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Michigan provides method for electricity and gas providers to apportion sales tax exemption for industrial processing

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On February 28, 2018, the Michigan Department of Treasury issued a Revenue Administrative Bulletin (RAB) to provide a reasonable method to electricity and natural gas providers to apportion the sales tax exemption for industrial processing.1 Because property eligible for the exemption may be used simultaneously for exempt and non-exempt purposes, a reasonable method must be applied to determine the percentage of use that qualifies for the exemption. The RAB presents the Department’s approved apportionment method to be used for the industrial processing exemption claims of electricity and natural gas providers.

Background Michigan law provides a sales and use tax exemption for industrial processing to the extent the property is used or consumed within industrial processing activities.2 If property eligible for the exemption is used for both exempt and non-exempt purposes, the Department is required to approve a reasonable method of apportionment to determine the exempt use of all property eligible for the exemption. Taxpayers may submit alternative methods of apportionment for approval, but the RAB provides the Department’s approved means of apportionment for providers whose transmission and distribution systems simultaneously perform exempt and non-exempt activity.

In Detroit Edison Co. v. Department of Treasury,3 the Michigan Supreme Court considered the application of the industrial processing exemption to an electrical system. As explained by the Court, altering the voltage of electricity is an exempt activity because it conditions electricity for ultimate sale at retail. The movement of electricity from stations to final consumers constitutes non-exempt distribution and shipping activities. The simultaneous exempt and non-exempt use of the electrical grid requires apportionment of the industrial processing exemption. 

Electricity Systems The RAB explains that an electricity grid refers to the interconnection of three specialized electricity processes: (i) generation; (ii) transmission; and (iii) distribution. The transmission and distribution components generally comprise the power delivery system that moves and delivers electricity to individual and business consumers. Specifically, the transmission system is a network of assets that supports the bulk transport of electricity at high voltages to efficiently move electricity across long distances throughout the electrical grid.4 The transmission process usually begins when electricity is “stepped up” to several thousand volts by transformers located at a generation plant. When it reaches the distribution point, the electricity passes through a local distribution substation that reduces the voltages for high-volume delivery over short distances. The distribution system is a network of assets that supports the movement and delivery of electricity to individual and business consumers.5

The treatment of assets as part of either the transmission or distribution system may be determined using the regulations promulgated by the Federal Energy Regulatory Commission (FERC). Taxpayers are advised to follow FERC’s rules and guidance to classify assets as either distribution or transmission.6

Electricity Transmission System The group of assets that constitutes an electricity transmission system may be apportioned as 60 percent exempt. Apportionment on a system-wide basis is based on the highly-interconnected design of modern transmission systems. Because the total use of any asset typically requires consideration of the entire system, the apportionment formula is based on the exempt use of the transmission system as a whole. 

Electricity Distribution SystemThe group of assets that constitutes an electricity distribution system may be separated into assets by function and the exempt use may be estimated based on the asset’s general use within the system. The Department will generally rely on FERC regulations for classifying assets into the categories listed below. Assets within an electrical distribution system may be apportioned under the following categories:

  • Stations and substations – 90 percent exempt;7
  • Transformers and related components – 90 percent exempt;8
  • Wires, cabling and related equipment – 25 percent exempt;9
  • Poles and pole top equipment – 25 percent exempt;10
  • Distributions tools and supplies – 50 percent exempt;11
  • Supervision, quality control and personal safety equipment – 50 percent exempt;12 and
  • Customer meters – 25 percent exempt.13

Natural Gas Systems The RAB explains that delivery to the final point of use in a natural gas system requires the use of an extensive and elaborate delivery system comprised of both interstate and intrastate systems. Interstate systems are regional and national pipeline networks that transport natural gas long distances across state lines. The gas must be highly pressurized at regular intervals in compressor stations located throughout the system. Because the large pipes and highly pressurized nature of the interstate system make it unsuitable to deliver natural gas to consumers, the interstate pipelines must generally connect with smaller-capacity intrastate pipes. The interchange between these two systems is known as the “citygate.” At this point, the natural gas is depressurized, scrubbed, filtered and odorized in final preparation for consumer use. Exempt industrial processing occurs at several stages within the natural gas delivery system.14 Due to the simultaneous distribution and shipping function that is performed throughout the system, a reasonable means of apportionment for each phase of natural gas delivery is necessary.

Industrial processing equipment within interstate systems may be treated as 100 percent exempt. Because natural gas is not considered a finished good capable of delivery until it passes into the intrastate system, the entire interstate system qualifies for the industrial processing exemption. 

