohio St.3d 81, 82, 552 N.E.2d                  
640, 641.  As defined in R.C. 5701.02, "real property"                           
"include[s] land itself * * * and unless otherwise specified,                    
all buildings, structures, improvements, and fixtures of                         
whatever kind on the land."                                                      
     "[T]he term 'incorporation,' as used in R.C.                                
5739.02(B)(13), requires physical affixation to the relevant                     
improvement. * * * We perceive  no basis for excluding such                      
requirement from the term 'incorporated' as used in the                          
construction contract provision found in R.C. 5739.01(B)."                       
Botkins Grain & Feed Co. v. Lindley (1982), 1 Ohio St. 3d 64,                    
68, 437 N.E.2d 1182, 1185-1186.                                                  
     The record shows that this transformer, a large piece of                    
equipment, was neither bolted nor otherwise affixed to the                       
concrete slab upon which it rested.  Am-Nat admits that it                       
could be moved with a crane.  It was, therefore, free-standing                   
and not a structure or part of real property.                                    
     The BTA's failure to find that the transformer was not                      
incorporated into the real property was unreasonable and                         
unlawful, and its decision in this respect is reversed.                          
     The decision of the BTA is affirmed in part and reversed                    
in part.                                                                         
                                     Decision affirmed in part                   
                                     and reversed in part.                       
                                                                                 
     Moyer, C.J., Douglas, Resnick, F.E. Sweeney and Cook, JJ.,                  
concur.                                                                          
     Wright and Pfeifer, JJ., concur in part and dissent in                      
part.                                                                            
     Wright, J., concurring in part and dissenting in part.                      
     I concur in the court's conclusion that the water cooling                   
system is exempt from taxation.  I dissent to the conclusion                     
that the machine hoppers, case erectors, and electrical                          
transformer are not similarly exempt.                                            
                               I                                                 
     The majority relies upon an erroneous interpretation of                     
Ball Corp. v. Limbach (1992), 62 Ohio St.3d 474, 584 N.E.2d                      
679, to reach the conclusion that the machine hoppers do not                     
qualify for the adjunct exemption.  In fact, the taxability of                   
machine hoppers was not before this court in Ball.                               
     In Ball, the Board of Tax Appeals ("BTA") determined that                   
manufacturing began at the co-extrusion machines and that the                    
hoppers were exempt as adjunct to the co-extrusion machines.                     
The BTA then denied an exemption for the raw material handling                   
system, which included vacuum tubes, silos and storage bins,                     
because the system was both preliminary to manufacturing and                     
not adjunct to machinery "directly used" in manufacturing.                       
Only the BTA's decision denying an exemption for the raw                         
material handling system was appealed by Ball Corp., and this                    
court affirmed:  "With regard to the appeal of Ball Corp., the                   
decision of the BTA which denied exception for the raw material                  
handling and processing system is reasonable and lawful and is                   
affirmed."  Id. at 479, 548 N.E.2d at 683.  The decision of the                  
BTA granting an exemption for the machine hoppers was left                       
undisturbed, and properly so.                                                    
     Our cases have consistently held that machinery, similar                    
to the machine hoppers at issue in this case, which directly                     
feeds manufacturing equipment is adjunct to that equipment and                   
therefore exempt from sales and use taxes.  In Bird & Son, Inc.                  
v. Limbach (1989), 45 Ohio St.3d 76, 82, 543 N.E.2d 1161, 1167,                  
we held:  "Inasmuch as the machine bins supply the blender box                   
with granules, it would appear that such items are 'adjuncts'                    
to a direct use as contemplated by former R.C. 5739.01(S) and                    
our decision[s] in Canton Malleable and Hawthorn Mellody,                        
supra.  Accordingly, it is our further determination that                        
equipment utilized to provide an immediate supply of raw                         
materials to machinery employed directly in the production of                    
personal property is an adjunct used during and in the                           
production of a product and necessary to carry on and continue                   
that production.  Such equipment is therefore subject to                         
exemption from sales and use taxation pursuant to former R.C.                    
5739.01(S)."                                                                     
     Even though the machine hoppers are "preliminary" to the                    
manufacturing process, in that they feed raw material to the                     
extruders where the manufacturing process actually begins, they                  
may still qualify for the adjunct exception under R.C.                           
5739.01(R).  That was the exact result reached in OAMCO v.                       
Lindley (1986), 24 Ohio St.3d 124, 125, 24 OBR 347, 348, 493                     
N.E.2d 1345, 1347:  "A precise mixing system composed of                         
various small conveyor belts regulates the flow of aggregate,                    
from the bins.  The result is a uniform size and weight of                       
aggregate which is essential to the required standardization of                  
product. *** Without these pieces of equipment, there could be                   
no mix specifications, nor constancy of finished product.                        
Without doubt, they are 'adjuncts used during and in, and                        
necessary to carry on and continue, production.'"                                
     The testimony before the BTA revealed that the machine                      
hoppers performed the necessary task of carefully controlling                    
the flow of resin into the extruders so that the extruders                       
operated properly in creating a salable product.  This                           
testimony, combined with our decisions in Bird & Son, supra,                     
and OAMCO, supra, leads to the conclusion that the machine                       
hoppers qualify for the adjunct exemption under R.C. 5739.01(R).                 
                               II                                                
     The majority also errs in finding that the case erectors                    
do not qualify for an exemption under R.C. 5739.02(B)(15).                       
