The Reconstruction of Morton Buildings

August 25, 2005
FOR IMMEDIATE RELEASE

The Reconstruction of Morton Buildings. Use taxes are generally imposed upon the use or consumption of an item in the state. The following article is a compilation of state tax cases which argue the taxability of the use tax imposed for the use of raw materials that were purchased outside of the state, manufactured into components outside of the state, and subsequently brought into the taxing state for use or further processing by the taxpayer. Some court decisions relied upon whether the raw materials retained their identity upon completion of the manufacturing process. Other decisions hinged upon the taxpayer's intentions for using the raw materials in the taxing state. Court decisions in fifteen states are summarized below, as well as the impacts these cases made on taxpayers and legislation.

The following is a reproduction from the Proceedings of the New York University Institute on State & Local Taxation, 2005. © Copyright 2005 by New York University. Published by Matthew Bender & Company, Inc., a Member of the LexisNexis Group, Newark, New Jersey. By Mona Guerrero Vineyard, edited by Ginny Buckner Kissling.

Overview

Alabama

California

Connecticut

Illinois

Indiana

Kentucky

Maryland

Massachusetts

Minnesota

Missouri

New York

North Carolina

Texas

Vermont

Wisconsin

Conclusion

§ 1.01 OVERVIEW

When states begin to lose money, there are several solutions they can propose. They can increase the tax rates, increase the tax base, or perhaps even propose new taxes on payroll, headcounts, or other basis. Closing doors to many tax saving opportunities is also a favored method of raising revenues. The Morton Buildings issue is one such opportunity that has been litigated in many states.

Morton Buildings, Inc. ("Morton") was in the business of manufacturing, selling, and installing prefabricated buildings primarily used in farming and industry. Morton would allow its customers to customize the building by allowing choices such as window and door placement. Morton's primary place of business was in Illinois. Orders placed in a given state would then be sent to outside of the given state, where all assembly of the building parts took place. Morton's building components were fabricated from lumber, steel, doors, rafters, plywood, and other items outside of the state from which the order was placed. Morton would cut the lumber, corrugate metal panels, and generally fabricate the building components from the raw materials. Morton purchased these raw materials also outside of the state. Once the building components were built, they would next be sent to the building site within the state from which they were ordered. Morton's employees in such state would then assemble and install the pre-manufactured parts into the customer's building.

Morton generally claimed that the raw materials from which the building components were made were not subject to use tax in the state where the building was constructed. Morton would also typically claim that the building components themselves were also not subject to use tax. The Morton Buildings issue is not new in itself. However, many states have changed their rules on the basis of this issue following litigation that was ruled in favor of the taxpayer. The following is an updated discussion of the status of the savings opportunity presented by the issue, argued by Morton and other taxpayers.

§ 1.02 ALABAMA

[1]	Commissioner v. RCA

Alabama imposes a use tax upon the storage, use or other consumption in the state of tangible personal property. ¹ In the case Commissioner of Revenue v. Radio Corporation of America, 287 Ala 395, 252 So 2d 55, 03/18/1971, ("Commissioner v. RCA"), RCA manufactured electronic data processing systems in Florida. RCA subsequently leased the systems to =Southern Bell for use in Alabama. The Commissioner contended that where a manufacturer rents or leases to others for use in Alabama, use tax should be due from the manufacturer measured by the purchase price of the materials becoming parts or components of such equipment. The Commissioner claimed that the taxable event in the instant case was the use by the taxpayer of manufactured products produced in its shops outside the state and leased to customers for use in the state. The tax should be based on the retail sales price of tangible personal property purchased outside the State of Alabama. The Commissioner viewed RCA as the ultimate consumer of the tangible personal property that it purchased to manufacture the data processing systems that it built for lease in Alabama. RCA claimed that there was no taxable event under the Alabama use tax statute ² because: (a) Rentals may not be taxed; (b) Only the use of tangible personal property "purchased at retail" may be taxed; (c) These systems were not purchased at retail by RCA, but were manufactured; (d) The many thousands of ingredients which went into the manufacturing system were purchased by RCA, but were not subsequently used in Alabama, because what RCA rented to Southern Bell was a completed system, not the thousands of ingredient parts. For purposes of this discussion, only the last contention is relevant. The court agreed with the Commissioner in the following judgment:
	We conclude that RCA did purchase at retail the materials out of which RCA manufactured the leased machine; that the lease of the materials in the finished form is a use of those materials in Alabama by RCA subject to use tax; and that the basis upon which use tax is to be computed is the cost or sales price to RCA for those materials.
[2]	Impact on Alabama Taxpayers

Alabama taxpayers may not benefit from any use tax exemptions based upon the Morton Buildings issue.

§ 1.03 CALIFORNIA

[1]	Western v. State Board

Western Contracting Corporation v. State Board of Equalization, 265 Cal. App. 2d 568, 71 Cal Rptr 472 (1968) ("Western v. State Board") was a court case discussing the same type of contention asserted by Morton. Western Contracting Corporation ("Western") constructed dredges. Western constructed a dredge, the Western Eagle, for use anywhere in the world. The Western Eagle was constructed in Kansas City, Missouri in 1958. The Western Eagle arrived in San Diego in 1959. Cal. Rev. & Tax Code Ann. 6204 provides as follows:
	An excise tax is hereby imposed on the storage, use, or other consumption in this State of tangible personal property purchased from any retailer.for storage, use, or other consumption in this State.
Western contended that the tangible personal property used to construct Western Eagle was not purchased for the purpose of use, storage, or other consumption in California. Western argued that it had not yet decided to use Western Eagle in California until after the Western Eagle's construction. The court in Western v. State Board was not swayed by the fact that Western did not decide until 1959 that it was going to use Western Eagle in California. The court states as follows:
	The lesson of the California use tax cases is that parts and materials are purchased for use in California if at the time of purchase it is contemplated that they might be used in California or elsewhere as the needs of the purchaser might require. (Emphasis added.)
The court continued to state that the Western Eagle was not used to perform any contract outside of California before it was brought to California. Therefore, had Western used the Western Eagle elsewhere before bringing it to California, Western would not have owed use tax upon the materials used to construct Western Eagle. Further, if Western could prove that Western Eagle was never intended for use in California, then the materials would not have been subject to California use tax.
[2]	Impact on California Taxpayers

