The opinion
N.C. Dep’t of Revenue v. FSC II, LLC, 2023 NCBC 9.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
WAKE COUNTY 22 CVS 5410
NORTH CAROLINA DEPARTMENT
OF REVENUE,
Petitioner,
ORDER AND OPINION ON PETITION
v. FOR JUDICIAL REVIEW
FSC II, LLC,
Respondent.
THIS MATTER comes before the Court on Petitioner North Carolina
Department of Revenue’s Petition for Judicial Review (the “Petition,” ECF No. 3)
seeking reversal of the Office of Administrative Hearings’ Final Decision (the “Final
Decision”) entering summary judgment in favor of Respondent FSC II, LLC.
After considering the Petition, the administrative record, the parties’ briefs,
the arguments of counsel, and all other appropriate matters of record, THE COURT,
for the reasons set forth below, hereby AFFIRMS the Final Decision.
North Carolina Department of Justice, by Special Deputy Attorney
Generals Ashley Hodges Morgan and Tania X. Laporte-Reveron, for
Petitioner North Carolina Department of Revenue.
K&L Gates, LLP, by A. Lee Hogewood III, Robert B. Womble, and
Zachary S. Buckheit, for Respondent FSC II, LLC.
Davis, Judge.
INTRODUCTION
1. To be a manufacturer or not to be a manufacturer? That is the question
in this tax appeal. A former North Carolina statute provided an exemption to the
North Carolina Sales and Use Tax Act that applied to “[a] manufacturing industry or
plant that purchases mill machinery . . . parts or accessories for storage, use, or
consumption in this State.” 1 The taxpayer company in this case—FSC II, LLC
(“FSC”)—existed primarily as a contractor. In the course of its normal work, FSC
regularly purchased raw materials that it then used to create hot mix asphalt
(“HMA”). FSC primarily used this HMA in fulfilling its existing construction
contracts but sold the remaining amounts of its HMA to third parties. Based on these
facts, FSC contends that it qualified as a manufacturer for purposes of the Mill
Machinery Exemption and was therefore liable only for a lower privilege tax on the
raw materials it purchased rather than the higher sales or use tax. 2 The North
Carolina Department of Revenue (the “Department”) disagrees. In resolving the
parties’ dispute, the Court must determine what it means to be a manufacturer for
purposes of the Mill Machinery Exemption and how that classification applies under
the circumstances of this case.
FACTUAL AND PROCEDURAL BACKGROUND
2. The material facts of this matter are not in dispute. 3
3. The Department is the North Carolina agency tasked with
administering state tax laws and regulations, including the North Carolina Sales and
1Throughout this opinion, the Court refers to this exemption as the “Mill Machinery
Exemption.”
2 The present appeal solely concerns FSC’s out-of-state purchases of these raw materials.
3 Indeed, the parties submitted a Joint Stipulation of Facts in the proceedings before the
Office of Administrative Hearings, which are quoted in relevant part herein.
Use Tax Act (hereinafter the “Sales and Use Tax Act” or the “Act”). See N.C.G.S. §§
143B-218, 105-164.1, et seq. (2021).
4. In their Joint Stipulation of Facts, the parties stipulated, in pertinent
part, as follows:
[a.] From January 1, 2012 to December 31, 2014 (“Period at Issue”),
[FSC] primarily engaged in public infrastructure construction
and commercial sitework construction. Additionally, during the
Period at Issue, [FSC] owned and operated four facilities in Wake
County, North Carolina that produced hot mix asphalt (“HMA”).
While the parties stipulate that the process of converting raw
materials to HMA primarily for resale constitutes
“manufacturing,” [FSC] contends that it is a manufacturer
operating a manufacturing plant within the meaning of the
statute and regulations at issue and the [Department] disagrees.
The parties stipulate that this disagreement may be resolved as
a matter of law and not as a matter of fact.
[b.] For tax years 2012 to 2014, [FSC]’s parent company, which files
income tax returns reflecting [FSC]’s business operations,
identified itself as being in the “Highway, Street, and Road
Construction” industry under the North American Industry
Classification System on the parent’s North Carolina income tax
returns.
