Opinion ID: 1205197
Heading Depth: 1
Heading Rank: 2

Heading: taxability of cross ties

Text: In order to meet its cross tie (railroad tie) needs, Union Pacific purchased raw logs from various places and shipped them to an independent tie treating plant in Oregon. The plant treated the ties with creosote, drilled holes for spikes, and milled the ties to ensure uniform size. After the treating plant completed this work, Union Pacific transported the ties to Utah and installed them there. Union Pacific then paid sales and use tax on them based only on the cost of the raw logs plus the cost of the creosote treatment. The Commission upheld a deficiency order requiring Union Pacific to include the cost of the drilling and milling in the amount taxed on the cross ties. The Commission concluded that the cost[s] involved in creating the installed products, such as milling costs, represent services rendered in the repair or renovation of tangible personal property and are taxable, relying on Utah Code Ann. § 59-12-103(1)(g), [4] and also concluded that [i]t is the addition of those costs into the total cost of the cross ties that truly represent[s] the taxable value of the ties. Union Pacific argues that the drilling and milling services do not fit the categories of taxable services contemplated by the statute. Union Pacific further contends that Utah's imposition of a sales tax on services performed in another state unconstitutionally interferes with interstate commerce. We review Union Pacific's constitutional claims under section 63-46b-16(4)(a). Subsection 4(a) provides that an appellate court may grant relief if the agency action, or the statute or rule on which the agency action is based, is unconstitutional on its face or as applied. We will apply a no-deference correction-of-error standard to review claims of unconstitutional agency action under this section. Questar Pipeline Co. v. State Tax Comm'n, 817 P.2d 316, 317-18 (Utah 1991). Regarding the statutory construction issue, to the extent the legislature delegated to the Commission discretion to interpret the sales tax statute, we will review the Commission's construction under a reasonableness-and-rationality standard; otherwise, we will apply a correction-of-error review to issues of statutory construction. See Morton Int'l, Inc. v. Auditing Div., 814 P.2d 581, 587-89 (Utah 1991).
Union Pacific claims that Utah oversteps the constitutional boundaries drawn by the commerce clause by levying a sales tax on services rendered in Oregon. In order to analyze this claim, we must first examine the Utah Sales and Use Tax Act (the Act) and distinguish between the sales tax component and the use tax component of the Act. The Commission's rules differentiate the two: A. The sales tax is imposed upon sales of tangible personal property made within the state of Utah, regardless of where such property is intended to be used, and on the amount paid or charged for all services for repairs and renovations of tangible personal property or for installation of tangible personal property rendered in connection with other tangible personal property. B. The use tax is imposed upon the use, storage or other consumption of tangible personal property, and upon the amount paid or charged for the services for repairs or renovations of tangible personal property or installation of tangible personal property in connection with other tangible personal property, if the tangible personal property is for use, storage, or consumption in Utah; and, ordinarily, if the transaction does not take place within the state of Utah. C. The two taxes are compensating taxes, one supplementing the other, but both cannot be applicable to the same transaction. The rate of tax is the same. D. The distinguishing factor in determining which tax is applicable is normally the place where the sale or service takes place. If the sale is made in Utah, the sales tax applies. If the sale is made elsewhere, the use tax applies. Utah Admin.R. 865-19-1S. To recapitulate, the sales tax imposes a transaction tax on certain sales and certain services that occur in Utah. Complementing the sales tax, the use tax imposes an excise tax on tangible property and certain services performed in connection with that property, where the property is stored or used in Utah but is not subject to Utah sales tax because it was purchased or the service was performed outside of Utah. See Barrett Inv. Co. v. State Tax Comm'n, 387 P.2d 998, 999 (Utah 1964). If the owner of property used in Utah paid sales or use tax in another state, that tax is credited to offset the use tax levied in Utah. [5] Because of the use tax, items used in Utah but purchased elsewhere share the same tax burden as those items purchased in Utah. The use tax, therefore, helps Utah merchants compete on equal terms with merchants in other states by removing the incentive for purchasers to search for states with lower sales tax in which to purchase items for use in Utah. See id.; Henneford v. Silas Mason Co., 300 U.S. 577, 581, 57 S.Ct. 524, 526, 81 L.Ed. 814 (1937) ( Silas Mason ); Paul J. Hartman, Federal Limitations on State and Local Taxation § 10:7 (1981). Union Pacific claims that Utah violated the commerce clause by levying a sales tax on services rendered in Oregon. In so claiming, Union Pacific misapprehends the nature of the tax imposed and how it relates to the commerce clause. Utah levied a use tax, not a sales tax. Utah did not levy a tax on the sale of the raw logs and the services performed out of state; instead, Utah taxed Union Pacific's use of cross ties within the state. For over fifty years, the United States Supreme Court has upheld the nondiscriminatory application of a tax on the use of property that has come to rest in a state. See, e.g., Silas Mason; Wiloil Corp. v. Pennsylvania, 294 U.S. 169, 55 S.Ct. 358, 79 L.Ed. 838 (1935). In Silas Mason, contractors working on Grand Coulee Dam on the Columbia River objected to the state of Washington's imposition of a use tax. Washington taxed equipment the contractors used in Washington but had purchased out of state. The Washington tax scheme levied a tax or excise for the privilege of using within this state any article of tangible personal property, including the cost of transportation from the place of purchase. 