Western v. State Board is still the governing precedent in California. California taxpayers must rely on how the materials purchased outside of the state are intended to be used, rather than how the materials purchased outside of the state are used for use tax purposes. The intended use of the materials is the deciding factor. This test differs from the test used in Sharp v. Morton in that the court did not consider whether or not the materials retained their character, however, was very concerned with the intent of the taxpayer in the applied use of the materials in the state. One might argue that a taxpayer's intent for property is more ambiguous than the real usage of property, however, the state's implementation of the test in itself has not yet been contested publicly since Western v. State Board.

§ 1.04 CONNECTICUT

[1]	Morton Buildings v. Bannon

Connecticut approached the issue of imposing the use tax upon materials purchased out of the state in Morton Buildings, Inc. v. Bannon, 222 Conn 49, 607 A2d 424 (1992) ("Morton Buildings v. Bannon").
Connecticut General Statutes 12-411(1) (West 1990) imposes a use tax:
	[O]n the storage, acceptance, consumption or any other use in this state of tangible personal property purchased from any retailer for storage, acceptance, consumption or any other use in this state of tangible personal property purchased from any retailer for storage, acceptance, consumption or any other use in this state.
Morton's case in Connecticut was on whether or not the use tax was due on raw materials that Morton converted into building components outside of the state for incorporation into prefabricated buildings that would be erected for customers in Connecticut. The trial court decided that Morton was in the business of selling contracts for improvement to realty, rather than selling tangible personal property. Therefore, the court ruled that the taxpayer must pay tax on the materials that it used and consumed in fulfilling the contracts. Morton appealed to the Superior Court of Connecticut. The court in Morton Buildings v. Bannon reviews a similar set of facts as are present in Sharp v. Morton. However, the facts in this case expand a bit to describe that some raw materials are shipped to the site in Connecticut without any out-of-state production processes. Other raw materials are constructed into building components outside of the state. Morton dutifully paid tax on the unaltered raw materials that were shipped to Connecticut without any pre-fabrication work done. Morton claimed that it had no Connecticut use tax liability for raw materials once its out-of-state production process had transformed such materials into prefabricated building and hardware components, as the production process constituted a "use" of the raw materials outside of Connecticut. The court outlines three conditions for the imposition of the use tax by the State of Connecticut:
	the allegedly taxable item was "tangible personal property" that was used in this state; the "tangible personal property" was "purchased" from a "retailer"; and the "tangible personal property" was purchased for "use in this state."
The court begins its analysis by applying each of the requirements of the use tax to Morton's facts and circumstances. The court found that Conn. Gen. Stat. Ann. 12-411(13) provides that "it shall be presumed that tangible personal property shipped or brought to this state by the purchaser was purchased from a retailer for storage, use or other consumption in this state." As Morton clearly brought the building components into the state for the purpose of installing them, then the first condition is met. Morton contended that it did not meet the second requirement because the transformation of raw materials into building components removed them from the definition of tangible personal property purchased from any retailer for use in the state. Morton stated that the raw materials are not identical to the resulting building components. The court found that indeed, the building components were fabricated by affixing materials, cutting lumber, and implementing all sorts of other changes to the raw materials outside of the state. Therefore, the court ruled that Morton's raw materials should not be subject to the Connecticut use tax when they are fabricated into building components outside of the state. The court did not answer the third requirement, as Morton clearly met the second requirement. The question of whether the tangible personal property was purchased for use in the state was a question left for another day.
[2]	Impact on Connecticut Taxpayers

The Connecticut Legislature reacted quickly to the outcome of the court case. The legislature amended the use tax statute effective as of July 1, 1992 in order to quash the court's ruling and impose the use tax upon Morton and upon all other taxpayers with Morton's set of facts. The amended statute Gen. Stat. Ann. 12-411(1) currently states as follows:
	An excise tax is hereby imposed on the storage, acceptance, consumption or any other use in this state of tangible personal property purchased from any retailer for storage, acceptance, consumption or any other use in this state, the acceptance or receipt of any services constituting a sale in accordance with subdivision (2) of subsection (a) of section 12-407, purchased from any retailer for consumption or use in this state, or the storage, acceptance, consumption or any other use in this state of tangible personal property which has been manufactured, fabricated, assembled or processed from materials by a person, either within or without this state, for storage, acceptance, consumption or any other use by such person in this state.(Emphasis added.)
Therefore, Connecticut taxpayers did not realize any future tax savings on this court case. However, those with open statutes of limitations before the effective date of the law change were probably able to obtain refunds for taxes paid under the same circumstances as described in Morton Buildings v. Bannon.