[c.] During tax year 2012, [FSC] used 85.46% of the HMA it produced
at its HMA facilities for various construction projects upon which
it served as a contractor or subcontractor and sold the remaining
HMA in FOB sales to North Carolina customers.
[d.] During tax year 2013, [FSC] used 79.73% of the HMA it produced
at its HMA facilities for various construction projects upon which
it served as a contractor or subcontractor and sold the remaining
HMA in FOB sales to North Carolina customers.
[e.] During tax year 2014, [FSC] used 81.10% of the HMA it produced
at its HMA facilities for various construction projects upon which
it served as a contractor or subcontractor and sold the remaining
HMA in FOB sales to North Carolina customers.
[f.] During the Period at Issue, [FSC] paid North Carolina sales tax
at the full applicable rates for tangible personal property (“TPP”)
that it purchased in North Carolina, including tools, parts, and
equipment that it used in producing HMA in state. During the
Period at Issue, [FSC] did not pay sales tax or accrue and remit
use tax for certain TPP that it purchased out of state, including
tools, parts, and equipment that it used in producing HMA in
state. It is [FSC]’s position that the law did not require [FSC] to
pay sales or use tax for TPP that [FSC] used in producing HMA
in state, to the extent such TPP constitutes “mill machinery or
mill machinery parts or accessories” within the meaning of
N.C.G.S. [§] 105-187.51 as in effect at the applicable times.
[g.] [FSC] did not pay the North Carolina privilege tax under former
N.C.G.S. § 105-187.51, which was in effect during the Period at
Issue, on [FSC]’s out-of-state purchases of tools, parts, and
equipment that it used to produce HMA in North Carolina.
[h.] During the Period at Issue, [FSC] charged and remitted the
correct sales tax due on its North Carolina sales of HMA.
(R., ECF No. 12, at RP_0070–71.)
5. In October 2014, FSC received a notice from the Department of a sales
and use tax examination scheduled to commence on 4 November 2014. (R., at
RP_0072.)
6. On 9 December 2015, as a result of that examination, the Department
issued a “Notice of Sales & Use Tax Assessment,” proposing the assessment against
FSC of additional state and county sales and use taxes during the Period at Issue in
the principal amount of $118,999.78, plus a 10% negligence penalty and interest with
respect thereto (the “Proposed Assessment”). (R., at RP_0073.) In calculating the
Proposed Assessment, the Department reviewed FSC’s 2014 invoices for FSC’s out-
of-state TPP purchases, including FSC’s purchases of tools, parts, and equipment for
HMA production in state, but not the invoices for the same types of purchases from
2012 and 2013. Instead, for years 2012 and 2013, the Department used a formula to
project FSC’s sales and use tax liability. However, FSC disputed whether the
Department was legally permitted to use such projections, in lieu of actually
reviewing the relevant invoices. (R., at RP_0073.)
7. As a result of this dispute over the appropriate methodology, FSC timely
requested that the Department review the Proposed Assessment. (R., at RP_0073.)
On 19 June 2018, after reviewing FSC’s 2012 and 2013 invoices, the Department
issued to FSC proposed adjustments to the Proposed Assessment. (R., at RP_0073.)
8. The proposed adjustments reflected that, during the Period at Issue, the
invoices for FSC’s out-of-state TPP purchases, including FSC’s purchase of tools,
parts, and equipment for HMA production in state, totaled $2,144,144.45, resulting
in higher tax liability for FSC. (R., at RP_0074.)
9. On 14 August 2019, FSC representatives, FSC’s counsel, and
Department representatives participated in a conference as required by N.C.G.S. §
105-241.13(b). (R., at RP_0074.) Following that conference, the Department issued
a Notice of Final Determination (“NOFD”), as required by N.C.G.S. § 105-241.14(b).
(R., at RP_0074.)