300 U.S. at 580. The tax scheme also provided credit against the use tax for sales or use tax paid in Washington or in some other state. Writing for the Court, Justice Cardozo noted that items obtained through interstate commerce do not necessarily remain in interstate commerce. Furthermore, he recognized that because states can levy a tax on property within the state, they can levy a tax on the use or enjoyment of property: The tax is not upon the operations of interstate commerce, but upon the privilege of use after commerce is at an end. Things acquired or transported in interstate commerce may be subjected to a property tax, non-discriminatory in its operation, when they have become part of the common mass of property within the state of destination.... For like reasons they may be subjected, when once they are at rest, to a non-discriminatory tax upon use or enjoyment. Id. 300 U.S. at 582, 57 S.Ct. at 526. Hence, the commerce clause permits a state to tax property which has become part of the common mass of property within the state. Moreover, it does not prohibit the state from including the price of services performed in the manufacture of tangible property in calculating the basis for the use tax levy. This is implicit in the nature of tangible personal property. Both raw materials and the services performed in transforming those raw materials into a finished article contribute to the value of an item of tangible property. Consequently, when a state bases a use tax on the selling price of an item of tangible property, the basis necessarily includes the cost of services because the seller incorporates the cost of the services into the selling price. The Court in Silas Mason, for example, upheld the Washington tax, which based the use tax on the total retail price of the construction equipment, not merely on the price of the unassembled component parts of the equipment. Id. at 579, 57 S.Ct. at 525. A state may also include the cost of services performed in connection with tangible personal property that the taxpayer already owns in calculating the basis for the use tax. The basis of the Washington tax approved in Silas Mason included the service of transporting goods already owned by the taxpayer. Id. at 580, 57 S.Ct. at 525. In Halliburton Oil Well Cementing Co. v. Reily, 373 U.S. 64, 83 S.Ct. 1201, 10 L.Ed.2d 202 (1963), the Court again considered a state use tax that included the cost of services in the basis for calculating the tax. Halliburton involved a use tax levied by the state of Louisiana that included the out-of-state costs of labor and shop overhead incurred in the manufacture of specialized equipment. The taxpayer manufactured oil well cementing trucks and electrical well logging trucks in Oklahoma, some of which the taxpayer used in Louisiana. Id. at 66, 83 S.Ct. at 1202. In examining the Louisiana use tax, the Halliburton Court did not object to inclusion of labor costs the taxpayer incurred in Oklahoma in the basis for calculating the Louisiana use tax. [6] We therefore hold that including the costs of services performed in Oregon in the basis of the Utah use tax imposed on Union Pacific's cross ties does not in itself impose a burden on interstate commerce.
Although the state may include the price of services performed in connection with tangible property in calculating the basis for a use tax, it cannot impose a tax which discriminates against interstate commerce. The Halliburton Court stated that equal treatment for in-state and out-of-state taxpayers similarly situated is the condition precedent for a valid use tax on goods imported from out-of-state. Id. at 70, 83 S.Ct. at 1204. The following facts stipulated by the parties in Halliburton demonstrate the discriminatory impact of the Louisiana tax: If Halliburton had purchased its materials, operated its shops, and incurred its Labor and Shop Overhead expenses at a location within the State of Louisiana, there would have been a sales tax due to the State of Louisiana upon the cost of materials purchased in Louisiana and a Use Tax on materials purchased outside of Louisiana; but there would have been no Louisiana sales tax or use tax due upon the Labor and Shop Overhead. Id. at 67, 83 S.Ct. at 1202. In order for the state to include out-of-state services in the basis for calculating the use tax, the Constitution requires that those services be taxable if performed within the state. If applied correctly, the Utah Sales and Use Tax Act does not discriminate against interstate commerce. The Commission's rules provide, The use tax is a complement to the sales tax and the rules promulgated, when applicable, are common to both taxes. Utah Admin.R. 865-21-2U; see Barrett Inv. Co. v. State Tax Comm'n, 15 Utah 2d 97, 387 P.2d 998, 999 (1964) (sales and use tax acts are correlative and complementary to each other). Moreover, courts should construe statutes so that they conform to constitutional mandates. Therefore, in reviewing the construction and application of the Act, this court will uphold the imposition of a use tax on tangible property imported from out of state only if the state could have taxed the involved transactions if they had occurred within the state. [7]