Specifically, the majority reads our opinion in Ball, supra, as                  
requiring that a packaging line must be fully automated, with                    
no manual placement of products into the prepared packages, to                   
qualify for an exemption under R.C. 5739.02(B)(15).  That                        
interpretation is not only inconsistent with our previous                        
cases, but it will also have the anomalous result of providing                   
a disincentive for Ohio manufactures to employ Ohio workers in                   
the packaging process.                                                           
     R.C. 5739.02(B)(15) provides an exemption for "machinery,                   
equipment, and material for use in packaging tangible personal                   
property produced for sale ***, or sold at retail."  As defined                  
by the statute, "packaging" involves placing items in                            
packages.  Id.  However, we have interpreted the "for use in                     
packaging" language broadly to include any equipment that is an                  
"integral part" of the packaging process.  For example, in                       
Hawthorn Mellody, Inc. v. Lindley (1981), 65 Ohio St.2d 47, 52,                  
19 O.O.3d 234, 238, 417 N.E.2d 1257, 1261-1262, and Kroger Co.                   
v. Limbach (1990), 53 Ohio St.3d 245, 246-247, 560 N.E.2d 192,                   
194, we held that conveyor systems which moved products to the                   
packaging area qualified for the packaging exemption.                            
     In this case, the BTA made the appropriate finding that                     
the case erectors are "an integral and essential part of a                       
continuous packaging operation."  The only question that                         
remains is whether the case erectors do not qualify for the                      
exemption solely because a portion of American National Can's                    
packaging system is manual.  Consistent with the language of                     
the statute and our reasoning in Hawthorn Mellody, supra, and                    
Kroger Co., supra, I believe that the exemption includes any                     
equipment which is an "integral part" of the packaging process,                  
regardless of whether the system is fully automated or not.  As                  
a result, I believe that the case erectors at issue are                          
entitled to an exemption pursuant to R.C. 5739.02(B)(15).                        
                              III                                                
     The last matter to which I dissent is the denial of an                      
exemption for the electrical transformer.  The applicable                        
statute provides: "[A] construction contract pursuant to which                   
tangible personal property is or is to be incorporated into a                    
structure or improvement on and becoming part of real property                   
is not a sale of such tangible personal property."  R.C.                         
5739.01(B)(5).  "Real property" is defined, in part, as: "all                    
buildings, structures, improvements, and fixtures of whatever                    
kind on the land."  R.C. 5701.02(A).                                             
     The majority misapplies a previous decision of this court                   
when it concludes that because the transformer, which weighs                     
34,500 pounds, was not bolted to the property it did not meet                    
the definition of "real property" set forth in R.C.                              
5701.02(A).  The majority derives the "physical affixation"                      
requirement from Botkins Grain & Feed Co. v. Lindley (1982), 1                   
Ohio St.3d 64, 1 OBR 105, 437 N.E.2d 1182.  However, that case                   
concerned livestock capsules which, as we noted, were highly                     
portable:  "In fact, a significant aspect of the marketability                   
of these structures is their portability.  They may be moved                     
with a minimum amount of effort and no damage to the capsule or                  
the pad."  Id. at 65, 1 OBR at 106, 437 N.E.2d at 1183-1184.                     
We also noted the potentially temporary, versus permanent,                       
nature of the capsules:  "The portability of the capsules is an                  
especially attractive feature to tenant farmers as well as                       
those farmers who intend to raise livestock for a relatively                     
brief time."  Id. at 65, 1 OBR at 106, 437 N.E.2d at 1184, fn.                   
4.  Consistent with the temporary nature of the capsules, this                   
court found that without physical affixation they could not                      
qualify as real property.  Id. at 68, 1 OBR at 108, 437 N.E.2d                   
at 1186.                                                                         
     The electrical transformer, unlike the livestock capsules,                  
is more like a permanent improvement to American National Can's                  
facility.  In fact, it serves the necessary function of                          
reducing the voltage received from an outside provider.  The                     
very nature of the transformer as a permanent and necessary                      
element of American National Can's facility distinguishes it                     
from the capsules at issue in Botkins, supra.  See Masheter v.                   
Boehm (1974), 37 Ohio St.2d 68, 66 O.O.2d 183, 307 N.E.2d 533,                   
paragraph two of the syllabus.  Furthermore, it would be                         
elevating form over substance to require a 34,500 pound piece                    
of equipment to be bolted to its concrete pad in order to                        
qualify as "real property" for purposes of R.C. 5739.01(B)(5).                   
The mere weight and permanent nature of the transformer make it                  
so that it is at least "constructively affixed" and therefore                    
qualifies as "real property."  This conclusion is consistent                     
with our decision in Pittsburgh-Des Moines Steel Co. v. Lindley                  
(1982), 1 Ohio St.3d 15, 1 OBR 39, 437 N.E.2d 302, where we                      
held that storage tanks which were similarly merely resting on                   
foundations qualified as real property.                                          
     For the foregoing reasons, I respectfully dissent.                          
     Pfeifer, J., concurring in part and dissenting in part.  I                  
concur in the majority's holdings that the water cooling system                  
is exempt from taxation and that the electrical transformer is                   
not exempt.  I would have held, however, that the machine                        
hoppers and case erectors are also tax exempt, and I therefore                   
concur in Parts I and II of Justice Wright's concurring and                      
dissenting opinion.