Exemption on Repairs to Industrial Machinery and Equipment

SUMMARY

QUESTION: Whether replacement industrial machinery and equipment for the steel manufacturing process constitute repairs under the provisions of Section 212.08(7)(xx), F.S. The items being replaced are the electric arc furnace, the transformer for the electric arc furnace, the electrical substation for the furnace and transformer, the melting facility foundation and housing, and six of the finishing mill stands.

ANSWER – Based on Facts Below: The production of steel is an integrated process beginning with the melting of scrap steel and concluding with the coiling or bundling of the finished steel products. There are no breaks in the production process once the melting of the scrap steel has started. Accordingly, the replacement industrial machinery and equipment will qualify for an exemption as repairs with the exception of the electrical substation. The electrical substation equipment is owned by the local utility and will not qualify for exemption.

September 15, 2007

Re: Technical Assistance Advisement 07A-030 Sales and Use Tax Exemption on Repairs to Industrial Machinery and Equipment Section 212.08(7)(xx), F.S. XX (“Taxpayer”) FEI # XX

Dear XX:

This is in response to your letter of XX, requesting a Technical Assistance Advisement (TAA) regarding the exemption on repairs to industrial machinery and equipment. This response to your request constitutes a TAA under Chapter 12-11, Florida Administrative Code (F.A.C.), and is issued to you under the authority of Section 213.22, Florida Statutes (F.S.).

XX (hereinafter “Taxpayer”) is a producer of hot rolled steel reinforcing products from scrap metal in a continuous casting process. This type of industry, referred to as a “mini-mill,” is properly classified under Standard Industrial Classification (“SIC”) code 3312, Steel Works, Blast Furnaces (Including Coke Ovens), and Rolling Mills.

Taxpayer’s operations begin with the scrap yard. Scrap cars and other steel products that have not been pre-processed are shredded to a certain size in a XX-hp shredder. Metals and “fluff” (plastic materials) are separated in an eddy current separator. The non-ferrous metals that are recovered are sold for recycling. The fluff materials are of no value and are disposed. The machinery and equipment for the casting process is housed in one long, continuous building. Shredded scrap metal is brought to the building via a railway from the scrap yard. At the building, an automated system feeds the scrap metal into a charge bucket. The charge bucket deposits its contents into the XX-ton batch electric arc furnace. The electric arc furnace will hold three charges from the charge bucket. In addition to the scrap metal, alloys are fed to the furnace as needed to insure the proper chemical composition of a particular batch of the molten steel.

At the appropriate time, the furnace pours the molten steel into a ladle. A crane moves the ladle to the casting area. The ladles are then opened to pour the molten steel into a reservoir called a tundish. Molten metal flows from the tundish to molds to form XX by XX-inch billets. The billets are then cut into XX-foot lengths.

Cranes then move the hot billets to either the reheat furnace or directly to the finishing mills. The finishing mill stands, or rolling mills, are a series of machines that compress or roll-form the hot billets into progressively smaller dimensions and ultimately into long pieces of rebar or wire rod. The steel that is roll-formed into wire is coiled, while the rebar is cut into 20-, 40-, or 60-foot lengths and bundled. Approximately 50 percent of the finished product is shipped to Taxpayer’s other facilities for further fabrication into lengths and shapes as specified by Taxpayer’s customers. The remaining percentage of the finished steel is sold to customers as coiled wire or bundled rebar.

Due to age, degradation, obsolescence, and safety concerns, Taxpayer must replace the melting components of the processing line, as well as certain mill stands. The electric arc furnace was installed at the facility in 1976. The transformer for the electric arc furnace, which was installed in 1996, has an expected service life of ten years. The melting process foundation and structure has been determined to be inadequate to support loads, and no upgrades are feasible. Six finishing mills were installed in 1975. They have been rebuilt several times. Spare parts are no longer readily available. The replacement melting components will be constructed adjacent to the existing melt area, so that the manufacturing process will not be interrupted during the equipment replacement project.

Whether the replacement industrial machinery and equipment for the steel manufacturing process constitute exempt “repairs,” as described in s. 212.08(7)(xx), F.S. The industrial machinery and equipment to be replaced include:

(1) the electric arc furnace, (2) the transformer for the electric arc, (3) the electrical substation for the transformer and furnace, (4) the melting facility foundation and housing, and (5) six of the finishing mill stands.

Applicable Authority The following passages from the Florida Statutes (F.S.) and the Florida Administrative Code (F.A.C.) are pertinent to the issue under consideration.