§ 1.05 ILLINOIS

[1]	American Can Company v. Department of Revenue

American Can Company v. The Department of Revenue, 47 Ill 2d 531, 267 NE2d 657 (1971) ("American Can v. DOR") is a different school of thought for the use tax application. The facts of American Can v. DOR are somewhat similar to that of Sharp v. Morton, however, the application of this case is much broader, encompassing more than just contractors, as Morton did. American Can Company ("American Can") was a New Jersey corporation that was authorized to do business in Illinois. American Can was in the business of manufacturing and selling containers for packaging food and other items. American Can manufactured all of its own manufacturing equipment, as well as the repair and replacement parts inevitably needed. The machinery and repair and replacement parts were all manufactured outside of Illinois in California, Ohio, and New York. The machinery and repair and replacement parts were manufactured from raw materials purchased outside of Illinois. American Can purchased many raw materials upon which it paid no sales tax in Illinois or in any other state. The materials were converted into the machinery and repair and replacement parts outside of Illinois and then sent into the manufacturing plants in Illinois to be incorporated into or replace the manufacturing machinery. Illinois imposed a use tax upon the privilege of using within the state tangible personal property purchased at retail from a retailer. ³ The DOR assessed the use tax upon the value of the raw materials that had been purchased outside of Illinois and made into machinery and repair and replacement parts for use in Illinois. The DOR stated its contention as follows:
	The tax herein sought to be imposed is on the components, and other materials which were purchased by Taxpayer. It is perhaps misleading that the term 'raw materials' is used herein. Taxpayer's machinery and replacement parts are made from steel or other alloy, bar metal and rough castings which taxpayer purchases at retail. These materials are cut, welded, shaped and machined in Taxpayer's machine shops and are then used for the fabrication of the machines and replacement and repair parts. ⁴
American Can Company v. The Department of Revenue, 47 Ill 2d 531, 267 NE2d 657 (1971) ("American Can v. DOR") is a different school of thought for the use tax application. The facts of American Can v. DOR are somewhat similar to that of Sharp v. Morton, however, the application of this case is much broader, encompassing more than just contractors, as Morton did. The DOR essentially contended that because an Illinois manufacturer would be liable for the use tax on materials incorporated into machines and parts in Illinois, it would give an undue advantage to an out-of-state manufacturer who incorporates the materials into machinery out of the state for subsequent use in the state. American Can contended that in order for the use tax to apply, the following criteria must be met:
	the property must have been purchased at retail for the use tax to apply; and the property must have been used in Illinois.
The first contention was met. American Can did purchase the property at retail. However, the raw materials were not used in Illinois. American Can contends that the raw materials were converted into other materials before being used in Illinois, and therefore, the raw materials were no longer raw materials, as they changed identity once they were incorporated into machinery and repair and replacement parts. The Illinois court investigated other state cases such as Chicago Bridge & Iron Co. v. Johnson, 19 Cal.2d 162 [119 P.2d 945] (1941) and considered the impact upon the ruling on future transactions. The court ultimately held that the materials were subject to the tax. The reasoning put forth by the court is as follows:
	[A] holding that the materials here are used in Illinois and subject to the tax is consistent with the policy and intendment of the Use Tax Act to protect citizens of Illinois from having their business diverted to out-of-state sellers. To exempt American from the application of the use tax here would operate to discriminate against Illinois citizens who manufacture or assemble machinery or parts in this State.
[2]	Impact on Illinois Taxpayers

Illinois taxpayers perhaps benefited from the holding of American Can in that most of the out of state manufacturers were not allowed an exemption for items completed outside of the state. Differing from the California court, the Illinois court pointed out that although the intention of American Can was considered when formulating where the use tax should be imposed, the actual test on the transactions of taxpayers would not necessarily depend upon their intended use of the item in Illinois, but rather it would depend upon the actual use of the item.

§ 1.06 INDIANA

[1]	Morton Buildings v. Indiana Department of Revenue

As in the other Morton Buildings cases, Morton Buildings, Inc. v. Indiana Department of State Revenue, 819 NE2d 913 (2004) ("Morton Buildings v. Indiana Department of Revenue") deals with the question of whether the raw materials Morton purchased and used outside of the state to make building components, that were eventually assembled into prefabricated buildings in Indiana, are subject to Indiana use tax. Ind. Code Ann. 6-2.5-3-2 establishes two conditions for the imposition of use tax on tangible personal property:
	The "tangible personal property" at issue must be "stor[ed], use[d], or consum[Ed] in Indiana;" and The "tangible personal property" at issue must have been "acquired in a retail transaction."
Morton contended that neither of these conditions were met with respect to the materials used to manufacture its buildings. The raw materials it acquired in a retail transaction were used in Morton's factories entirely outside of Indiana to fabricate building components. Further, the materials Morton did use in Indiana - the building components - were not acquired in a retail transaction; rather, they were fabricated by Morton and had an identity separate and distinct from the raw materials used to make them. Morton contended that raw materials were not taxable because they were not used in Indiana and the building components were not taxable because they were not purchased in a retail transaction. The Court ruled in favor of Morton in this case. The Court found that the raw materials purchased at retail were consumed in the production process out-of-state and, therefore, were never used in Indiana. Furthermore, the building components were fabricated by Morton, and not acquired by Morton. Morton did not owe use tax on either the raw materials or the building components.
[2]	Impact on Indiana Taxpayers

Indiana has not yet revised this law. Taxpayers with similar fact patterns may benefit from utilizing this tax savings opportunity.

