Lynn A. Gandhi is a partner and business lawyer with Foley & Lardner LLP in Detroit.
In this installment of Smitten With the Mitten, Gandhi discusses the Michigan Supreme Court’s opinion in the matter of TOMRA of North America v. Department of Treasury.
Copyright 2020 Lynn A. Gandhi.
All rights reserved.
On June 16 the Michigan Supreme Court released its long-awaited opinion in the matter of TOMRA of North America v. Department of Treasury.1 The unanimous opinion authored by Justice David Viviano confirms a broad reading of Michigan’s industrial processing exemption and puts to rest continued attempts by the Department of Treasury to impose a narrow application of the exemption. More importantly, the opinion reversed the long-held maxim that tax exemptions are to be strictly construed against the taxpayer. Manufacturers and processors, as well as those that provide services to either, are urged to review their eligibility for exemption from sales and use tax for purchases of tangible personal property used in performing industrial processing activities.
Background
TOMRA is a seller and lessor of reverse-vending machines used for bottle and can recycling. The machines are typically found in grocery stores to assist retailers in complying with bottle-deposit laws. The customer inserts empty cans and bottles into the machine, where they are separated by color, flattened or punctured, shredded, and placed in bins. The machine provides the customer with a receipt, which the customer may take to the service counter for redemption.
Once a container is inserted into a machine, a conveyor belt moves the container to an optical reader. The optical reader scans the Universal Product Code on the container to determine if the container is an acceptable returnable container for recycling and whether the store takes the particular beverage and brand. If a container is not acceptable, it is rejected. The machine uses programmed information to determine the material content, weight, and color of the container. The containers are sorted by material content, and the machine maintains a count of containers. Aluminum cans are crushed and placed in a bin within the machine. Plastic bottles are sorted by color, punctured, compacted, and placed in a bin within the machine. Glass containers are sorted by color and placed in bins within the machine.
The bins are transported to processing plants. At the plants, the containers are further compacted into bales of material and sold to customers that further process the materials into a wide variety of consumer products, such as new containers, carpeting, and automotive parts. TOMRA also sold repair parts for the machines. TOMRA claimed its machines were exempt from Michigan sales and use tax under the industrial processing exemption contained within each act,2 as the machines sort, inspect, perform quality control, perform production material handling, and are otherwise engaged in activities that constitute industrial processing activities.3
After an informal conference that upheld the department’s denial of its refund claims,4 TOMRA filed a complaint at the Michigan Court of Claims. The court of claims found that the activities performed by the machines occurred before the industrial processing begins; therefore, the machines did not qualify for exemption.5 On appeal, the Michigan Court of Appeals reversed the court of claims,6 finding that industrial processing is not precluded from occurring when “tangible items are never in raw-material storage.”7 The dissent argued that the temporal limitation of the general provision, which provides “industrial processing begins when tangible personal property begins movement from raw materials storage and ends when finished goods first come to rest in finished goods inventory storage,” applies to all of the industrial processing activities listed in the more specific provisions of the exemption.8
Michigan’s Industrial Processing Exemption
In 1999, Michigan’s industrial processing exemption was significantly rewritten with the intent to expand the benefits of the exemption.9 The Legislature expanded the exemption to not only manufacturers and processers, but also to servicers. The definition was enlarged to include assembly activities, research and experimental activities, and remanufacturing.10 Under the Sales Tax Act, “Industrial processing” is defined at MCL 205.54t(7) to mean:
. . . the 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. Industrial processing begins when tangible personal property begins movement from raw materials storage and ends when finished goods first come to rest in finished goods inventory storage.11
The emphasized language of the second sentence of the general definition of industrial processing thus provides a temporal limitation in which industrial processing must occur.
