In tax law, there is both a form and substance component to every result. If only one of the two are achieved, the ultimate result is often uncertain.
Within the ethanol industry, it has been common for companies building ethanol manufacturing facilities to engage a single contractor to both build the facility buildings and equip the facility with the needed machinery and equipment. This is largely due to the specialized facilities and equipment required to create ethanol. But this business practice can create some tax issues.
Nebraska has a sales and use tax exemption for manufacturing machinery and equipment purchased by a manufacturer, but does not exempt the purchase of building components used to build manufacturing facilities. Certainly a company building an ethanol facility will want to receive the manufacturing machinery and equipment sales tax exemption. For ethanol facilities, that exemption could be worth millions in sales and use taxes.
These were the facts in a recent case before the Nebraska Supreme Court. The company constructing an ethanol facility wanted to claim the Nebraska manufacturing machinery and equipment exemption on the machinery and equipment placed in its facility by the contractor. Unfortunately in that case, the contractor who was engaged to build the facility elected to be an Option 3 contractor – this meant that the contractor was treated as the consumer of any materials which the contractor used to perform its obligations. (In Nebraska law, contractors have three options for dealing with sales and use taxes on the building materials and other items used in the performance of their construction contracts.) Because the contractor was deemed to be the “consumer,” the Department of Revenue claimed that the machinery and equipment at the ethanol facility was not purchased by a manufacturer and was not eligible for the manufacturing machinery and equipment exemption.
The Nebraska Supreme Court ruled in favor of the Department. This means that companies who purchase machinery and equipment through Option 2 or Option 3 contractors may not be eligible for the Nebraska manufacturing machinery and equipment exemption on such equipment. Companies who purchase equipment through their building contractor should insist that the contractor be Option 1 (or negotiate a price reduction for the additional sales tax the companies would likely have to pay).
Even more generally, this case may serve as a reminder that both the substance and form of a transaction needs to match the tax law rules – or negative consequences may arise. In the above case, the company would have qualified for the manufacturing machinery and equipment exemption in substance. Plainly, it bought machinery and equipment for use in manufacturing. But because the company’s contractor did not select the proper contractor option (it should have selected Option 1), the company was not eligible for the exemption. The form of the transaction did not match the law’s requirements.
We don’t like seeing taxpayers pay more in tax than they have to. If you would like us to review the potential tax implications of a significant transaction which you, your company or your client is considering, don’t hesitate to contact a member of the Tax Group. Tax planning now is often far less costly than an adverse tax result later.