§ 1.07 KENTUCKY

[1]	Morton Buildings v. The Revenue Cabinet

Morton's set of facts did not change in Kentucky, however, the Kentucky judicial system was not as sympathetic to its cause as other state courts. Morton purchased raw materials outside of Kentucky from which it manufactured building components. The building components were then shipped into Kentucky where they were assembled into buildings for Morton's Kentucky customers. Morton filed a refund request for the period November 1, 1985 through October 31, 1989 for use taxes that it contended were not due on its purchases of raw materials that it used to manufacture building components outside of the state. Ky. Rev. Stat. Ann. 139.310 imposes an excise tax on the storage, use, or other consumption of tangible personal property in Kentucky. The first court case ruled on August 30, 2001, Morton Buildings, Inc. v. Revenue Cabinet, K-18239, K92-R-80, Kentucky Board of Tax Appeals (2001), stated that the word "or" is disjunctive in meaning, and that if Morton engaged in one of the three statutory actions, then Morton would be subject to use tax. Morton cited its many winnings in other states in order to support its claim, however, the court was not swayed by these decisions and denied the refund claim. Morton appealed the case, and was denied again by the Kentucky Circuit Court. The Kentucky Circuit Court found as follows:
	The manufacture of raw materials into the building components out-of-state will not aid Morton in avoiding the use tax.raw materials are consumed in Kentucky when they are brought in the state for use whether or not they are first manufactured.
Therefore, Morton owed use tax on its purchases of raw materials that it used to manufacture building components outside of the state. The Kentucky Court of Appeals affirmed the Circuit Court decision denying the refund of use tax paid on materials purchased, stored, and transformed outside of Kentucky in a decision issued on July 25, 2003.
[2]	Impact on Kentucky Taxpayers

No other taxpayers were known to be successful in asserting that raw materials were not subject to use tax if first used outside of the state.

§ 1.08 MARYLAND

[1]	Comptroller of Treasury v. American Can Company

American Can, like Morton, made its case heard in several states. In this case, Comptroller of Treasury v. American Can Company, 208 Md 203, 117 A2d 550 (1955) ("Comptroller v. American Can"), American Can appealed the decision of the Comptroller of the Treasury that denied American Can a refund of use tax paid on raw materials purchased outside of the State of Maryland. The court reversed the Comptroller's denial in American Can's appeal. The Comptroller then appealed the decision. Comptroller v. American Can questioned the application of the use tax provision presented in Md. Ann. Code art. 81, 369 (1951), which reads as follows:
	[A]n excise tax is hereby levied and imposed on the use, storage or consumption n this State of tangible personal property purchased from a vendor within or without this State. for use, storage or consumption within the State.
American Can's situation in Maryland is identical to its set of facts and circumstances already discussed. However, the reasoning used by the Maryland court in deciding this case is noteworthy. The court considered that the finished product, the machinery and repair and replacement parts were shipped into Maryland, and not at all the raw materials upon which Maryland sought to impose a use tax. The court summarized its position as follows:
	The raw materials would be utterly useless for the purpose of making containers. To interpret the use of the finished product as a use of the raw materials disregards the fact that before the use began the raw materials had been converted into tangible personal property of a different nature and utility. ⁵
The court based its decision upon the plain meaning of the statute language employed in 1951, in Maryland Code Art. 81, 369, which provided that the tax is imposed upon the use of tangible personal property. The court concluded that the raw materials were never actually used as raw materials in Maryland. The court further noted that the machinery and repair and replacement parts constructed from the raw materials were not actually purchased in Maryland or elsewhere.
[2]	Impact on Maryland Taxpayers

The current Maryland tax code imposes a tax on a use in the state of tangible personal property or a taxable service. ⁶ If the use of the items is taking place within the state, then it is reasonable to assume that the use is taxable. The current construction of the statute may leave some room for interpretation by Maryland taxpayers. However, the previous statutory language of Md. Ann. Code art. 81, 369 (1951), upon which American Can relied, is no longer valid within the Maryland tax code.

§ 1.09 MASSACHUSETTS

[1]	Morton Buildings v. Commissioner of Revenue

Massachusetts imposes a use tax upon the storage, use, or other consumption in the commonwealth of tangible personal property purchased from any vendor for storage, use, or consumption within the commonwealth at the rate of five per cent of the sales price of the property. ⁷ In the case Morton Buildings, Inc. v. Commissioner of Revenue, 683 NE2d 720, 43 Mass App Ct 441, (1997) ("Morton Buildings v. Commissioner of Revenue"), as before, Morton contended that the use tax did not apply to its purchases of raw materials. The use tax is imposed on tangible personal property that:
	is stored, used, or otherwise consumed in the Commonwealth; is purchased from any vendor; and was purchased for storage, use, or consumption within the Commonwealth.
The Commissioner in this case conceded that the building components were not taxable, because Morton did not purchase them, but rather, produced them. The Commissioner sought to tax the building component components instead, such as lumber, nails, and other raw materials. The Commissioner claimed that:
	the raw materials, which Morton bought out-of-State, are but lightly transformed when they appear in Massachusetts as building components.[t]he lumber that Morton brought to Massachusetts as a [l]ower [c]olumn is the lumber Morton purchased connected to nails minus the lumber cut off or drilled out during fabrication. Even though the lumber and nails become part of the [l]ower [c]olumn they each retained a distinct physical existence and are subject to the use tax.
The Court disagreed with the Commissioner's contention. It held that "one could not disassemble a truss and have recognizable lumber, steel, and nails to be used or consumed in Massachusetts." Therefore, Morton's raw materials were not subject to Massachusetts use tax.
[2]	Impact on Massachusetts Taxpayers

This Court relied upon the Morton Building's decisions in other states as well as its own statutory rules. Further, the Court seemed to take into consideration the degree to which the items were consumed or installed. The Commissioner may question some items that are not completely consumed or incorporated into a final product before they entered Massachusetts. In fact, Morton did not contest that certain elements of the building components such as doors and windows were subject to use tax, because these items could be installed in Massachusetts' jobs without significant alteration. According to Massachusetts Department of Revenue Directive No. 01-2, 5/8/2001, if property is not altered, or is altered in an insignificant way, it will be subject to the use tax when used in Massachusetts. The taxpayer bears the burden of proof that the property has been transformed.

