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Guidance Provided on Industrial Production Exemption from Sales Tax

The Minnesota Tax Court recently found that certain detachable tools used in manufacturing were exempt from sales tax under the Industrial Production Exemption. American Structural Metals, Inc. v. Commissioner of Revenue, Minnesota Tax Court Docket No. 6594 (May 13, 1996). The disposable tools had a "direct effect" by working with other items that caused a physical or chemical change in the product, even though they did not have actual contact. Briggs and Morgan represented the company in this case where the Tax Court applied a less restrictive "direct effect" test than the Department of Revenue (DOR). Businesses should review their purchases and determine if claims for a refund should be filed for tools and other accessory items.

Tax Exemption

In general, machinery and equipment is subject to a sales tax. However, there is an exception, which is called the Industrial Production Exemption and has been in the sales tax laws since 1967, for certain material used or consumed in the manufacturing process. Minn. Stat. §297.A.25, Subd. 9. This exemption also covers tax-free purchases for certain detachable tools and accessories that satisfy three conditions. These requirements are met, if the tools:

  1. are separate detachable units;
  2. are used in producing a "direct effect" upon the product; and
  3. have an ordinary useful life of less than 12 months.

The new case involved a business that manufactured beams, trusses, and girders for use in buildings, bridges, and skyways. The business also fabricated metals into decorative and artistic designs. For example, the cauldron for the Olympic flame, the Erector Set light tower that supported the cauldron, and the steel bridge with Olympic rings were fabricated by it in Minnesota, before being disassembled and transported to Atlanta for the 1996 Olympic games.

The Direct Effect Test

The legal issue in the decision was concerned with the application of the "direct effect" test. The fabricator used various tools and accessories such as cutting tips, nozzles, contact tips, and electrodes, which were attached to the last 3" of welding torches and cutting guns. These items were conceded by the DOR to be separate and detachable and met the short-lived 12-month rules. However, the DOR contended the items did not have a "direct effect" on the metals worked upon because they merely held, guided, or channeled inert gases and were not "integrally" involved in the cut or weld processes.

After noting that the "direct effect" requirement was a fact test, the Tax Court held that the tools and accessory items were exempt. The disputed items had the same function, purpose, location, and appearance as drill bits, saw blades, and cutting tools that were qualified items under Minn. Rule 8130.5500, Subp. 9.B and therefore, "[I]tems that perform the same function should receive the same tax treatment." The fact that the items operated near the metal, the close time proximity of their use, the absence of intervening causes prior to the cut or weld and their interaction with the metal were found persuasive by the Court and supported the conclusion that these items had a "direct effect" upon the product.

This case is significant. Not only is it the first time that a court has ruled on the scope of the Industrial Production Exemption since 1984, but meaningful and substantial guidance was provided on what satisfies the "direct effect" test. It is now clear that tools and accessory items do not need to come into physical contact with the product, or be the agent that by direct contact with the product produces physical or chemical changes. Rather, an item will qualify if its use serves the purpose or function of determining the shape, contour, configuration, content or arrangement of content of the product, or any part of the product, being manufactured.
The DOR will not appeal the decision. In addition, items such as "collets," "contact tips," "drill chucks," "electrodes," "torch cups," and "torch tips" are now tax qualified. These types of items are currently listed as taxable in Fact Sheet 145, "Industrial Production Sales Tax" (Last revised July 1995).


In light of the more lenient application of the "direct effect" test in American Structural Metals, Inc. v. Commissioner of Revenue, companies should review their purchases and determine if claims for refund should be filed under the Industrial Production Exemption. In general, the statute of limitations on filing of refund claims is 3.5 years from the time of filing of the return.

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