Opinion ID: 2603565
Heading Depth: 1
Heading Rank: 8

Heading: the business and occupation tax and the exclusion of incidental activities

Text: RCW 82.04.120 provides the following definition: To manufacture embraces all activities of a commercial or industrial nature wherein labor or skill is applied, by hand or machinery, to materials so that as a result thereof a new, different or useful substance or article of tangible personal property is produced for sale or commercial or industrial use, and shall include the production or fabrication of special made or custom made articles. To manufacture shall not include activities which consist of cutting, grading, or ice glazing seafood which has been cooked, frozen or canned outside this state. This definition is supplemented by former WAC 458-20-136 (Rule 136) which read in pertinent part: [3] It means the business of producing articles for sale, or for commercial or industrial use from raw materials or prepared materials by giving these matters new forms, qualities, properties, or combinations. It includes such activities as making, fabricating, processing, refining, mixing, slaughtering, packing, curing, aging, canning, etc. It includes also the preparing, packaging and freezing of fresh fruits, vegetables, fish, meats and other food products, the making of custom made suits, dresses, and coats, and also awnings, blinds, boats, curtains, draperies, rugs, and tanks, and other articles constructed or made to order. It also includes the generation or production of electrical energy for resale or consumption outside the state. ... The term to manufacture does not include activities which are merely incidental to nonmanufacturing activities. Thus, the following do not constitute manufacturing: Washing and screening of coal, or the bucking and yarding of logs, by the extractors thereof; pasteurizing and bottling of milk by a dairy; cooking and serving of food by a restaurant; the mere cleaning and freezing of whole fish; repairing and reconditioning of tangible personal property for others, etc. Likewise, neither an artist, a portrait photographer, nor a prescription pharmacist is a manufacturer. (Italics ours.) Group Health asserts that the Department must give Rule 136 the full force and effect of law pursuant to RCW 82.32.300. It argues that Rule 136 authorizes a de minimis approach, as used in Otis Elevator Co. v. United States, 618 F.2d 712 (Ct. Cl. 1980). Otis involved Otis Elevator's status as a Western Hemisphere trade corporation within the meaning of Internal Revenue Code section 921, the dispositive issue being the extent to which Otis Elevator was a corporation all of whose business, other than incidental purchases, was conducted in Western Hemisphere countries. Regarding incidental purchases the court in Otis states at pages 718-19: [P]laintiff challenges the correctness of the Treas.Reg. § 1.921-1(a)(1) definition of incidental purchases. Rather than meaning purchases which are (i) minor in relation to the entire business or (ii) nonrecurring or unusual in character, plaintiff contends that incidental purchases as used in section 921 should be defined as purchases incident to the conduct of the business. In plaintiff's view, purchases made outside the Western Hemisphere, if incident to the conduct of its business, must regardless of the level of such purchases always be considered to be incidental purchases. Since Treas.Reg. § 1.921-1(a)(1) specifically rejects plaintiff's definition, we could agree with plaintiff only if we were to hold the regulation invalid to the extent it defines the phrase incidental purchases. This we decline to do. While incidental purchases is susceptible to either plaintiff's or the regulation's definition, the definition adopted by Treas.Reg. § 1.921-1(a)(1) is a reasonable one and is consistent with section 921. Since Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes, we therefore uphold the validity of the definition adopted by the regulation. (Citations omitted.) [6] The de minimis approach used in Otis involved a percentage comparison of the purchases of goods manufactured outside the Western Hemisphere to the total gross purchase receipts. The Otis court deemed 15 percent of total gross receipts incidental. We accordingly hold that in determining whether a corporation's purchases made outside the Western Hemisphere are purchases    which are    minor in relation to the entire business, as this phrase is used in this regulation, the correct approach is to compare the dollar value of a corporation's purchases made outside the Western Hemisphere in a given year with its gross receipts in that year. If this percentage is sufficiently small, such purchases will be minor in relation to the entire business. .. . Otis, at 724-25. The carpentry and print activities of Group Health involve less than .1 percent of the total expenses of Group Health. This fact alone does not suffice, however, to show that the carpentry and print activities in question were incidental. The Otis court looked to Treasury regulations for the definition of incidental purchases. The WAC regulations do not define incidental manufacturing for our purposes. However, Rule 136 speaks of the [w]ashing and screening of coal ... pasteurizing and bottling of milk ... repairing and reconditioning of tangible personal property for others ... The thrust of Rule 136 is qualitative rather than quantitative. The text examples of Rule 136 clearly support a qualitative approach. The quantitative de minimis approach used in Otis is inappropriate. Manufacturing is defined as an activity which produces a substance or article either for sale or commercial use or industrial use. RCW 82.04.120. The relevant test involves a comparison of the product or substance which emerges from that which was initially submitted to treatment or processing. McDonnell & McDonnell v. State, 62 Wn.2d 553, 557, 383 P.2d 905 (1963) states: [C]onsideration should be given to the following factors: among others, changes in form, quality, properties (such changes may be chemical, physical, and/or functional in nature), enhancement in value, the extent and the kind of processing involved, differences in demand, et cetera, which may be indicative of the existence of a new, different, or useful substance. See also Bornstein Sea Foods, Inc. v. State, 60 Wn.2d 169, 175, 373 P.2d 483 (1962). The carpentry and print activities of Group Health, albeit minimal, constitute manufacturing even though the goods were produced for their own use and not for sale. These activities produce new, different and useful products. Thus the carpentry and print work is within the definition of manufacture provided by RCW 82.04.120. Rule 136 does not exempt from taxation activities which satisfy this definition. The Department's assessment of business and occupation and use taxes on these activities was proper.