State justices to hear dispute over tax’s ‘ manufacturing’ exemption

State attorneys say a group that helped “manufacture” clean water is muddying up state statutes in order to avoid a nearly $ 100,000 tax debt.

A yearslong legal dispute between a Kansas construction company that expanded a Russellville water treatment plant and state tax officials was submitted last week to the state’s high court over nearly $ 100,000 in owed taxes that the company claims was exempt by state law.

It’s unclear how soon the Arkansas Supreme Court will rule on the case.

The company in question, Carrothers Construction Co. LLC, seeks an abatement for $ 94,994.89, plus nearly a decade in interest, over taxes the Arkansas Department of Finance and Administration said was owed for the project.

The Paola, Kan., company won a bid in 1998 with City Corp. in Russellville to install upgrades and do construction in an effort to double the city’s capacity to treat “raw surface water” into clean drinking water.

In 2004, years after the work was done, an audit by the finance department found that, despite the company’s protest, the company was not allowed exempt purchases for equipment and materials used in expanding the Arkansas plant.

An administrative law judge ruled in 2005 that the company didn’t meet the “manufacturing” exemption in the state’s sales and use tax and ordered the company to pay.

The Kansas company appealed in Pulaski County Circuit Court in 2007, and then after a delay, refiled its case against the Department of Finance and Administration

in late 2010.

Judge Wendell Griffen ruled in June that the equipment and machinery used by the company in working on the plant did qualify for the exemption because they were “engaged in manufacturing activities,” and he ordered state officials to wipe the tax debt clean.

But state attorneys appealed Griffen’s ruling, arguing that the out- of- state company was not involved in manufacturing because the plant it worked on “started with water and ended with water and nothing was manufactured.”

Section 26- 52- 402 of the Arkansas Code states that machinery purchased for the purpose of manufacturing, or for the purpose of creating new or expanding existing manufacturing facilities, is exempt from the state’s sales and use tax.

The code also lists several things that qualify as “manufacturing or procession,” such as oil extraction, refining, egg processing, printing and the retreading of automobile tires.

State attorneys said there is no mention of water cleaning in the code and, pointing to older state cases — including one where a seller of washing machines claimed it was exempt from the tax because the end products, laundered and ironed clothes, were “a more desirable product” than the soiled garments that came in — that Carrothers’ claim for exemption fails on its face.

“The facility it expanded does not manufacture anything. Instead, it cleans dirty water for ultimate human consumption,” state attorneys wrote in their court arguments. “It starts with unclean, raw water and ends with potable water. Nothing new is manufactured.”

Attorneys for Carrothers argued that the complex, multistep process to treat water for safe consumption qualifies as manufacturing and said it was similar to a 1975 case in which the Supreme Court ruled that a state soft drink bottler was involved in “manufacturing.”

“The process of converting water from raw surface water to potable drinking water — a process that involves three separate phases of chemical and mechanical processes — is at least as much of a transformation from raw goods to finished goods as [ other past cases],” Carrothers’ attorneys wrote.

“[ In the soft drink case], it appears that both the beginning product ( water from the city supply) and the end product ( a soft drink) were fit for human consumption. In the case at bar, in contrast, the beginning product was not fit for human consumption, whereas the final product was.”