Union Pacific purchased raw logs from various vendors located outside Utah and paid sales taxes on these purchases. After acquiring title, the railroad shipped these logs to an independent contractor in Oregon for creosote treatment and milling and drilling services in preparation for their use as cross ties. The railroad held title to the ties at all times after the initial purchase of the raw logs. [8] Union Pacific paid use tax based on the cost of the raw logs plus the creosote treatment. However, Union Pacific did not include the cost of drilling and milling services in calculating the basis of the use tax. The Act permits the state to tax retail sales of tangible personal property made within the state, certain enumerated services rendered within the state, and in-state storage, use, or consumption of tangible property purchased outside the state. Utah Code Ann. § 59-12-103. The basis for the taxation of personal property and certain services rendered in connection therewith is calculated on the amount paid or charged for the sale or service. Id. The use tax, as discussed in section A above, mirrors the sales tax in its application. Accordingly, the use tax should also be based on the amount paid for the raw logs and the amount paid for those services that are taxable under the terms of the statute. The only provisions that could conceivably apply to the milling and drilling services performed on the cross ties are the following: (g) services for repairs or renovations of tangible personal property or services to install tangible personal property in connection with other tangible personal property; (h) cleaning or washing of tangible personal property. Utah Code Ann. § 59-12-103. Union Pacific argues that drilling and milling are not the same as washing, cleaning, repairing, or renovating. The Commission found that the cost[s] involved in creating the installed products, such as milling costs, represent services rendered in the repair or renovation of tangible personal property and are taxable. It is the addition of those costs to the total cost of the cross ties that truly represent[s] the taxable value of the ties. The notion of taxable value applied by the Commission implies that the Commission included the amount paid for the services performed on the ties because those services added to the value of the ties. The value of the ties, however, is not the proper basis for calculating use tax. The basis for calculating use tax in the instant case is the amount paid for the raw logs when purchased plus the amount paid for services that fall into one of the specified categories of taxable services. The Commission has attempted to classify the milling and drilling services as repairs or renovations. Because we conclude that the Commission has discretion to interpret the terms repairs and renovations, we review the Commission action for reasonableness and rationality. Utah Administrative Rule 865-19-78S (rule 78S), guides the taxation of services pursuant to Utah Code Ann. § 59-12-103: A. Persons who wash, clean, repair, or renovate tangible personal property, whether material is furnished by the seller or not, are required to collect the sales tax upon the total charge made for the rendition of such services. B. Amounts paid or charged for installing tangible personal property in connection with other tangible personal property are subject to tax. The Commission found that the categories of taxable services contained in rule 78S provide for the taxation of the creosote treatment and the drilling and milling services. The creosote treatment involved applying tangible personal property, the creosote, to other tangible personal property, the cross ties. The creosote treatment is thus taxable. [9] See BJ-Titan Servs. v. State Tax Comm'n, 842 P.2d 822 (Utah 1992). Rule 78S, however, does not support taxing the drilling and milling services on logs Union Pacific had previously purchased. Milling logs into uniform size and drilling spike holes do not involve the installation of tangible personal property. Furthermore, drilling and milling do not suggest the same type of activity as washing or cleaning. The Commission appears to view drilling and milling as equivalent to repair or renovation. Repair and renovation, however, suggest activities that fix an already manufactured product. To repair is to restore by replacing a part or putting together what is torn or broken. To renovate is to restore to a former better state. Webster's Ninth New Collegiate Dictionary 998 (1984). Drilling and milling the cross ties did not involve repairing existing cross ties or restoring the existing cross ties to a former better state. [10] Thus, even under a deferential standard of review, we agree with Union Pacific that the drilling and milling services are not repairs or renovations within the meaning of section 59-12-103(1)(g). We note that the witness for the Auditing Division admitted as much at the hearing before the Tax Commission, and this admission went uncontested. The proper focus is not on what Union Pacific imported into this state, i.e., finished railroad ties, but rather on the transactions that actually took place, whether inside or outside Utah, and the taxability of each transaction. The Commission erroneously adopted the former approach in concluding that the drilling and milling services were taxable because they contributed to the taxable value of the ties. Union Pacific separately purchased raw logs, drilling and milling services, and creosoting services. Union Pacific paid taxes on the purchase of raw logs and the purchase of creosoting services. But none of the provisions in the Sales and Use Tax Act permit the taxation of the drilling and milling services when performed independently from the sale of the ties themselves. We therefore hold that the Commission erred in requiring Union Pacific to pay use tax for the amount paid for these services.