Missouri supreme court denies sales tax manufacturing exemptions

On Sept. 13, 2022, the Missouri Supreme Court held that a taxpayer’s purchases of equipment used to produce vehicle history reports (VHRs) were not exempt from Missouri sales and use taxes as equipment used in manufacturing.¹ In reversing the Missouri Administrative Hearing Commission (AHC), the Missouri Supreme Court determined that the operation of the equipment did not constitute “manufacturing” because it did not transform an input into an output with a separate and distinct use, identity or value. The taxpayer merely collected data relating to numerous vehicles and extracted the relevant data pertaining to the vehicle for which a VHR was requested.

Background

The taxpayer, Carfax, Inc., creates VHRs that it sells to consumers and car dealers. A VHR is generated for a specific vehicle to provide information about the vehicle’s history, including ownership and title history, mileage, accidents, maintenance and repairs, and manufacturer recall notices. The VHR also may include Carfax’s insights regarding the vehicle’s history. In creating a VHR, Carfax collects raw data from numerous sources, including state departments of motor vehicles, state police databases, manufacturers, car dealers, insurance companies and vehicle repair centers. This data is stored at a facility in Missouri. Carfax performs an automated process to remove incorrect and inconsistent data. After the data is corrected, Carfax uses its proprietary systems to organize and merge the new data into its database. In fulfilling an order for a VHR for a particular vehicle, Carfax extracts only the information from its database concerning the vehicle.

The Missouri Director of Revenue (Director) audited Carfax’s 2013–2016 sales and use tax returns. Pursuant to this audit, the Director assessed over $106,000 in taxes and interest after determining that the purchase of the disputed equipment² was not exempt from sales and use taxes because it was not used to “manufacture” the VHRs. Carfax subsequently appealed the Director’s assessment to the AHC. In reversing the assessment, the AHC concluded that the purchases of the equipment were exempt from tax because Carfax used the equipment directly in “manufacturing” the VHRs. The Director appealed the AHC’s decision to the Missouri Supreme Court.

Manufacturing exemptions

Missouri provides two sales and use tax exemptions related to manufacturing that are relevant to this case. First, Missouri exempts “[m]achinery and equipment . . . purchased and used to establish new or to expand existing manufacturing . . . if such machinery and equipment is used directly in manufacturing . . . a product which is intended to be sold ultimately for final use or consumption.”³ Also, Missouri law creates a sales and use tax exemption for “machinery, equipment, and materials used or consumed in the manufacturing, processing, compounding, mining, or producing of any product.”⁴ The AHC agreed with Carfax’s argument that these statutes exempted the purchases of the disputed equipment from sales and use taxes.

Equipment not used in manufacturing

The Missouri Supreme Court reversed the AHC and held that Carfax does not “manufacture” the VHRs as this term is used in the two sales and use tax exemption statutes discussed above. In interpreting the first exemption statute, the Missouri Supreme Court has held that “manufacturing” includes only activities that “transform an input into an output with a separate and distinct use, identity, or value” from the original.⁵ The court noted that it has tried to define the “outer reaches” of the definition of “manufacturing” as it related to the exemption in prior cases, and rejected claims when the test described above was not met.⁶ The court historically has held that “manufacturing” occurs for purposes of the exemption when the equipment is used to produce a “meaningful transformation of the input into the output such that the ‘separate and distinct use, identity, or value’ test is satisfied.”⁷

In rejecting Carfax’s argument, the court explained that it was not persuaded that the operating of the equipment to create VHRs constitutes “manufacturing.” Carfax collects vast amounts of data relating to numerous vehicles and then extracts the data for the particular vehicle for which the VHR is requested. As noted by the court, Carfax may explain or correct some of the aggregate data, but “the VHR does not (and does not purport) to do anything other than present the customer with whatever information created by others concerning the vehicle that Carfax has been able to obtain.” The court determined that this activity does not satisfy the requirement that the equipment be used to transform an input to an output with a different use, identity or value. Although Carfax provides a marketable and valuable service, the service is not a transformation of an input that constitutes manufacturing.

The court acknowledged that its decisions regarding the application of the manufacturing exemption statutes require it to consider activities that were not contemplated when the statutes were enacted. In fact, the court noted that the “present case is a close call,” but the legislature could amend the manufacturing exemption to include the disputed equipment used to create VHRs. Since the court was required to apply the principle of strict construction in determining the scope of “manufacturing” as it applies to sales and use tax exemptions, the court strictly construed the manufacturing exemptions against the taxpayer.⁸

Commentary

In this case, the Missouri Supreme Court determined the applicability of the sales and use tax exemptions for equipment used in “manufacturing” by considering whether an input has been transformed into an output with a separate and distinct use, identity or value. This analysis is useful in deciding whether certain activities constitute manufacturing for purposes of the exemptions. As the court noted, there are many new types of activities that were not contemplated by the Missouri legislature when the manufacturing exemptions were enacted. The scope of the exemptions is particularly unclear when they are potentially applied to data processing or high-technology services that do not fall under the traditional concept of manufacturing. While the decision to deny the exemption for equipment used to create VHRs was a “close call,” the court determined that the activity was an extraction of information rather than a transformative process.

The decision does not put a massive restriction on the manufacturing exemption, but does clarify its breadth somewhat. Taxpayers whose main trade or business falls outside the traditional manufacturing process should continue to consider the extent to which a manufacturing exemption could cover equipment that is used to develop a product for sale. However, taxpayers should be aware of the general principle (in Missouri and elsewhere) that even obtaining a relatively broad manufacturing exemption still requires sustaining the burden of proof in order to be entitled to such exemption.

1 Carfax, Inc. v. Director of Revenue, Missouri Supreme Court, No. SC99367, Sep. 13, 2022.  
2 The disputed equipment included servers, networking equipment, software, storage area network (SAN) drives, conferencing equipment, uninterruptible power supply (UPS) devices, workstations and related equipment.
3 Mo. Rev. Stat. § 144.030.2(5) (emphasis added by Missouri Supreme Court).
4 Mo. Rev. Stat. § 144.054.2 (emphasis added by Missouri Supreme Court).
5 Branson Props. USA, L.P. v. Director of Revenue, 110 S.W.3d 824, 826 (Mo. banc. 2003).
6 In prior decisions, the court denied the manufacturing exemption for the following activities: altering voltage and amperage to facilitate the transmission of electricity; repacking products; cleaning and inspecting eggs; cleaning and repairing uniforms; and retreading or recapping tires.
7 Branson Props., 110 S.W.3d at 826. In prior decisions, the court allowed the manufacturing exemption for the following activities: manufacturing and affixing words onto a page to create a newspaper; treating and purifying water; slaughtering livestock to create marketable food; commercial printing; and grinding, crushing, and sorting rock into various sizes for commercial use.
8 Interventional Cent. for Pain Mgmt. v. Director of Revenue, 592 S.W.3d 350, 352 (Mo. banc 2019).

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