The intrastate distribution system beyond the citygate may be apportioned as 50 percent exempt. Unlike the interstate system, the intrastate system beyond the citygate performs exempt and non-exempt activities simultaneously and throughout the system. The apportionment factor is intended to balance the intrastate distribution system’s dual purpose of consumer delivery and general pressure regulation. 

Other Reasonable Apportionment Formulas The RAB explains that the apportionment formulas provided above are designed to be reasonable and generally applicable to all electricity and natural gas providers. However, an apportionment calculation is a factual inquiry and may vary based on the specific design characteristics and equipment used within a particular utility system. A taxpayer may request to apportion the exemption on other factual grounds, but must provide sufficient evidence that its calculation of exempt use is reasonable, and bears the burden of proving the total exempt use of the property.

Commentary Due to the complex nature of their operations, electricity and natural gas providers historically have had difficulty in determining how much of their property should be treated as exempt for purposes of the industrial processing exemption. Apportionment accounts for the fact that property is often simultaneously used in these industries for exempt and non-exempt purposes. The RAB applies the Michigan Supreme Court’s reasoning from Detroit Edison as well as FERC’s regulations to formulate a reasonable apportionment method that will qualify as a “safe harbor” for taxpayers. Electricity providers must determine whether equipment is part of either the transmission system or the distribution system. The electricity transmission system is 60 percent exempt, but electricity providers must categorize equipment to determine the applicable apportionment percentage for equipment that is part of the electricity distribution system. The apportionment methodology is less complex for natural gas providers. After it is determined whether equipment is part of either an interstate line or an intrastate line, the applicable apportionment percentage is used to determine the amount of the exemption. 

The issuance of the RAB is designed to minimize the number of situations in which taxpayers submit their own alternative apportionment methodologies through what may be an arduous documentation process. It will be interesting to see whether the RAB’s apportionment methodologies result in taxpayers prospectively obtaining a substantial increase in the industrial processing exemptions that they take, and if so, whether taxpayers may look to apply these methodologies and pursue refund claims for retroactive periods. 



1 Revenue Administrative Bulletin 2018-4, Michigan Department of Treasury, Feb. 28, 2018. 
2 MICH. COMP. LAWS §§ 205.54t; 205.94o. For purposes of the exemption, “industrial processing” is ”[t]he activity of converting or conditioning tangible personal property by changing the form, composition, quality, combination, or character of the property for ultimate sale at retail or for use in the manufacturing of a product to be ultimately sold at retail.” Specifically, “[i]ndustrial processing begins when tangible personal property begins movement from raw materials storage to begin industrial processing and ends when finished goods first come to rest in finished goods inventory storage.” MICH. COMP. LAWS §§ 205.54t(7)(a); 205.94o(7)(a).
3 869 N.W.2d 810 (Mich. 2015).
4 The transmission system includes transformers, high-voltage transmission lines, transmission towers and poles, and other related equipment that alters or moves electricity to the point where it is converted to distribution voltages. 
5 The distribution system includes substations, transformers, distribution lines, and other assets that are responsible for the alteration and subsequent delivery of electricity at levels safe for consumer use. 
6 If FERC guidelines do not apply, the relative location of assets and the voltage levels by which assets interact with electricity may be determinative. 
7 This category includes stations and substations that receive electricity at high voltages from the transmission system. These assets reduce voltages to deliver electricity through the distribution system and include bus compartments, condensers, switchboards and other switching equipment at the station.
8 These assets increase or decrease electricity voltage within the distribution system and are generally located in stations, in substations or on utility poles. 
 9 This category includes assets that are used to move electricity at various voltage levels directly to consumers or to other stations, substations or transformers within the distribution system. Related equipment such as switches, circuit breakers, insulators, splices and other line devices are included.
10 These assets generally support overhead distribution conductors, wires and cabling used to move electricity throughout the system. Examples of assets in this category include poles, towers, anchors, brackets, racks, guards and railings. 
11 This category includes tools and equipment related to the installation, repair and maintenance of certain station and substation equipment, poles, pole top equipment, transformers, wires and cabling and other distribution assets. 
12 These assets include equipment to provide for systems control and dispatching, general monitoring functions and personal safety.
13 This category includes customer meters or other related equipment that monitors total electricity consumption by the consumer. 
14 For example, scrubbing and filtering of natural gas ensures the integrity and purity of the gas within interstate lines and conditions the gas for ultimate sale. Also, depressurization and odorization at the citygate further conditions natural gas for consumer use.



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