Century Aluminum of Kentucky, Gp v. Department of Revenue, Finance and Administration Cabinet Commonwealth of Kentucky

• Court: Court of Appeals of Kentucky
• Decided: July 8, 2021
• Docket: 2020 CA 000301
• Status: Unknown

Opinion

RENDERED: JULY 9, 2021; 10:00 A.M. NOT TO BE PUBLISHED

Commonwealth of Kentucky Court of Appeals

NO. 2020-CA-0301-MR

CENTURY ALUMINUM OF KENTUCKY, GP APPELLANT

APPEAL FROM FRANKLIN CIRCUIT COURT v. HONORABLE THOMAS D. WINGATE, JUDGE ACTION NO. 19-CI-00424

DEPARTMENT OF REVENUE, FINANCE AND ADMINISTRATION CABINET COMMONWEALTH OF KENTUCKY APPELLEE

OPINION AFFIRMING

** ** ** ** **

BEFORE: JONES, MAZE, AND TAYLOR, JUDGES.

MAZE, JUDGE: Appellant, Century Aluminum of Kentucky, GP (“Century”),

appeals the Franklin Circuit Court’s order holding certain items are subject to sales

and use tax under KRS1 139.470(9).2 For the following reasons, we affirm.

1 Kentucky Revised Statutes. 2 On April 27, 2018, KRS 139.470(10) was amended and renumbered as KRS 139.470(9). The amendment does not affect the issues in this case. BACKGROUND

Century manufactures aluminum in its facility in Hawesville,

Kentucky. For its manufacturing process, Century purchased anode stubs,

Inductotherm lining, thermocouples and tube assemblies, welding wire, and

industrial gases (collectively, the “items”) from Kentucky vendors. The vendors

charged tax on these items, which was then paid to Appellee, Commonwealth of

Kentucky, Finance and Administration Cabinet, Department of Revenue (the

“Department”).

Initially, Century paid the six percent (6%) sales and use tax to the

vendors, who then remitted the tax to the Department. Because Century believed

the items were exempt from the sales and use tax, the vendors, on Century’s

behalf, filed refund requests pursuant to KRS 139.770. The refund requests

covered the items purchased from November 2010 to May 2015. The Department

denied the refund requests for each item stating the items were “repair,

replacement, or spare parts,” which are not exempt from sales and use tax under

KRS 139.470(9).

The vendors entered into agreements assigning their rights to the

refunds to Century. See KRS 134.580(2). Then, Century, as assignee, requested

final rulings from the Department for the items in question. See KRS 131.110(4).

-2- The Department issued seven separate final rulings denying the refund claims. See

KRS 131.110(3).

Century appealed the seven final rulings with the Kentucky Claims

Commission (the “Commission”). See KRS 49.220(3). The Commission

consolidated the seven appeals and an evidentiary hearing was held in September

2018. The hearing officer recommended that Century’s refund requests be paid

because the items were exempt supplies under KRS 139.470(9). The Commission

subsequently adopted the hearing officer’s recommendation and issued a final

order on March 27, 2019.

The Department appealed the Commission’s final order to the

Franklin Circuit Court, pursuant to KRS Chapter 13B and KRS 49.250. On

February 3, 2020, the circuit court reversed the Commission’s final order, finding

the items were not exempt from the sales and use tax under KRS 139.470(9)

because the items were “repair, replacement, or spare parts,” which are taxable.

This appeal, pursuant to KRS 13B.160, followed. Additional facts will be

developed as necessary.

STANDARD OF REVIEW

Pursuant to KRS 13B.150(2), a circuit court shall not substitute its

judgment for that of the Commission “as to the weight of the evidence on

-3- questions of fact.” However, the circuit court may reverse the Commission’s final

order if it finds the order is:

(a) In violation of constitutional or statutory provisions;

(b) In excess of the statutory authority of the agency;

(c) Without support of substantial evidence on the whole record;

(d) Arbitrary, capricious, or characterized by abuse of discretion;

(e) Based on an ex parte communication which substantially prejudiced the rights of any party and likely affected the outcome of the hearing;

(f) Prejudiced by a failure of the person conducting a proceeding to be disqualified pursuant to KRS 13B.040(2); or

(g) Deficient as otherwise provided by law.

KRS 13B.150(2).