10. The NOFD stated that—based on the proposed adjustments to the
Proposed Assessments—FSC owed $118,999.78 in state and local sales and use taxes,
$11,899.98 in penalties, and $52,422.89 in interest through 31 March 2020, less
interest adjustments of $4,602.25, resulting in a total amount of $178,720.40 in taxes
owed to the Department. (R., at RP_0170.) The NOFD also stated that after
reviewing FSC’s objections, the Department had “determined that the assessment
proposed against [FSC], as adjusted, is correct.” (R., at RP_0170.) Furthermore, the
NOFD noted that “[t]he net effect of the aforementioned adjustments to the Proposed
Assessment is an increase in the Taxpayer’s overall Tax liability.” (R., at RP_0174.)
However, the Department chose not to increase FSC’s tax liability as a result of FSC’s
request for review and only sought recovery of the original amount stated in the
Proposed Assessment—that is, $118,999.78—plus a 10% negligence penalty and
interest. (R., at RP_0174.)
11. Of the $118,999.78 that the Department contended was owed by FSC,
the parties agreed that FSC owed at least $44,479.75 in use taxes plus applicable
interest for out-of-state TPP purchases that FSC conceded did not involve
manufacturing tools, parts, or equipment. (R., at RP_0074.)
12. However, FSC disputed that it owed any of the remaining $74,520.03 in
use tax, interest, and penalties. FSC asserted that its out-of-state purchases of tools,
parts, and equipment for HMA production were subject only to the North Carolina
privilege tax under N.C.G.S. § 105-187.51 by virtue of the Mill Machinery Exemption,
plus interest. (R., at RP_0074–75.) 4
13. Conversely, the Department maintained its position that FSC did, in
fact, owe the remaining $74,520.03 based on its position that these tools, parts, and
equipment were not subject to the Mill Machinery Exemption. (R., at RP_0075.)
4 Although not relevant to this appeal, FSC also disputed that the 10% negligence penalty
was applicable to any privilege tax it owed under N.C.G.S. § 105-187.51.
14. On 24 April 2020, FSC filed a Petition for Contested Tax Case Hearing
with the Office of Administrative Hearings (“OAH”) pursuant to N.C.G.S. § 150B-23.
(R., at RP_0897.) Subsequently, the parties filed cross-Motions for Summary
Judgment. (R., at RP_0897.)
15. Following briefing and a hearing, Administrative Law Judge Melissa
Owens Lassiter (the “ALJ”) issued a Final Decision in this matter on 4 April 2022.
(R., at RP_0897.)
16. Based on the Joint Stipulation of Facts submitted by the parties, the
Final Decision addressed the following two issues:
[(i)] Whether [FSC]’s purchases of tools, parts, and equipment from
vendors located outside North Carolina, from July 1, 2012
through December 31, 2014, which [FSC] used in its asphalt
plants in North Carolina to produce hot mix asphalt, were exempt
from use taxes under N.C. Gen. Stat. § 105-164.13(5a) and N.C.
Gen. Stat. 105-187.51?
[(ii)] Whether [the Department’s] Notice of Final Determination
proposing an assessment of $118,999.78 in use taxes, plus
penalties and interest, against [FSC] for purchases of tools, parts,
and equipment from vendors located outside North Carolina,
which [FSC] then used in its asphalt plants in North Carolina,
from July 1, 2012 through December 31, 2014, was correct?
(R., at RP_0898.)
17. In the Final Decision, the ALJ granted summary judgment for FSC
regarding its entitlement to the Mill Machinery Exemption based on the ALJ’s
determination that FSC’s use of the TPP it purchased to produce HMA constituted
“manufacturing” such that FSC was therefore exempt from the sales and use tax. (R.,
at RP_0918–19.) The ALJ directed the Department to issue a new Notice of Final
Determination that was consistent with the rulings contained within the Final
Decision. (R., at RP_0920.)
18. On 4 May 2022, the Department filed its Petition seeking judicial review
in Wake County Superior Court. The matter was subsequently designated as a
complex business case by the Chief Justice of the Supreme Court of North Carolina
and assigned to the undersigned. The Department and FSC each submitted briefs in
support of their respective positions. On 14 December 2022, the Court held a hearing
on the Petition, at which both parties were represented by counsel. The Petition is
now ripe for resolution.