In addition to this general definition of industrial processing (subsection (7)), the statute provides a list of specific activities that constitute industrial processing (subsection (3)).12 These specific activities include production and assembly; research or experimental activities; engineering related to industrial processing; inspection, quality control, or testing to determine whether particular units of materials or products or processes conform to specified parameters at any time before materials or products first come to rest in finished goods inventory storage; planning, scheduling, supervision, or control of production or other exempt activities; design, construction, or maintenance of production or other exempt machinery, equipment, and tooling; remanufacturing; the processing of production scrap and waste up to the point it is stored for removal from the plant of origin; recycling of used materials for ultimate sale at retail or reuse; production material handling; and the storage of in-process materials.13
The 1999 Amendments recognized that not all processing occurs in one location by one manufacturer. Indeed, most manufacturing today occurs in stages conducted by different persons at different locations. The statute specifically allowed the exemption to be claimed by persons who are not industrial processors but who operate machinery and equipment that conducts industrial processing activities, when the processed material is ultimately used by an industrial processor.14 Since these amendments were enacted, industrial processing may commence with a person using a machine to perform industrial processing and providing the in-process product to another processor, and so forth, until the final industrial processor transforms the property into the finished good for sale to the consumer.15 Multiple processes may occur, and the machinery and equipment used in performing the processes at multiple locations can qualify for exemption. The test for industrial processing looks to the use the machinery and equipment is put to, not to the user.16
The Temporal Limitation
The primary question addressed by the court was whether the temporal limitation of subsection (7) applied to the specific activities listed in subsection (3), an issue not previously addressed by the court.17 The department claimed that an activity listed in subsection (3) must also meet the provisions of subsection (7)(a) to qualify as industrial processing. TOMRA argued that the specific provisions of subsection (3) were in addition to the general definition of subsection (7), as the Legislature plainly intended that the listed activities were to be considered industrial processing regardless of whether they met the general definition of industrial processing in subsection (7). The department’s interpretation would negate both the clear intent and the plain language of the 1999 Amendments.
The Michigan Supreme Court found that the temporal limitation in the general provision does not apply to the provisions enumerating specific activities, which by themselves are deemed to constitute industrial processing, stating that “the temporal limitation does not establish a threshold requirement for exemption as long a Subsection (3) applies.”18 The court further noted that many of the activities statutorily designated as “industrial processing” fall outside the temporal limitation in the general definition.19
The court found subsection (3) includes activities that occur wholly separate and apart from raw material storage and, in some cases, before raw materials storage. Activities such as “research or experimental activities,” “engineering related to industrial processing,” “design [and] construction . . . of production or other exempt machinery, equipment, and tooling” are all activities that occur separate from, and often before, raw material storage and would never meet the temporal requirement of subsection (7). Similarly, “recycling” and “remanufacturing” occur after an item has entered finished goods storage and would also not meet the requirement of subsection (7). While inspection, quality control, or testing20 may occur after movement from raw material storage, imposing subsection (7) as a restriction on these activities would negate the language of subsection (3)(d) that qualifies these activities when they occur “at any time before materials or products first come to rest in finished goods inventory storage.”21 If the temporal limitation was meant to apply to all of subsection (3), the broader period of the term “at any time” in subsection (3)(d) would be unnecessary.22 Application of the second sentence of subsection (7)(a) as a limitation renders the allowable activity period of subsection (3)(d) nugatory and surplusage. The court highlighted that accepting the department’s proposed construction of the statute would “lay waste to large swaths of Subsection (3).”23
Addressing the Preference Against Tax Exemptions
More meaningful than the specific issue regarding the recycling machines, the court clarified the interpretive standards applicable to tax exemptions. This has far-reaching ramifications for Michigan’s jurisprudence. Under the duty to harmonize potential conflicts in the language of a statute, the court explained certain canons of statutory construction, particularly as they relate to tax exemptions. In TOMRA, the court rejected the long-held maxim that tax exemptions are strictly construed against the taxpayer,24 and adopted a more appropriate standard — that tax exemptions are applied according to their plain text, absent ambiguous language.25
In rejecting the often repeated language that “tax exemptions are strictly construed” against the taxpayer and in favor of the taxing unit, the supreme court rejected the finding of the court of appeals below26 and found such determination to be fundamentally wrong. The supreme court held that courts may not strictly construe unambiguous statutory provisions against one party or the other and must simply give unambiguous statutory provisions their fair meaning, according to their plain text.27
The court noted that the preference against tax exemptions is a judicially created substantive canon, which is “premised on certain policies or political objectives” rather than “its usefulness in uncovering a statute’s ordinary meaning.”28 The canon was based in the Jackson-era political doctrine that “legislation favoring one class or group should be limited, if allowed at all.”29 The court found that as judicially created, the canon cannot illuminate the ordinary language of whether a statute enacted by the Legislature provides a tax exemption, and held that the canon cannot overcome the plain language of the statutory text.30 In other words, there is no basis to interpret exemption language against the taxpayer; such language must be read and upheld as plainly written.31 Such canon should be applied only if the language is ambiguous.