Here, the parties do not dispute that the findings of facts were

supported by substantial evidence in the record. Instead, Century disputes the

circuit court’s interpretation of the relevant statutes: KRS 139.470(9) and KRS

139.010(34).3 We review statutory interpretation cases as a matter of law de novo.

3 KRS 139.010(34), effective June 27, 2019, was previously numbered KRS 139.010(35) and, before that, KRS 139.010(26). The renumbering of this statute does not affect the issues in this case.

-4- Louisville Edible Oil Prod., Inc. v. Revenue Cabinet Kentucky, 957 S.W.2d 272,

274 (Ky. App. 1997) (citations omitted).

ANALYSIS

For its appeal, Century argues that the circuit court erred by not

harmonizing KRS 139.470(9)(b)2., which states that certain items are tax-exempt,

with KRS 139.010(34), which is the definition statute for KRS Chapter 139.

Specifically, Century claims the two statutes conflict by exempting certain items

from the sales and use tax while also defining certain items as subject to the sales

and use tax.

Because this appeal involves the construction and application of the

sales and use tax exemption, we begin our analysis with the observation that “tax

exemptions are disfavored and will be narrowly or strictly construed, with all

doubts resolved against the exemption’s application . . . .” Popplewell’s Alligator

Dock No. 1, Inc. v. Revenue Cabinet, 133 S.W.3d 456, 461 (Ky. 2004).

Accordingly, we resolve close questions concerning statutory exemptions against

awarding an exemption. We now turn to the statutes at issue.

According to KRS 139.470(9), certain items are exempt from taxes,

including:

(a) Gross receipts derived from the sale of tangible personal property, as provided in paragraph (b) of this subsection, to a manufacturer or industrial processor if

-5- the property is to be directly used in the manufacturing or industrial processing process of:

1. Tangible personal property at a plant facility;

....

(b) The following tangible personal property shall qualify for exemption under this subsection:

1. Materials which enter into and become an ingredient or component part of the manufactured product;

2. Other tangible personal property which is directly used in the manufacturing or industrial processing process, if the property has a useful life of less than one (1) year. Specifically these items are categorized as follows:

a. Materials. This refers to the raw materials which become an ingredient or component part of supplies or industrial tools exempt under subdivisions b. and c. below;

b. Supplies. This category includes supplies such as lubricating and compounding oils, grease, machine waste, abrasives, chemicals, solvents, fluxes, anodes, filtering materials, fire brick, catalysts, dyes, refrigerants, and explosives. The supplies indicated above need not come in direct contact with a manufactured product to be exempt. “Supplies” does not include repair, replacement, or spare parts of any kind; and

c. Industrial tools. This group is limited to hand tools such as jigs, dies, drills, cutters,

-6- rolls, reamers, chucks, saws, and spray guns and to tools attached to a machine such as molds, grinding balls, grinding wheels, dies, bits, and cutting blades. Normally, for industrial tools to be considered directly used in the manufacturing or industrial processing process, they shall come into direct contact with the product being manufactured or processed; and

3. Materials and supplies that are not reusable in the same manufacturing or industrial processing process at the completion of a single manufacturing or processing cycle. A single manufacturing cycle shall be considered to be the period elapsing from the time the raw materials enter into the manufacturing process until the finished product emerges at the end of the manufacturing process.

(c) The property described in paragraph (b) of this subsection shall be regarded as having been purchased for resale.

(d) For purposes of this subsection, a manufacturer or industrial processor includes an individual or business entity that performs only part of the manufacturing or industrial processing activity, and the person or business entity need not take title to tangible personal property that is incorporated into, or becomes the product of, the activity.

(e) The exemption provided in this subsection does not include repair, replacement, or spare parts[.]

(Emphasis added). The phrase “repair, replacement, or spare parts,” as used in the

statute, is defined in KRS 139.010(34)(a)-(b) as “any tangible personal property

-7- used to maintain, restore, mend, or repair machinery or equipment” and “does not

include machine oils, grease, or industrial tools[.]”

Century contends that these two statutes conflict because almost all

items that qualify for a tax-exemption under KRS 139.470(9)(b)2.b. are also used

to “maintain, restore, mend, or repair machinery or equipment” and, thus, not

exempt under KRS 139.010(34)(a)-(b). If these two statutes are not harmonized,

Century claims that KRS 139.470(9) is meaningless and null.