LEGAL STANDARD
19. When a trial court “exercises judicial review over an agency’s final
decision, it acts in the capacity of an appellate court.” Meza v. Div. of Soc. Servs., 364
N.C. 61, 75 (2010) (quoting N.C. Dep’t of Env’t & Nat. Res. v. Carroll, 358 N.C. 649,
662 (2004)).
20. Chapter 150B of the North Carolina General Statutes provides that
“[t]he court reviewing a final [agency] decision may affirm the decision or remand the
case for further proceedings [and] [i]t may also reverse or modify the decision if the
substantial rights of the petitioners may have been prejudiced[.]” N.C.G.S. § 150B-
51(b) (2021). “In reviewing a final decision in a contested case, the court shall
determine whether the petitioner is entitled to the relief sought in the petition based
upon its review of the final decision and the official record.” Id. § 150B-51(c).
21. Here, the Department appeals the Final Decision of the OAH granting
summary judgment in favor of FSC. “Appeals arising from summary judgment orders
are decided using a de novo standard of review.” Midrex Techs. v. N.C. Dep’t of
Revenue, 369 N.C. 250, 257 (2016). Under the de novo standard of review, the Court
will “consider[] the matter anew and freely substitute[] its own judgment” for that of
the OAH. Carroll, 358 N.C. at 660 (quoting Mann Media, Inc. v. Randolph Cnty.
Planning Bd., 356 N.C. 1, 13 (2002)). “In reviewing a final decision allowing . . .
summary judgment, the court may enter any order allowed by . . . Rule 56” of the
North Carolina Rules of Civil Procedure. N.C.G.S. § 150B-51(d).
22. Under Rule 56, summary judgment is appropriate “if the pleadings,
depositions, answers to interrogatories, and admissions on file, together with the
affidavits, if any, show that there is no genuine issue as to any material fact and that
any party is entitled to . . . judgment as a matter of law.” N.C. R. Civ. P. 56(c). A
genuine issue is “one that can be maintained by substantial evidence.” Dobson v.
Harris, 352 N.C. 77, 83 (2000). A material fact is one that “would constitute or would
irrevocably establish any material element of a claim or defense.” Abner Corp. v. City
Roofing & Sheetmetal Co., 73 N.C. App. 470, 472 (1985). “Summary judgment is
appropriate if . . . the facts are not disputed and only a question of law remains.” Wal-
Mart Stores E. v. Hinton, 197 N.C. App. 30, 37 (2009) (quoting Carter v. W. Am. Ins.
Co., 190 N.C. App. 532, 536 (2008)). Thus, where—as here—the material facts are
undisputed on appeal, “a summary disposition of the claims is proper and
appropriate.” Technocom Bus. Sys. v. N.C. Dep’t of Revenue, 2011 NCBC LEXIS 1, at
*12 (N.C. Super. Ct. Jan. 4, 2011).
23. FSC, as the “taxpayer claiming a deduction,” must bring itself “within
the statutory provisions authorizing the deduction.” Wal-Mart Stores E., 197 N.C.
App. at 54–55 (quoting Ward v. Clayton, 5 N.C. App. 53, 58 (1969)).
ANALYSIS
24. The sole issue before the Court is whether the ALJ erred in granting
summary judgment in favor of FSC on the basis that the TPP purchased by FSC from
out-of-state for its production of HMA should be subject to the lower 1% privilege tax
as opposed to the higher sales or use tax. Or, stated more succinctly, the issue is
whether the ALJ correctly determined that FSC was entitled to the Mill Machinery
Exemption. In analyzing this issue, it is necessary to first review the statutory
provisions relevant to this issue as they existed during the relevant time period.