§ 1.10 MINNESOTA

[1]	Morton Buildings v. Commissioner of Revenue

In Morton Buildings, Inc. v. Commissioner of Revenue, 488 NW2d 254, (1992) ("Morton Buildings v. Commissioner of Revenue"), the Minnesota Supreme Court reviewed the Minnesota Tax Court's finding that the items of tangible personal property Morton used, stored, or consumed in Minnesota were not the raw materials they purchased, but the building components and hardware made out of the raw materials, which are "new and different items of tangible personal property." Thus, the raw materials on which the use tax was imposed were not used, stored, or consumed in Minnesota, but were used, stored, and consumed in Morton's building component factories outside Minnesota. Minnesota Statute 297A.14 imposed a use tax on tangible personal property when all three of the following conditions are met:
	the item of tangible personal property must be used, stored, or consumed in Minnesota; the item of personal property must be purchased; and the purchase of the item of personal property must have been for use, storage, or consumption in Minnesota.
The Minnesota Supreme Court reversed the Tax Court's decision. The Supreme Court found that Morton's premise in Minnesota and in other states was faulty. The opinion stated that:
	The tax court decision, and that of the other jurisdictions in which Morton has prevailed, is bottomed on the notion that the processing of the raw materials in other locations somehow precludes their later use in the construction of buildings in Minnesota. We conclude that this is contrary to the applicable statutory definitions and the common usage of the word "use."
	***
	This court never has required that raw materials be unaltered when used in Minnesota in order to trigger liability for the use tax.
[2]	Impact on Minnesota Taxpayers

The Minnesota Legislature acted quickly after this case was decided. In 1992, the legislature added language to Minn. Stat. Ann. 297A.14 which imposed a use tax on every person who uses, stores, or consumes tangible personal property in Minnesota which has been manufactured, fabricated, or assembled by the person from materials, either within or without the state. This insertion effectively blocked future Morton Building's - type claims. Later, in the year 2000, the Minnesota Legislature repealed Minn. Stat. Ann. 297A.14 and replaced it with the current use tax statute, Minn. Stat. Ann. 297A.63, which also effectively impedes a Morton Building's - type claim by imposing the use tax as follows:
	A use tax is imposed on a person who manufactures, fabricates, or assembles tangible personal property from materials, either within or outside this state and who uses, stores, distributes, or consumes the tangible personal property in Minnesota. The tax is imposed on the sales price of retail sales of the materials contained in the tangible personal property at the rate of tax imposed under section 297A.62. (Emphasis added).

§ 1.11 MISSOURI

[1]	Morton Buildings v. Director of Revenue

Morton also filed a complaint in Missouri, Morton Buildings, Inc. v. Director of Revenue, 88-001879RZ (1989) ("Morton Buildings v. Director of Revenue"), where Morton asserted that it was entitled to a refund of use taxes paid on raw materials used in another state to manufacture goods which are eventually assembled into a building in the state. Missouri imposed a use tax upon the following:
	A tax is imposed for the privilege of storing, using, or consuming within this state any article of tangible personal property purchased on or after the effective date for sections 144.600 to 144.745 in an amount equivalent to the percentage imposed on the sales price in the sales tax law in section 144.020. This tax does not apply with respect to the storage, use, or consumption of any article of tangible personal property purchased, produced, or manufactured outside this state until the transportation of the article has finally come to rest within this state or until this article has become commingled with the general mass of property to this state. Every person storing, using, or consuming in this state tangible personal property purchased from a vendor is liable for the tax imposed by this law.
The court in Missouri considered several cases including International Business Machines v. David, 408 S.W.2d 833 (1966) ("IBM v. David") which ruled that IBM was not liable for use tax on the raw materials which it used outside of Missouri to produce the computers that it brought into Missouri for sale to its customers. The court in Morton v. Director states that although the lumber, steel sheeting, nails, and other raw materials were useful before they arrived in Missouri, they did not remain individual entities upon which the Director could charge the use tax. If the materials had still remained raw materials when they entered Missouri, then the court may have ruled otherwise in Morton v. Director. As the fact remained that the raw materials were not still raw materials, but rather, work in processes by the time they entered the state, then the Missouri court held that Morton owed no use tax on the raw materials.
[2]	Southwestern Bell Yellowpages, Inc. v. Director of Revenue (2001)

In Southwestern Bell Yellowpages, Inc. v. Director of Revenue, 00-1500 RV, Missouri Administrative Hearing Commission (2001), Southwestern Bell Yellow Pages, Inc. ("Southwestern Bell") claimed that it was owed a refund of use tax paid on raw materials and printing charges used to manufacture yellow page telephone directories. The court reviewed the same use tax law as it reviewed in its decision for Morton. Southwestern Bell's paper was purchased outside of the state and was consumed and transformed into telephone directories before the directories entered the state. Southwestern Bell relied on the reasoning in IBM v. David, as it was used by Morton in Morton v. Director, in which the materials changed their form before entering the state. The Director argued that because the paper was still paper, the paper did not change its form as it did in IBM v. David. Southwestern Bell argued that the paper was a raw material, and that once it entered the state, it was no longer a raw material, but rather, a telephone directory. The court agreed with Southwestern Bell, relating the case to Morton Buildings v. Director. The Director subsequently appealed this decision to the Supreme Court of Missouri (the "Supreme Court"). That decision is analyzed below.
[3]	Southwestern Bell Yellow Pages, Inc. v. Director of Revenue (2002)