Strictly construing tax exemptions tilts the playing field against the taxpayer, whether the Legislature actually intended that or not. It encourages courts to reflexively rule for the Department of Treasury whenever the case is not a slam-dunk winner for the taxpayer.32 Such rule poses the real risk of tempting courts to decide for the department by default or to defer to the department’s interpretation of an otherwise unambiguous tax exemption. This has been the experience of most state tax practitioners, in Michigan as well as in other states. Indeed, the Michigan Court of Appeals has previously strictly construed a tax exemption against the taxpayer not to resolve an ambiguity but simply because both parties’ arguments were “plausible.”33
In the well-written amicus curiae brief filed by the Michigan Manufacturers Association, the interplay between the canons of statutory interpretation are succinctly explained by reference to Justice Thomas M. Cooley, reminiscent in tone to Yoda in Star Wars34: “Beyond the words we are not to look, where the meaning is plain and intelligible.”35 The reason for this is simple, as “an enacted text is itself the law” and “the statute speaks for itself.”36 The department had urged the court, as it often does, to construe the industrial processing exemption strictly against the taxpayer because it is contrary to the principles of uniformity and equal taxation. The manufacturers association aptly noted that it would be oxymoronic for the department to presume that the Legislature disfavored an exemption at the same time it was enacting one.
The court noted that statutory text must always be read as a whole, taking into account the structure of the text as well as the physical and logical relation of the text to the other parts of the statute.37 The court found that the term “context,” as a primary determinant of meaning, embraces not just textual purpose but also historical associations due to past usage and a word’s immediate syntactic setting.38 Relying on the interpretive canon that words “should not, if possible, be rendered surplusage,” the court found that extending the temporal limitation of subsection (7) to all claims for exemption would render significant portions of subsection (3) without meaning or function.39 Relying further on the contextual canon of general/specific,40 the court found that interpreting subsection (3) as the more specific provision resolves the conflicts between the temporal limitation of subsection (7) and the specific activities of subsection (3).41
Conclusion
Despite the continuing global pandemic, the tide of justice has turned in Michigan in a positive light to taxpayers. Plain language of a statute will be applied, absent ambiguities. And canons of strict construction will be applied only as a last resort, not a tool of deference to the Department of Treasury. Also, it is now clear that the temporal limitation of the industrial processing exemption does not apply as a bar to those activities specifically included in the definition of industrial processing.
FOOTNOTES
1 Nos. 158333 and 158335, 2020 WL 3261606 (Mich. 2020).
2 The exemption for industrial processing in the General Sales Tax Act (GSTA) is at MCL 205.54t; the exemption for industrial processing in the Use Tax Act (UTA) is at MCL 205.94o.
3 TOMRA also sold repair parts for the machines, for which a refund was also sought under MCL 205.54t(4)(b), which exempts repair parts for exempt machinery.
4 At the informal conference, the department determined that the shredding and crushing processes for aluminum and plastic are industrial processing but erroneously held that sorting waste does not constitute industrial processing. Such position is contrary to Granger Land Development Co. v. Department of Treasury, 286 Mich. App. 601, 614; 78 N.W.2d 611 (2009).
5 Slip. op. at 3.
6 TOMRA of North America Inc. v. Department of Treasury, 325 Mich. App. 289, 301; 926 N.W.2d 259 (2018), a split published decision.
7 Id. at 302-303.
8 Id. at 304 (K.F. Kelly, J., dissenting).
9 In 1999, however, the industrial processing exemption was extensively amended by the Legislature in 1999 PA 116 (amending the GSTA) and 1999 PA 117 (amending the UTA). Because the amendments of the industrial processing exemption of the GSTA and UTA were identical, 1999 PA 116 and 1999 PA 117 are referred to collectively as the 1999 Amendments. See Senate Fiscal Agency analysis of H.B. 4744, noting the desire to clarify and expand the exemption.
10 Defined as overhauling, retrofitting, fabricating, or repairing a product or its component parts for ultimate sale at retail. Id. at 5.
11 MCL 205.54t(7)(a) (emphasis added). The exemption is slightly different under the UTA, which defines “industrial processing” to mean:
. . . the 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 or affixed to and made a structural part of real estate located in another state. Industrial 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.