25. The North Carolina Sales and Use Tax Act (the “Act”), N.C.G.S. § 105-
164.1 et seq., as applicable to this dispute, 5 imposed a retail sales tax on a retailer’s
net taxable sales or gross receipts, as appropriate, from sales at retail at the general
State rate, as well as the applicable local and transit rates of tax. N.C.G.S. §§ 105-
164.4(a), 105-467, 105-483, 105-498, 105-509.1, 105-537 (2014). A retailer was
defined, in part, as “[a] person engaged in the business of . . . making sales at retail[.]”
Id. § 105-164.3(35). The Act provided, in pertinent part, that “[t]he general rate of
tax applies to the sales price of each item or article of tangible personal property that
5 In 2017, N.C.G.S. § 105-187.51 was repealed. See N.C. Session Laws 2017-57 s. 38.8(a),
effective July 1, 2018 and applicable to sales made on or after that date.
is sold at retail and is not subject to tax under another subdivision in this section.”
Id. § 105-164.4(a)(1). For purposes of the Act, “sales price” was defined in relevant
part as “[t]he total amount or consideration for which tangible personal property,
digital property, or services are sold” and specifically included the retailer’s cost of
the property sold; the cost of materials used, labor or service costs; all costs of
transportation to the retailer; charges by the retailer for any services necessary to
complete the sale; delivery charges; and installation charges. Id. § 105-164.3(37).
26. The Act also imposed a complementary use tax on products purchased,
leased, or rented for storage, use, or consumption in the State. Id. §§ 105-164.6, 105-
468, 105-483, 105-498, 105-509.1, 105-537. This use tax was imposed as an “excise
tax” and was levied on the purchase price of tangible personal property. Id. §§ 105-
164.3(33), 105-164.6(a). Pursuant to the Act, the “person who purchases, leases, or
rents tangible personal property” was liable for payment of the use tax. Id. § 105-
164.4(6)(b).
27. However, the Act also set out certain exemptions. N.C.G.S. § 105-164.13
provided that “[t]he sale at retail and the use, storage, or consumption in this State
of the following tangible personal property . . . are specifically exempt from the tax
imposed by this Article[.]” The ensuing list of exempted property included “[p]roducts
that are subject to tax under Article 5F of this Chapter.” Id. § 105-164.13(5a).
28. Article 5F included the “Mill Machinery Exemption” contained within
section 105-187.51, which stated, in pertinent part, as follows:
§ 105-187.51. Tax imposed on mill machinery.
(a) Scope.—A privilege tax is imposed on the following persons:
(1) A manufacturing industry or plant that purchases mill
machinery or mill machinery parts or accessories for storage, use
or consumption in this State. A manufacturing industry or plant
does not include the following:
a. A delicatessen, cafe, cafeteria, restaurant, or
another similar retailer that is principally engaged in the
retail sale of foods prepared by it for consumption on or off
its premises.
b. A production company.
...
(b) Rate.—The tax is one percent (1%) of the sales price of the
machinery, part, or accessory purchased. The maximum tax is
eighty dollars ($80.00) per article. As used in this section, the
term “accessories” does not include electricity.
Id. § 105-187.51.
29. Notably, the statute did not expressly define the phrase “manufacturing
industry or plant” or, for that matter, any variation of the word “manufacture.”
30. Because section 105-187.51 granted an exemption from the otherwise
applicable rate of sales and use tax, a taxpayer seeking the exemption “bears the
burden of showing, by a preponderance of the evidence, that it is eligible for the lower
rate of taxation and is entitled to remit the 1% Privilege Tax rather than the general
State and local rates of tax.” N.C. Dep’t of Revenue v. Tri-State Scrap Metal, 2019
NCBC LEXIS 42, at *14 (N.C. Super. Ct. July 8, 2019).