In Southwestern Bell Yellow Pages, Inc. v. Director of Revenue, 94 SW3d 388 (2002), the Supreme Court reviewed all of the same items that the previous decision considered in the case. However, the Supreme Court noted that Southwestern Bell actually used the paper within Missouri because Southwestern Bell exercised rights over the raw paper incident to its ownership when it fulfilled its advertising contracts with Missouri businesses. Southwestern Bell produced directories from the paper, and transported the paper into Missouri. The Supreme Court also reviewed the legislative intent, an often vague and subjective concept, and stated that the legislative intent supports the plain language interpretation of the code. The Supreme Court ruled that Southwestern Bell's purchase of the paper intended for telephone directories in Missouri constituted a use. The Supreme Court further ruled that Southwestern Bell should pay the use tax because Southwestern Bell would otherwise have an advantage over other taxpayers that did not purchase raw materials outside of the state. The Supreme Court ultimately found that the previous opinion did not conform to the language of the statute or the intent of the legislature.
[4]	Impact on Missouri Taxpayers

Unfortunately for Missouri taxpayers, the Supreme Court did not consider Morton Buildings v. Director in its decision for Southwestern Bell. Therefore, taxpayers must assume that raw materials purchased out of the state that are made into other items before being brought into the state are subject to Missouri use tax. One may wonder what the outcomes would have been if Southwestern Bell had performed a more drastic change to the raw materials. One may also wonder what the outcomes may have been if the courts chose other precedents in the Southwestern Bell cases such as Morton v. Director. Taxpayers should be advised that the three court cases leave much room for interpretation.

§ 1.12 NEW YORK

[1]	Morton Buildings v. State Tax Commission

Morton next filed suit in New York In the Matter of Morton Buildings, Inc. v. Roderick G. W. Chu et al., Constituting the State Tax Commission of the Department of Taxation and Finance of the State of New York, 126 AD2d 828, 510 NYS2d 320 (1987) ("Morton Buildings v. State Tax Commission"). The facts of the case are once again the same as in the above circumstances. The State of New York ruled that Morton was liable for New York use tax on the cost of certain raw materials that were constructed into building components. Use tax is imposed by N.Y. Tax Law 1110(A) if tangible personal property:
	is used within the state, and has been "purchased at retail."
Use is defined as the exercise of any right or power over tangible personal property by the purchaser thereof and includes but is not limited to any affixation to real or personal property. The Tax Commission argued that the raw materials that Morton purchased were used in the state because they were affixed to real property. However, Morton contended that the raw materials were not affixed to real property because they were wholly consumed and transformed during the manufacturing process, and that the components, and not the raw materials, are affixed to real property.
The court considered that the Tax Commission's interpretation was an extreme interpretation of the tax code because it would have rendered a substantial portion of the tax law meaningless. For example, under N.Y. Tax Law 1110(B), a manufacturer of finished products used in the construction of capital improvements could be taxed at the cost of raw materials only if the manufacturer also sells the finished product in the regular course of business. The Tax Commission's interpretation of the tax law would be in clear conflict with this law. The court was unprepared to accept a viewpoint in clear conflict with any part of the tax code. Therefore, the New York court ruled that Morton was correct in its assertion that the raw materials did not fall within the scope of the use tax imposed by N.Y. Tax Law 1110(A).
[2]	Impact on New York Taxpayers

The effect of the case was to effectively eliminate tax on raw materials not used in the state. However, a legislative change took effect in 1989 that changed the issue for contractors. The legislature changed the statute by stating that use tax is due on tangible personal property used or incorporated into a structure, building or real property by a contractor, subcontractor, or repairman in erecting structures or buildings.

§ 1.13 NORTH CAROLINA

[1]	North Carolina v. Morton Buildings

The Morton Buildings issue was tested again in 2003 In the Matter of: The Denial of Claims for Refund of Sales and Use Tax for the Periods of November 1, 1993 through June 30, 1996 and January I, 1997 through August 21, 1999 by the Secretary of Revenue Secretary of Revenue of the State of North Carolina v. Morton Buildings, Inc., 405, 03/18/2003.
	N.C. Gen. Stat. 105-164.6(a), provided as follows: An excise tax ... is imposed on the storage, use, or consumption in this State of tangible personal property purchased inside or outside the State for storage, use or consumption in this State N.C. Gen. Stat. 105-164.6(b) provides in relevant part: An excise tax ... is imposed on the purchase price of tangible personal property purchased inside or outside the State that becomes a part of a building or other structure in the State.
Morton contended that use taxes should be refunded on the grounds that the purchases on which those taxes were paid are not subject to use tax under N.C. Gen. Stat. 105-164.6. As before, Morton claimed that it had made no taxable "purchases" because it had originally acquired raw materials, not the building components eventually imported into North Carolina; that the raw materials were "used" outside the state; and that the building components had not been purchased, but rather "manufactured."
The Department of Revenue ("DOR") took a different standpoint than in most other states. The DOR claimed that since the taxpayer entered into agreements to fabricate and erect prefabricated buildings at locations in North Carolina, the taxpayer met the definition of a contractor. Contractors are deemed to be the users or consumers of tangible personal property that is used in the performance of contracts, and are liable for the applicable state and local sales or use tax on their purchases of materials that are used or consumed.
The Court denied Morton's contentions, and found that the raw materials were not first used outside of North Carolina before being incorporated into buildings within North Carolina. The Court reasoned that the business purpose, or intention of using the building components in North Carolina added weight against the argument that the components were first used outside of the state. The record shows that the raw materials, such as lumber and steel, were assembled outside of North Carolina only for the business purpose of subsequently incorporating the materials into structures erected in North Carolina. Therefore, they were used first in North Carolina.
The Court also agreed with the DOR's contention that the building components were incorporated into real property, and therefore, Morton qualified as a contractor for sales and use tax purposes. All of Morton's purchases of tangible personal property for incorporation into realty were subject to use tax.
[2]	Impact on North Carolina Taxpayers

North Carolina has not had a successful Morton Building's issue. No statute changes were implemented as a result of this case. Use tax is due on items intended for use in the state, even if the items are shipped into the state have undergone substantial alteration.