12 MCL 205.54t(3) and MCL 205.94o(3).
13 MCL 205.54t(3)(a)-(k).
14 MCL 205.54t(1)(b), (c).
15 Granger Land Development Co. v. Department of Treasury, 286 Mich. App. 601; 78 N.W.2d 611 (2009) (allowing the exemption for waste processing to produce methane for an intermediary to produce electricity sold to a utility and consumers).
16 See Elias Bros. Restaurants Inc. v. Department of Treasury, 452 Mich. 144, 157; 549 N.W.2d 837 (1996).
17 Slip. op. at 11-12. The Court noted that in its opinion in Detroit Edison Co. v. Department of Treasury, 498 Mich. 28; 869 N.W.2d 810 (2015), it had suggested that a taxpayer could claim an exemption by satisfying either the general definition of industrial processing (subsection (7)(a)) or by showing it was engaged in one or more of the enumerated activities listed in subsection 3, making “it clear that Subsection (7)(a) and Subsection 3 are discrete inquiries.”
18 Slip. op. at 12.
19 These include the activities of “planning” or “scheduling” of production, “design, construction or maintenance of production or other exempt machinery, equipment and tooling” as well as “research and experimental activities.” See MCL 205.54t(3)(e) and MCL 205.94o(3)(e); MCL 205.54t(3)(f) and MCL 205.94o(3)(f); and MCL 205.54t(3)(b) and MCL 205.94o(3)(b).
20 MCL 205.54t(3)(d).
21 Slip. op. at 13, citing to MCL 205.54t(3)(d).
22 Slip. op. at 13.
23 Id. Note also that the department’s published guidance does not require the application of the temporal limitation for industrial processing activities. Revenue Administrative Bulletin 2000-4, Sales and Use Tax — Industrial Processing (June 13, 2000), provides explanations and examples of the activities contained in subsection (3). None of the explanations or examples impose a requirement that raw material storage be specifically identified as occurring before the exempt industrial processing activity. Examples 5 and 6 state that equipment and supplies used and consumed in testing raw materials meet the testing and quality control function and are exempt as long as the testing occurs before finished goods storage.
24 Slip. op. at 4.
25 Slip. op. at 8.
26 Slip. op. at 5, TOMRA of North America Inc. v. Department of Treasury, 325 Mich. App. 289, 296; 926 N.W.2d 259 (2018).
27 Slip. op. at 7.
28 Slip. op. at 5, referencing Brian G. Slocum, Ordinary Meaning: A Theory of the Most Fundamental Principle of Legal Interpretation (2015).
29 Slip. op. at 6, citing Green v. Graves, 1 Doug. 351, 366-367 (Mich. 1844) (discussing “the doctrine of equal rights and equal privileges, so much cherished by the people,” that militated against monopoly power or privilege).
30 Slip. op. at 7.
31 Madugula v. Taub, 496 Mich. 685, 696; 853 N.W.2d 75 (2014) (“When a statute’s language is unambiguous, ‘the Legislature must have intended the meaning clearly expressed, and the statute must be enforced as written. No further judicial construction is required or permitted.’”). See also Singer, section 66:9.
32 Antonin Scalia and Bryan A. Garner, Reading Law: The Interpretation of Legal Texts (2012), at 363.
33 Auto-Owners Ins. Co. v. Department of Treasury, 226 Mich. App. 618, 622; 575 N.W.2d 770 (1997).
34 Michigan’s 25th chief justice, for whom the Cooley Law School at Western Michigan University is named.
35 Citing to Thomas M. Cooley, A Treatise on the Law of Taxation (1876), at 198.
36 Reading Law, supra note 32, at 397; see also McIntire, 461 Mich., at 153.
37 Slip. op. at 14, citing Scalia and Garner, supra note 32.
38 Slip. op. at 14, n.35.
39 Slip. op. at 14; see also People v. Seewald, 499 Mich. 111, 123; 879 N.W.2d 237 (2016) (“When possible, we strive to avoid constructions that would render any part of the Legislature’s work nugatory.”).
40 Which provides that when a statute contains both a general provision and a specific provision, the specific provision controls and is treated as an exception to the general provision. Slip. op. at 15, citing RadLAX Gateway Hotel LLC v. Amalgamated Bank, 566 U.S. 639, 645 (2012).
41 In determining which provision is more specific and therefore controlling, the court considered which provision applies to a narrower set of circumstances. Slip. op. at 15, fn. 41.
END FOOTNOTES