Gaddy v. Hummelstein Iron & Metal, Inc.

George Rose Smith, Justice. Our compensating (or use) tax law contains an exemption for machinery that is directly used in manufacturing. Ark. Stat. Ann. § 84-3106 (D) (2) (Supp. 1977). The appellee Hummelstein buys and sells scrap metal. The state revenue department ruled that Hummelstein’s machinery is subject to the tax, for the reason that Hummelstein is not engaged in manufacturing. The appellee paid the tax under protest and brought this suit for recovery. This appeal is from a decree holding that Hummelstein is a manufacturer and is therefore entitled to claim the exemption. The appellee buys scrap metal in many forms, but in the testimony the clearest description of its operation relates to its handling of old cars, which it buys in great numbers. After the non-metallic materials, such as rubber and upholstery, have been removed from an old car, the engine block (for which there is a separate market) is pulled out. The remaining metal parts are then separated according to their nature, such as steel, iron, aluminum, brass, and copper. Dirt and other foreign matter must be removed. Large parts of a car, such as its steel body, are cut into pieces small enough to be separated by hand according to the grade of the particular metal. (Number two heavy melting steel is mentioned in the testimony as one grade.) The various metals and grades are then compressed into cubes or bales that may weigh as much as eight or nine hundred pounds. Steel, for example, is compressed into cubes small enough to go into the furnace doors at steel mills, where the scrap metal is to be made into new steel products. The bales or cubes of scrap metal are what the appellee sells to its customers. Under the statute and our earlier cases the appellee cannot be classified as a manufacturer. The statute refers both to “manufacturing” and “processing,” § 84-3106 (D) (2) (e), but it is settled that “manufacturing and processing are not two distinct operations and that a taxpayer, in order to be entitled to the exemption, must first qualify as a manufacturer.” Heath v. Westark Poultry Processing Corp., 259 Ark. 141, 531 S.W. 2d 953 (1976). That holding is sound, for we have pointed out that “processing” is such a flexible term that it might be applied to such simple matters as washing potatoes preliminary to placing them in sacks or removing stems from strawberries. Scurlock v. Henderson, 223 Ark. 727, 268 S.W. 2d 619 (1954). Thus the question is not whether the appellee is engaged in “processing” but whether it is engaged in “manufacturing,” which our statute declares is to be understood in its ordinary meaning. § 84-3106 (D) (2) (e), supra. Cases from other jurisdictions are of scant assistance, because their statutes differ from ours. Our own precedents, however, are controlling. We are unable to distinguish the case at bar, in principle, from our decision in Scurlock v. Henderson, supra. There the question was whether cotton ginning machinery was exempt under the statute as it then read, which exempted “tangible personal property used by manufacturers or processors or distributors for further processing, compounding, or manufacturing ...” Act 487 of 1949, § 6. The parallel between that case and the present one is very close. There we noted that a ginner removes trash from the cotton. Here the appellee removes dirt from its scrap iron. We noted that a ginner separates the cotton fiber from the cotton seed. Here the appellee separates the various metals from one another. We alluded to the fact that a ginner compresses the cotton into bales. Here the appellee compresses the scrap metal into cubes that are salable. We concluded that cotton ginning machinery was not exempt from the tax, because “ginning is not processing or manufacturing. ” The controlling principle, as we see it, is simply that the cotton ginner begins and ends with the same commodity, cotton, in an unmanufactured form, just as the appellee begins and ends with scrap metal that is yet to be made into something else. The appellee relies upon our holding in Ark. Ry. Equipment Co. v. Heath, 257 Ark. 651, 519 S.W. 2d 45 (1975), where we held that a company which bought old railway tank cars and converted them into highway culverts was engaged in manufacturing. We stressed the complexity of the steps that were required to convert the tank cars into culverts and the fact that a different product was being created. We concluded that the taxpayer was in fact “a manufacturer of culverts.” Here, by contrast, we cannot say that the appellee is a manufacturer of scrap metal, because that is what it begins, with and what it ends with. It changes the form of scrap metal, but it does not make a new product. It must be remembered that the appellee is seeking an exemption from the tax. We have consistently followed the rule that “an exemption from taxation must be strictly construed and to doubt is to deny the exemption.” Morley v. E. E. Barber Constr. Co., 220 Ark. 485, 248 S.W. 2d 689 (1952). The appellee has failed to meet its burden of showing clearly that it is engaged in manufacturing and is therefore exempt from the tax. Although not argued in the briefs, the suggestion has been made in our 'discussion of the case that the scope of the exemption has been broadened by amendment since our decision in the cotton ginning machinery case. Actually, the exemption has been narrowed. As mentioned above, the original exemption was of “tangible personal property used by manufacturers or processors or distributors for further processing, compounding, or manufacturing.” By Act 5 of the First Extraordinary Session of 1968, § 2, the exemption was rewritten to read essentially as it does today. What the amendment did was to limit the exemption to machinery and equipment used directly in the various stages of manufacturing “at manufacturing or processing plants or facilities in the State of Arkansas.” We quote the pertinent part of the exemption as rewritten in 1968: (2) Machinery and equipment used directly in producing, manufacturing, fabricating, assembling, processing, finishing or packaging articles of commerce at1 manufacturing or processing plants or facilities in the Stale of Arkansas [italics supplied], but only to the extent that such machinery and equipment is purchased and used for the purposes set forth in this subsection. * * * * * (c) It is the intent of this subsection to exempt only such machinery and equipment as shall be utilized directly in the actual manufacturing or processing operation at any time from the initial stage where actual manufacturing or processing begins through the completion of the finished article of commerce and the packaging of the finished end product. The term “directly” as used in this Act is to limit the exemption to only the machinery and equipment used in actual production during processing, fabricating or assembling raw materials or semi-finished materials into the form in which such personal property is to be sold in the commercial market. Hand tools, buildings, transportation equipment, office machines and equipment, machinery and equipment used in adninistrative, accounting, sales and other such activities of the business involved and all other machinery and equipment not directly used in the manufacturing or processing operation are not included or classified as exempt. The purpose of the 1968 amendment is perfectly clear. The original act, by exempting all tangible personal property used by manufacturers, could arguably have exempted office furniture, typewriters, automobiles, and various other personal property not used directly in the manufacturing process. The amendment limited the exemption to machinery and equipment used directly in manufacturing, but it still has to be used “at manufacturing or processing facilities.” Thus the basic question is precisely the same as it was in the cotton ginning machinery case: Is this taxpayer engaged in manufacturing? Upon the authority of that decision the answer must be No. Reversed. Footnotes [1] Bya typographical error the word “at” was written as “and” when the subsection was re-enacted in Act 760 of 1975, § 2, which added an exemption of poultry processing equipment, but the fact that “and” was a typographical error is apparent not only from the context but also from the correct use of “at” in the corresponding sentence in § 1 of the same act, dealing with the sales tax instead of the use tax.