§ 1.14 TEXAS

[1]	Sharp v. Morton Buildings

Texas imposes a use tax upon the storage, use, or other consumption in this state of a taxable item purchased from a retailer for storage, use, or other consumption in this state. ⁸ In a landmark decision known as Sharp v. Morton Buildings, Inc., 953 SW2d 300 (1997) ("Sharp v. Morton Buildings"), Morton challenged the use tax imposed upon its raw materials.
Morton would charge customers a lump sum that included both the labor to assemble the building and the building components. Morton asserted that Morton was not subject to Texas use tax on its raw materials because the materials were first used outside of the State of Texas to construct the building components. Texas Administrative Code tit. 34, 3.291(b) states that a lump-sum contractor is a "consumer of all materials, supplies, and equipment used or incorporated into a customer's property. As a consumer, a contractor must pay tax to suppliers at the time the materials are purchased." Therefore, because Morton was the deemed user of the materials purchased such as lumber, metal, windows, and doors, the State of Texas imposed the use tax upon those materials. Even though the materials were all purchased out of the state, and were assembled into building components out of the state, Texas imposed the use tax on the components because Morton shipped them to Texas for use in Texas.
Morton claimed the use tax could only be imposed upon items of tangible personal property purchased for use, storage, or consumption in Texas. Morton contended that the raw materials used to construct its building components were first used, stored, or consumed outside of Texas when they were converted into the building components. Morton's subsequent contention was that the building components themselves were not purchased, and therefore, could not be taxed in Texas.
The State of Texas contended that the raw materials were consumed in the state by Morton, and therefore, should be subject to Texas use tax. The trial court found that Morton should not owe use tax because the building components were manufactured, rather than purchased building components. However, the court also considered whether the building components were merely raw materials conjoined into something else, and therefore, the Comptroller would have made a correct assertion.
The court found that the building components were distinct from the constituent raw materials, and that, the raw materials were first "used" outside of Texas. The court concluded that the building components were not subject to use tax pursuant to Tex. Tax Code Ann. 151.101 (Vernon 2002). The court summarized its position as follows:
	Because the lumber and steel are not used in their raw form in Texas but instead are used after their transformation into building components, they are not taxable. Because Morton did not purchase the building components, the components are not taxable. Our conclusion that the manufacturing process converts the raw materials into something else also blunts the State's argument that the raw materials can be used both out of state and in state. Because the raw materials no longer exist, they are not put to a taxable use in Texas. ⁹
[2]	Impact on Texas Taxpayers

Sharp v. Morton specifically addressed the taxability of raw materials converted by a contractor for use within the State of Texas. However, the same reasoning used by the Texas appellate court may currently be applied to many other types of taxpayers for many other items. Anything that is purchased outside of the state and converted into another item may be considered as first "used" outside of the state.
Applying the Texas case, if a taxpayer purchased paper outside of the state for the purpose of transforming that paper into a catalog or pamphlet while it was still outside of the state, the taxpayer would not owe Texas use tax on the paper and ink used to create the pamphlet, because the paper and ink would be first used outside of the state. If a promotional item such as a t-shirt was purchased outside of the state and the taxpayer imprinted upon it before shipping the t-shirt to Texas, then the t-shirt would be first used outside of the state and would not be subject to Texas use tax.
However, the Texas Legislature passed House Bill 2425, which amended the Tex. Tax Code Ann. 151.011(a) to read as follows:
	Except as provided by Subsection (c) of this section, "use" means the exercise of a right or power incidental to the ownership of tangible personal property over tangible personal property, including tangible personal property other than printed material that has been processed, fabricated, or manufactured into other property or attached to or incorporated into other property transported into this state, and, except as provided by Section 151.056(b) of this code, includes the incorporation of tangible personal property into real estate or into improvements of real estate whether or not the real estate is subsequently sold. (Emphasis added).
The addition of this language into the definition of a taxable use effectively states that if tangible personal property, other than printed material, has been changed, or manufactured into a different product before being shipped into the state, then the tangible personal property would still be considered used in Texas for Texas use tax purposes. All of the materials used to make the building components at issue in Sharp v. Morton would then be taxable. This statute became effective on October 1, 2003.

§ 1.15 VERMONT

[1]	Morton Buildings v. Vermont

The Vermont Department of Taxes appealed a Washington Superior Court order granting a use tax refund to Morton Buildings for taxes on raw materials it purchased outside of Vermont, assembled into building components at its Gettysburg, Pennsylvania factory, and then brought into Vermont to construct prefabricated buildings in Morton Buildings, Inc. v. Vermont Department of Taxes, 167 Vt 371, 705 A2d 1384, (1997) ("Morton Buildings v. Vermont").
In order for the department to impose a use tax on the materials Morton incorporates into its building components and thereafter into its buildings, the department would have to show that (1) Morton purchased tangible personal property at retail, and (2) Morton used the same tangible personal property in Vermont.
Morton contended that the tangible personal property it used to construct buildings in Vermont is not the same tangible personal property that it purchased at retail. Morton asserted that through its manufacturing process, the raw materials it purchased at retail were transformed into different items of tangible personal property. For this reason, Morton asserted that the two requirements to impose a use tax on the building components were not met. Thus, the building components it used in Vermont were not, it argues, purchased at retail.
The Court did not accept Morton's arguments. First, the Court declared that the use tax statute on which Morton relied did not specifically state that raw materials that are used in manufacturing lose their separate identity as personal property purchased at retail are subject to a use tax. The use tax language and the definition of tangible personal property are both very broad. The definition of "use" given in Vt. Stat. Ann. tit. 32, 9701(13) is as follows:
	Use: means the exercise of any right or power over tangible personal property by the purchaser thereof and includes, but is not limited to, the receiving, storage or any keeping or retention for any length of time, withdrawal from storage, any installation, any affixation to real or personal property, or any consumption of that property.
The Court found that the building components were encompassed in this statute as tangible personal property subject to use tax. Next, the Court declared that the transformation of raw materials into building components did not meet the definition of manufacturing. The Court could not discern how the trusses, lumber, and other component parts could be considered new and different items from their raw materials. Finally, the Court held that to rule in favor of Morton would be unfair to similarly situated taxpayers. A taxpayer purchasing its raw materials from New Hampshire would not have to pay taxes on those items, where a taxpayer purchasing all materials within Vermont would not pay tax on its materials.
[2]	Impact on Vermont Taxpayers

