SBE Issues Written Decision in Second MIC Case

By Chris Micheli

Introduction

In its public hearing on March 26, 2002, the California State Board of Equalization (SBE) heard the second taxpayer appeal involving the manufacturers’ investment credit (MIC).  In the Appeal of Milpitas Materials Company and Jon & Rita Minnis [2002-SBE-003], the SBE ruled 5-0 in favor of the taxpayer that a concrete-mixer truck should not be bifurcated into a qualified (mixer drum) and non-qualified (truck chassis) asset for purposes of claiming the MIC.  This case represents the second straight decision against the Franchise Tax Board (FTB) involving a taxpayer’s MIC appeal.

The SBE effectively decided that such a “dual-use” bifurcation advocated by the FTB was not permitted under the MIC statute.  The second, and more difficult, issue before the SBE concerning whether the taxpayer had incurred “qualified costs” involving an Internal Revenue Code Section 1031 like-kind exchange was withdrawn by the taxpayer prior to the hearing.  Hence, that issue was not decided by the SBE in this case.  However, readers should expect a similar issue will be before the SBE by the end of this year.

            As a result of similar concrete-mixer truck cases during the audit stage, the FTB issued Legal Ruling 2001-4 in August 2001.  That Legal Ruling set forth two holdings:  First, the manufacturing process ends at the point that the ready-mix concrete reaches the job site.  Second, only the mixing drum, and not the chassis, of the truck qualifies for the MIC.  The decision in Appeal of Milpitas Materials Company effectively quashes that Legal Ruling.  We would expect LR 2001-4 to be withdrawn by the FTB.

Taxpayer’s Key Arguments

In its opening brief, the taxpayer principally argued that the ready-mix concrete truck cannot be split into two pieces.  “Primary use” in either manufacturing or maintenance is a function of time, not a value judgment of various uses as argued by the FTB.  If the mixer truck is primarily used in the manufacturing process, then the entire asset should qualify for the MIC.

In its supplemental brief, the taxpayer argued that the FTB misconstrues the primary use test.  In addition, Milpitas created one piece of qualified property used in a qualified manufacturing activity and so the truck chassis and mixer should not be bifurcated into separate assets and treated differently.

FTB’s Key Arguments

            In its opening brief, the FTB principally argued that transportation is not a qualified activity for purposes of the MIC and assets used primarily for transportation purposes do not qualify for the MIC.

            In addition, the FTB noted that its audit branch staff had initially concluded that the entire cement mixer truck (both the mixing drum and chassis) did not constitute qualified property for purposes of the MIC because the asset could not meet the “primarily used” test.  The legal branch staff subsequently reversed this position.

            Moreover, the FTB relied heavily upon the federal treatment of the cement mixer chassis that this asset should be bifurcated between a manufacturing element (mixing drum and related equipment) and a transportation element (truck chassis).  Only the manufacturing element constitutes qualified property for purposes of the MIC according to the FTB.

In its supplemental brief, the FTB argued the taxpayer’s bifurcation of the cement mixer into a mixer (manufacturing) and chassis (transportation) component for federal and state depreciation purposes should be binding for MIC purposes.

            Again, the FTB argued there is a long history of federal tax treatment of cement truck assets that recognizes a significant, and in some cases exclusive, transportation purpose.  It was unnecessary for the FTB to address the taxpayer’s activity arguments because they are moot:  The taxpayer’s qualified activity is manufacturing.

Board Hearing Highlight

At the SBE hearing on March 26, there was a relatively brief oral argument.  Neither side used its entire allotted time.  The taxpayer’s representative first withdrew the “qualified cost” issue and spent its opening time period questioning the taxpayer (its client).  The taxpayer was asked to describe, for example, why the concrete truck chassis was always purchased separately from the mixer drum, as well as the actual ready-mix concrete process.  No argument was offered by the taxpayer’s representative.

Then, the FTB counsel reviewed the process by which this issue reached the SBE and that it looked to federal law and the taxpayer’s own treatment for depreciation purposes to determine that the assets (mixer drum and chassis) should be handled separately for purposes of claiming the MIC.  Prior to the conclusion of oral argument by the FTB, the SBE granted a motion to find in favor of the taxpayer on this narrow question.

The SBE’s Written Decision

            In 2002-SBE-003, the SBE issued its formal written decision in this case.  The decision was adopted at its hearing on June 20, 2002 by a vote of 4-0-1.  The SBE’s decision addressed the issue of “whether appellant’s ready mixed concrete trucks meet the requirements for qualified property for purposes of the MIC.”[1]  The opinion reviewed the facts of the case and examined how the taxpayer constructed its ready-mix cement mixers.