Section 212.08(5)(b)6., F.S., provides in part:

a. “Industrial machinery and equipment” means tangible personal property or other property that has a depreciable life of 3 years or more and that is used as an integral part in the manufacturing, processing, compounding, or production of tangible personal property for sale or is exclusively used in spaceport activities. A building and its structural components are not industrial machinery and equipment unless the building or structural component is so closely related to the industrial machinery and equipment that it houses or supports that the building or structural component can be expected to be replaced when the machinery and equipment are replaced. Heating and air-conditioning systems are not industrial machinery and equipment unless the sole justification for their installation is to meet the requirements of the production process, even though the system may provide incidental comfort to employees or serve, to an insubstantial degree, nonproduction activities. The term includes parts and accessories only to the extent that the exemption thereof is consistent with the provisions of this paragraph. . . .

Section 212.08(7), F.S., provides in part:

(xx) Certain repair and labor charges.— 1. Subject to the provisions of subparagraphs 2. and 3., there is exempt from the tax imposed by this chapter all labor charges for the repair of, and parts and materials used in the repair of and incorporated into, industrial machinery and equipment which is used for the manufacture, processing, compounding, production, or preparation for shipping of items of tangible personal property at a fixed location within this state. 2. This exemption applies only to industries classified under SIC Industry Major Group Numbers 10, 12, 13, 14, 20, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, and 39 and Industry Group Number 212. As used in this subparagraph, “SIC” means those classifications contained in the Standard Industrial Classification Manual, 1987, as published by the Office of Management and Budget, Executive Office of the President. . . .

Rule 12A-1.096, F.A.C., provides in part:

(9) Types of industrial machinery and equipment that will or will not qualify for the exemption. (a) For the purpose of this exemption industrial machinery and equipment includes: 1. Special foundations required for the support of such qualifying machinery and equipment; 2. Electrical wiring from the nearest power panel or disconnect box to the qualifying machinery and equipment; . . . . Determination

The exemption on repairs as provided by s. 212.08(7)(xx), F.S., is available to those industries that are classified under specified SIC Industry Major Group Numbers. Taxpayer’s business activity is properly classified under Standard Industrial Classification (“SIC”) code 3312, Steel Works, Blast Furnaces (Including Coke Ovens), and Rolling Mills. Since Industry Group Number 33, Manufacturing, is one of the numbers that are specifically listed as eligible for the exemption on repairs in the exemption statute, Taxpayer would be eligible for the exemption. However, the critical question is from what perspective the exemption is to be applied.

The exemption on repairs is limited to “labor charges for the repair of, and parts and materials used in the repair of and incorporated into, industrial machinery and equipment.” It applies to any parts or materials incorporated into existing industrial machinery and equipment. If a stand-alone machine is scrapped and replaced with a new one, that new machine cannot be classified as a part or material that has been incorporated into a greater existing machine or piece of equipment. If, however, a series of operations are performed sequentially without interruption by machinery and equipment that is usually integrated by virtue of physical connections, such as by piping systems, loss of function of any part of the line would cause the remainder of the line to become inoperable as well. Replacement of the defective element would in that case be an incorporation of parts and materials to repair the integrated line.

The replacement of an entire production line, however, would not be an exempt repair, because the added machinery and equipment could not be characterized as a part of a greater whole. In addition, where there is a discrete process, only machinery and equipment involved in that process will be considered integrated for the repair exemption. Points in the overall manufacturing process at which materials are not being acted upon in any way other than to move or store them, and points at which those materials could either be sold or used in their current form or undergo additional processes, are interruptions that break the integration of machinery and equipment.

The operations at Taxpayer’s fixed location can be divided into two independent operations: the scrap yard operations and the casting operations. Although the machinery and equipment within the scrap yard process are not at issue within this advisement, it appears that operations there may involve several discrete processes. For example, the shredding of scrap cars and other steel items may be a separate, discrete process from the sorting of the scrap into ferrous, non-ferrous, and waste materials by the eddy current separator. Further, those operations may be separate, discrete processes from the aggregating and transporting of the ferrous scrap to the casting operations, or the aggregating of the non-ferrous scrap for resale and the waste materials for disposal. A stoppage in any one of these activities, such as an equipment breakdown, would not necessarily affect other operations in a material way.

Conversely, the casting operations are highly integrated. A breakdown in any part of the process would affect the ability of the remainder of the process to continue in operation. Once steel has begun to be melted in the electric arc furnace, the process must continue through the coiling of the steel wire or the cutting of the rebar. For example, without the electric arc furnace melting steel, all of the downstream processes would not have any steel to process. Similarly, without the finishing mills in operation, it would not be possible to begin melting the steel. These facts are illustrated by the way Taxpayer must perform the equipment replacement activities. The new equipment must be built and installed along side of and with the current machinery and equipment still in operation, so that the entire manufacturing process may continue. Otherwise, the entire facility would have to be shut-down to perform the renovations.