The statute reads the same as it did at the time this case was argued. The construction of the statute is similar as those statutes in states where Morton Buildings was successful. However, this case leads us to conclude that the Vermont Department of Revenue would likely deny any claims for refund based upon the Morton Buildings premise.

§ 1.16 WISCONSIN

[1]	Morton Buildings v. Wisconsin

Morton successfully argued its case in Morton Buildings, Inc. v. Wisconsin Department of Revenue, 89-S-438, (1991) ("Morton Buildings v. Wisconsin"). The Court found that the raw materials used to create building components were stored in out-of-state warehouses and then used or consumed out-of-state.
Since the Wisconsin use tax was premised on the "storage, use or other consumption in this state of tangible personal property ... purchased from any retailer ..." ¹⁰ , the Court agreed that the requisite storage, use, or consumption of raw materials occurred outside of Wisconsin when Morton fabricated the building components.
The Court also agreed with Morton and ruled that the building components were never purchased from any retailer, so did not come into the definition of taxable items.
[2]	Impact on Wisconsin Taxpayers

Although this decision was one of the most straightforward of all of Morton's outcomes, the impact was fairly large for Wisconsin taxpayers. Most notably, the Wisconsin Legislature changed the statute Wis. Stat. Ann. 77.53 effective August 12, 1993 to impose a use tax upon:
	the storage, use or other consumption of tangible personal property manufactured, processed or otherwise altered, in or outside this state, by the person who stores, uses or consumes it, from material purchased from any retailer.
The repeal and reissuance of the law effectively bars future Morton Buildings type claims. However, the law change was not retroactive, so these types of claims may still be valid.
Wis. Admin. Code 11.68(4)(a) also provides added guidance on suppliers' sales of building materials to contractors who incorporate the materials into real property in performing construction activities. The regulation specifies that raw materials purchased outside of Wisconsin used by a contractor in manufacturing tangible personal property outside of Wisconsin, or that are fabricated or altered outside of Wisconsin by a contractor so as to become different or distinct items of tangible personal property from the constituent raw materials, and are subsequently stored, used or consumed within Wisconsin by that contractor are all subject to use tax.

§ 1.17 CONCLUSION


The opportunities revealed by these cases are often rescinded by state legislatures in times of lean economics. However, many states did not change the statutes upon which Morton and other successful taxpayers based their claims. These states, as well as those states not discussed, should still be challenged where the facts are amenable to the statute language.

MONA GUERRERO VINEYARD
Ms. Mona Guerrero Vineyard is a Senior Consultant in the Dallas sales and use tax practice of Ryan & Company, Inc. where she specializes in multistate tax research, tax system implementation, audit representation, reverse audit representation, and tax planning.

Mona is a Certified Public Accountant in Texas, and a graduate of the University of Texas at Austin with a Bachelor of Business Administration in Accounting and a Masters of Professional Accounting. She has given lectures on state and local taxes at her alma mater, the University of North Texas in Denton, and the Interstate Tax Corporation. Mona is an active Associate Member of the Institute for Professionals in Taxation as well as the Dallas/Fort Worth State Tax Association.

Edited By:

GINNY BUCKNER KISSLING
Ms. Ginny Buckner Kissling is a Principal in the Dallas office of Ryan & Company, Inc. where she also specializes in multistate audit representation, reverse audit representation, state tax research, and tax planning. Since starting her career with Ryan & Company in 1992, she has narrowed her practice focus to primarily Fortune 500 companies in the manufacturing, refining, and insurance industries. In addition to client service, Ginny lectures on various state and local tax topics for Ryan & Company clients and the Ryan & Company SALT Development Program. Additionally, she has appeared as a speaker for the Council On State Taxation, the National Business Institute, the New York University Institute on State & Local Taxation, Institute for Professionals in Taxation ("IPT") and the Interstate Tax Corporation.

As an Associate Sales Tax Member of IPT, she actively participates in planning committees and has attended the IPT Instructor/Speaker Training School. She served as the Executive Director and the Secretary/Treasurer of the Dallas/Fort Worth State Tax Association, a not-for-profit association whose purpose is to educate local tax professionals on current state and local tax issues. Ginny is a graduate of the University of North Texas with a Bachelor of Science Degree in Accounting and a Master of Science Degree in Accounting, with an emphasis in taxation.

¹	Ala. Code 40-23-61(a)
²	Ala. Code 40-23-61
³	35 Ill. Comp. Stat. Ann. 105/3 (West 2000).
⁴	American Can Company v. The Department of Revenue, 47 Ill 2d 531, 267 NE2d 657 (1971).
⁵	Comptroller of Treasury v. American Can Company, 208 Md 203, 117 A2d 550 (1955).
⁶	Md. Code Ann. Tax-Gen. 11-102 (1957)
⁷	Mass. Gen. Laws Ann. 64I 2
⁸	Tex. Tax Code Ann. 151.101(a) (Vernon 2002)
⁹	Sharp v. Morton Buildings, Inc., 953 SW2d 300 (1997)
¹⁰	Wis. Stat. Ann. 77.53

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