As the SBE explained, “Instead of purchasing standard ready mixed concrete mixer trucks as one unit, [the taxpayer] purchases mixer barrels (and the accompanying components) and truck chassis units separately from different suppliers.  Its employees assemble the mixer barrels and truck chassis at [the taxpayer]’s facilities, making modifications during the assembly process not made on standard trucks purchased as one unit.  [The taxpayer] claims to make the modifications to improve safety, to increase the life of the trucks, and to maintain the cleanliness of the trucks.”[2]

            As noted by the SBE, “the truck engine thus must always provide power to the hydraulic pump to turn the mixer barrel.”[3]  Also noted is that the taxpayer provides truck-mixed concrete to its customers, which is described in SIC Code 3273.  Both of the parties, as well as the FTB’s earlier Legal Ruling (see discussion above), agree that the manufacturing process for truck-mixed concrete begins when raw materials are added to the truck mixer barrel and ends when the taxpayer discharges the concrete from the truck mixer at the job site.

            The SBE’s opinion relies upon the actual language of Code 3273 of Division D of the SIC Manual as that provision identifies as a manufacturing activity the manufacture of Portland cement concrete manufactured and delivered to a purchaser in a plastic and unhardened state.[4]  This is the only SIC Code that describes both manufacturing and transportation activities.

            In addition, the SBE reviewed five points upon which the FTB and the taxpayer agreed in order for properly frame the issue on appeal:  SIC Code 3273 describes manufacturing activities; the taxpayer is a “qualified taxpayer”; when the manufacturing process begins and ends; the mixer barrels are qualified property; and, assuming the concrete mixer trucks are “single integrated pieces of manufacturing equipment,” then the entire truck is “qualified property.”[5]

            This case hinged upon whether the mixer truck’s chassis is “primarily used” in manufacturing activity.  The SBE opinion reviewed the arguments of both the taxpayer and the FTB in this regard.  While the FTB argued that the trucks have manufacturing and transportation elements, the SBE “agrees with [the taxpayer] and concludes the ready mixed concrete trucks comprise a single integrated piece of manufacturing equipment and thus constitute qualified property for purposes of the MIC.”[6]

            The SBE based its decision upon our conclusion that “recognizes the reality that a truck-mounted mixer barrel cannot perform its designated manufacturing function apart from a truck chassis.”[7]  Again, the opinion turned to the SIC Manual’s description that ready-mixed concrete manufacturing includes manufacturing and delivery of the concrete.

“The SIC Manual description acknowledges the unique nature of the ready mixed concrete manufacturing process by recognizing that to achieve the proper concrete mix ready mixed concrete must be mixed and/or agitated enroute to the job site.”[8]  Moreover, this properly reflects the parties’ agreement concerning the start and end of the manufacturing process for truck-mixed concrete (which does not end until the concrete arrives at the job site).

            The SBE also relied upon the FTB’s own MIC regulations[9] that provide an example of a forklift used to transport raw materials within a manufacturing plant constitutes “qualified property.”  The SBE found the transportation function of the taxpayer’s concrete mixer trucks is “analogous” to the transportation function of the forklift in the regulatory example provided.

            Specifically, the SBE found that the FTB’s argument regarding the dual purpose or dual nature of the truck mixers “unpersuasive.”  Moreover, the SBE “observes that [the FTB]’s ‘dual-purpose’ argument appears to stray from the statutory language of the MIC.”[10]  In addition, the FTB’s approach seems to look to the primary “purpose” of the asset, rather than to the primary “use” of an asset in order to be in one of the qualified activities.[11]  Finally, the “transportation” element is “subsumed into the manufacturing category in the ready mixed concrete manufacturing context.”[12]  This particular manufacturing activity cannot occur without the transportation function.

            The SBE then turned to the FTB’s final argument and determined that the FTB’s “reliance on the former federal excise tax levied on specified highway vehicles [was] inapposite.”[13]  This is due to the fact that the FTB “ignores the obvious distinction between the purposes of the former federal transportation excise tax and the MIC.”[14]

            The opinion notes that the federal excise tax was designed to impose a tax on vehicles that use the nation’s highways, “while the MIC seeks to encourage manufacturers to purchase manufacturing equipment for use in California.”[15]  The SBE chose not to address one question posed by the FTB in its brief “because we find no reason to determine classification under the MIC according to where or from whom an asset is purchased.”[16]

            As a result of this decision, the SBE held that a concrete mixer truck constitutes a single piece of manufacturing equipment that is primarily used in a qualified activity, and therefore satisfies the definition of “qualified property” under the MIC statute.  Moreover, the SBE determined that the FTB’s “bifurcation” of an asset is improper and not permitted under the language of the MIC statute.

© Chris Micheli.

Chris Micheli is an attorney and registered lobbyist for the Sacramento governmental relations of Carpenter Snodgrass & Associates, and can be contacted at (916) 447-2251 or cmicheli@carpentersnodgrass.com.