In response, the Department argues that harmonization of KRS

139.470(9)(b)2.b. with KRS 139.010(34) is unnecessary because the two statutes

do not conflict. The Department notes that KRS 139.470(9) provides examples of

exempt items and KRS 139.010(34) merely defines “repair, replacement, or spare

parts” as used in KRS 139.470(9).

At the September 2018 hearing of this matter, three witnesses testified

regarding the items at issue. William Morgan, a technical manager for Century

with thirty years of experience in the aluminum industry, testified that each item

had a useful life of less than one year, was used directly in manufacturing, at a

manufacturing facility, and was tangible personal property. These are criteria

outlined in KRS 139.470(9). Mr. Morgan also testified that, at the end of each

item’s useful life, the items had no value or were scrap. Additionally, Century had

Robert C. Clark, a certified public accountant and retiree from the Department,

-8- testify regarding the statutes at issue. Mr. Clark testified that the items were tax-

exempt and the two governing statutes conflict. Finally, Richard Dobson, an

executive director with the Department, testified that the sales and use tax

exemption was not applicable to the items. Thus, Mr. Dobson testified that the

Department correctly denied Century’s refund request.

After the hearing, the Commission concluded that the items at issue

were not “repair, replacement, or spare parts” and, thus, were tax-exempt. The

Commission, relying on Mansbach Metal Co. v. Department of Revenue, 521

S.W.2d 85, 87 (Ky. 1975), held that a distinction must be drawn between items that

are used up and items that simply wear out to determine if the items are tax-

exempt. Based on Mr. Dobson’s testimony that the Department does not consider

this distinction, the Commission held that the Department erroneously interpreted

KRS 139.470(9) and KRS 139.010(34) because “[a]lmost all exempt supplies” also

fit the definition of non-exempt supplies. To harmonize these statutes, the

Commission adopted Century’s proposed four-part test4 to conclude that the items

4 Century’s four-part proposed test is: (1) Determine the useful life of the tangible personal property at issue if the machine or equipment that the tangible personal property allegedly maintains, restores, mends, or repairs is operating without the introduction of the product being manufactured. (2) Determine the useful life of the tangible personal property at issue if the machine or equipment that the tangible personal property allegedly maintains, restores, mends, or repairs is operating with the introduction of the product being manufactured. (3) If there is a difference in the useful lives of the tangible personal property between (1) and (2), then the tangible personal property is being consumed in the manufacturing process and is exempt from tax. (4) If there is no difference in the useful life of the tangible personal property between (1) and (2), then the tangible personal property is a taxable repair, replacement, or spare part.

-9- at issue were designed to be used up in the manufacturing process and, thus, were

tax-exempt.

On appeal, the circuit court reversed the Commission’s final order and

held that the two relevant statutes do not conflict. The circuit court held that KRS

139.470(9) provides examples of tax-exempt items, but also makes clear that if the

items are purchased as “repair, replacement, or spare parts,” then they are not tax-

exempt. The circuit court then found that each item was used as “repair,

replacement, or spare parts” and, thus, were taxable as discussed below.

First, the circuit court addressed the anode stubs used in Century’s

manufacturing process. The anode stubs are part of the larger anode assembly

consisting of the anode rod and a “yolk,” to which the anode stubs are welded

using the welding wire and industrial gases. Century’s witness, Mr. Morgan,

testified that the anode stubs are used to “maintain” the anode assembly and that

replacing the anode assembly is necessary to maintain the entire manufacturing

process. Because “repair, replacement, or spare parts” is defined as “any tangible

personal property used to maintain, restore, mend, or repair machinery or

equipment,” the circuit court concluded that anode stubs were not tax-exempt

under the statutes.

Second, the circuit court addressed the welding wire and industrial

gases, which Mr. Morgan testified were necessary to join the anode stub to the

-10- yoke. Based on Mr. Morgan’s testimony that the welding wire and industrial gas

must be used to “restore” the anode assembly, the circuit court held that these

items met the definition of “repair, replacement, or spare parts” and, thus, were not

Third, the circuit court addressed the thermocouples and tube

assemblies, which Mr. Morgan testified act as a thermometer and need regular

replacing due to metal fatigue from the high temperature baths in the

manufacturing process. Because Mr. Morgan testified that the thermocouples and

tube assemblies were purchased to “replace” existing ones, the circuit court held

that they qualify as replacement parts and were not tax-exempt.