Section 212.08(7)(xx), F.S., does not define the phrase “industrial machinery and equipment.” There is, however, a similarly worded, long-standing exemption in s. 212.08(5)(b), F.S., for purchases of industrial machinery and equipment by new and expanding businesses. That exemption applies to “[i]ndustrial machinery and equipment” purchased by “businesses which manufacture, process, compound, or produce for sale items of tangible personal property at fixed locations . . . .” The phrase “industrial machinery and equipment” is defined by that exemption statute to include structural components when such structural components are so closely related to the industrial machinery and equipment that the structural component can be expected to be replaced when the machinery and equipment are replaced. Rule 12A-1.096, F.A.C., is the administrative rule for the new and expanding business exemption. Subsection (9) of that rule similarly provides in part that special foundations required for the support of qualifying machinery and equipment will be considered as a part of the machinery and equipment. Further, that subsection also specifies that electrical wiring from the nearest power panel or disconnect box to the qualifying machinery and equipment is considered to be a part of the machinery and equipment.

Generally, Rule 12A-1.096(9)(a)2., F.A.C., provides that the electrical wiring from the machinery and equipment back to the first panel box or disconnect is considered to be a part of the machinery and equipment. It should be noted that the provisions of subsection (9) regarding electricity contemplate a generic factory building where a variety of machinery and equipment may be installed at any number of spots in the building by connecting to the building’s existing electrical system. At Taxpayer’s facility, electrical power is delivered to the fixed location via power lines at 230 kV. This power is stepped-down at the electrical substations located in an area at the fixed location to 34.5 kV. All of this electrical equipment is owned by the local utility. Taxpayer pays a monthly fee for the equipment at the electrical substations.

Power from the substations is then routed by power lines to the various production areas of the plant. One of these substations is dedicated to providing power for the electric arc furnace. Power for the electric arc furnace may be turned on and off at the furnace control room located in the melting facility. It is understood that the transformer for the new electric arc furnace is also located in the furnace control room. This transformer would be fully automated and perform no functions other than providing service for the electric arc furnace.

Conclusions (1) The replacement of the electric arc furnace would be a repair to an integrated manufacturing process. This process begins with the melting of scrap steel and concludes with the coiling of steel wire or the bundling of steel rebar. Therefore, the replacement of the electric arc furnace would qualify for the exemption on repairs as provided by s. 212.08(7)(xx), F.S.

(2) The transformer performs no functions other than providing service for the electric arc furnace. It is physically located at a point which is after the electrical service is connected to the melting facility. The transformer would be considered a part of the industrial machinery and equipment pursuant to Rule 12A-1.096(9), F.A.C. Therefore, the replacement of the transformer would qualify for the exemption on repairs as provided by s. 212.08(7)(xx), F.S.

(3) The electric substation for the electric arc furnace and transformer is considered to be a part of the electrical service for the fixed location itself and not a part of the integrated production line. Further, the electrical substation is owned by the local utility, not Taxpayer. Accordingly, the replacement of the electrical substation will not qualify for the exemption on repairs as provided by s. 212.08(7)(xx), F.S.

(4) The melting facility’s foundation and housing would be considered a part of the industrial machinery and equipment pursuant to Rule 12A-1.096(9), F.A.C. Therefore, the replacement of the melting facility’s foundation and housing would qualify for the exemption on repairs as provided by s. 212.08(7)(xx), F.S.

(5) The replacement of six of the finishing mill stands would be a repair to an integrated manufacturing process. This process begins with the melting of scrap steel and concludes with the coiling of steel wire or the bundling of steel rebar. Therefore, the replacement of the six finishing mill stands would qualify for the exemption on repairs as provided by s. 212.08(7)(xx), F.S.

This response constitutes a Technical Assistance Advisement under Section 213.22, F.S., which is binding on the Department only under the facts and circumstances described in the request for this advice, as specified in Section 213.22, F.S. Our response is predicated upon those facts and the specific situation summarized above. You are advised that subsequent statutory or administrative rule changes or judicial interpretations of the statutes or rules upon which this advice is based may subject similar future transactions to a different treatment from that which is expressed in this response.

You are further advised that this response, your request and related documents are public records under Chapter 119, F.S., which are subject to disclosure to the public under the conditions of Section 213.22, F.S. Your name, address, and any other details, which might lead to identification of the taxpayer, must be deleted before disclosure. In an effort to protect the confidentiality of such information, we request you provide the undersigned with an edited copy of your request for Technical Assistance Advisement, backup material and response within fifteen days of the date of this advisement.

Sincerely, Jeffery L. Soff Tax Law Specialist Technical Assistance and Dispute Resolution

Cc: XX Asst. V.P. & Controller id# 32685