Finally, the circuit court addressed the Inductotherm lining, which Mr.

Morgan testified separates the molten cast iron from the furnace components in the

manufacturing process. Because Mr. Morgan testified that the Inductotherm lining

was used to “maintain” the induction furnaces, the circuit court held that this item

was not tax-exempt.

Because each of the foregoing items were “repair, replacement, or

spare parts,” as defined in KRS 139.010(34), the circuit court concluded that

Century was not entitled to a refund. Furthermore, the circuit court rejected

Century’s proposed four-part test because it “ignore[d] the fact that all tangible

personal property used in the manufacturing process wears down or is used up”

-11- and this test would only serve to exempt nearly all items from the sales and use tax

in KRS 139.470(9). Instead, the circuit court held that the proper test is whether

items of tangible personal property are introduced into the manufacturing process

“to maintain, restore, mend, or repair machinery or equipment” as set forth in KRS

139.010(34) or whether items of tangible personal property are used up or

consumed because of their involvement in the manufacturing process. If an item is

used “to maintain, restore, mend, or repair machinery or equipment,” then it is

subject to the sales and use tax. However, if the item is used up or consumed

because of its involvement in the manufacturing process, then it is not subject to

the sales and use tax.

After careful review, we conclude that the two statutes at issue are not

in conflict. While KRS 139.470(9) outlines items that are exempt from the sales

and use tax, this statute also clearly excludes items purchased as “repair,

replacement, or spare parts” from the exemption. That exclusion is contained

within KRS 139.470(9). Then, the Legislature defined that exclusion in KRS

139.010(34), which is the definition statute for KRS Chapter 139. Therefore, the

two statutes do not need to be harmonized and we hold that the circuit court

correctly interpreted the statutes at issue.

Also, we agree with the circuit court’s rejection of Century’s proposed

four-part test. In KRS 139.470(9), the Kentucky Legislature set forth the

-12- parameters for how to classify an item as tax-exempt or taxable. Clearly, the

Legislature intended for certain items in the manufacturing process to be tax-

exempt and for other items to be taxable. In light of the express language of the

statute, the circuit court properly interpreted the statutes and applied the

Legislature’s words as written to evaluate the items at issue. We also agree with

the circuit court’s application of the law to the facts to conclude that the items were

introduced “to maintain, restore, mend, or repair machinery or equipment” and,

therefore, are taxable.

At this point, we recognize Century’s argument that the Department

improperly attached evidence to its appellate brief. Century urges the Court to

disregard the Department’s references to the Legislature’s intent regarding KRS

139.470(9) because those materials were not part of the record below and can only

be introduced when a statute is considered ambiguous.

As a general matter, Century is correct that evidence not offered or

introduced as evidence in the lower court, with exceptions, will not be considered

by an appellate court. However, we also note that we are bound by KRS

446.080(1), which directs that “[a]ll statutes of this state shall be liberally

construed with a view to promote their objects and carry out the intent of the

legislature[.]” Accordingly, “the cardinal rule of statutory construction is that the

intention of the legislature should be ascertained and given effect.” MPM Fin.

-13- Grp., Inc. v. Morton, 289 S.W.3d 193, 197 (Ky. 2009) (citation omitted). “We also

bear in mind that where the language of a statute is clear and unambiguous on its

face, we are not free to construe it otherwise even though such construction might

be more in keeping with the statute’s apparent purpose.” Id. (citation omitted).

In this case, the language of KRS 139.470(9) and KRS 139.010(34) is

clear and unambiguous. The Court did not need to examine the legislative history

referenced by the Department to interpret the language of the statutes or ascertain

the Legislature’s intent. See Cummings v. Covey, 229 S.W.3d 59, 61 (Ky. App.

2007).

CONCLUSION

In conclusion, the circuit court properly interpreted the statutes and

applied the law to the facts to conclude that the items were taxable as “repair,

replacement, or spare parts” under KRS 139.470(9) and KRS 139.010(34). For the

foregoing reasons, we affirm the circuit court’s order.

JONES, JUDGE, CONCURS.

TAYLOR, JUDGE, DISSENTS AND DOES NOT FILE A SEPARATE OPINION.

-14- BRIEFS FOR APPELLANT: BRIEF FOR APPELLEE:

Steven L. Lenarz Richard W. Bertelson, III Goshen, Kentucky Frankfort, Kentucky

-15-