31. In this appeal, the Department argues that FSC cannot be deemed to be
a “manufacturing industry or plant” because at all relevant times it was a contractor
rather than a manufacturer. The Department asserts that the TPP purchased by
FSC from out-of-state is subject to the general rate of use tax—as opposed to the lower
1% privilege tax—because FSC was “primarily engaged in the construction of public
infrastructure projects and performed commercial sitework, such as paving roads and
parking lots” and used the majority of the HMA it produced in completing those
projects. (Pet.’s Br. Supp., ECF No. 15, at 2.) 6
32. FSC, conversely, contends the ALJ correctly determined that it is
entitled “to the then applicable favorable tax treatment for out of state purchases of
manufacturing machinery in the operation of its hot mix asphalt manufacturing
business and plants for the Relevant Period.” (Resp’t’s Br. Opp., ECF No. 16, at 2.)
FSC contends that it is entitled to this favorable tax treatment because it acted as a
“manufacturer” and “manufacturing industry” within the meaning of the Mill
Machinery Exemption during the Period at Issue.
33. Thus, the heart of the parties’ dispute concerns whether FSC qualifies
as a “manufacturing industry or plant.” Although, as noted above, N.C.G.S. § 105-
187.51 does not define the term “manufacturing,” our Supreme Court has stated the
following regarding the meaning of the term in a case involving an analogous issue:
It is everywhere conceded that the term manufacturing as used in tax
statutes is not susceptible of an exact and all[-]embracing definition, for
it has many applications and meanings. Where, as here, the statute
does not define the term, courts have resorted to the dictionaries to
ascertain its generally accepted meaning and have then undertaken to
determine its application to the circumstances of the particular case.
There are many holdings and statements to the effect that to constitute
6 The Department notes that the tax on the purchases of TPP at issue are not subject to
apportionment because “the use tax is not divisible or subject to apportionment because of
its one-time application to the purchase transaction.” (Pet.’s Br. Supp., at 12.)
manufacturing, the operation, process, or activity in question must
produce a new and different commodity or work a substantial change in
the basic material.
Master Hatcheries, Inc. v. Coble, 286 N.C. 518, 520–21 (1975) (emphasis in original)
(citing Duke Power Co. v. Clayton, Comr. of Revenue, 274 N.C. 505 (1968)).
34. Furthermore, in Duke Power, the Supreme Court elaborated on this
proposition:
In its generic sense, “manufacturing” has been defined as the producing
of a new article or use or ornament by the application of skill and labor
to the raw materials of which it is composed . . . . To make an article
manufactured, the application of the labor must result in a new and
different article with a distinctive name, character, or use . . . . Thus, the
usual connotation of manufacturing is the making of a new product from
raw or partly wrought materials.
Duke Power, 274 N.C. at 513–14.
35. The Department does not dispute that the process of producing HMA
using the parts and equipment at issue that were purchased by FSC is consistent
with the above-quoted definition of manufacturing as articulated by our Supreme
Court. Nor does the Department contend that the TPP purchased by FSC did not
constitute “mill machinery or mill machinery parts or accessories for storage, use or
consumption in the State.” N.C.G.S. § 105-187.51.
36. Instead, the Department argues that FSC’s creation of HMA, by itself,
is not enough to transform it into a “manufacturing industry or plant” for purposes of
the Mill Machinery Exemption. The Department contends that FSC must also show
that it was primarily, or principally, engaged in the sale of the HMA it produced in
order to qualify for the exemption. 7 FSC is unable to do so, the Department asserts,
due to the fact that during the relevant time period it was instead primarily engaged
in its work as a contractor rather than as a retail seller of HMA. In support of this
assertion, the Department points to the undisputed evidence of record showing that
during each of the relevant years FSC used between 79.73% and 85.46% of the HMA
it produced on construction projects for which it served as a contractor or
subcontractor.
37. In a related argument, the Department further contends that section
105-187.51(a)(1) is ambiguous due to the fact that it does not expressly address
circumstances where, as here, a taxpayer “manufactures” a product but mainly uses
that product for its own purposes—rather than selling it to third parties. In light of
this existing ambiguity coupled with the fact that this statutory provision creates an
exemption from taxation, the Department contends, section 105-187.51(a)(1) should
be construed narrowly and in accordance with the Department’s proffered
interpretation.
38. In response, FSC claims that the Department is making up out of whole
cloth a de facto “51% rule” under which FSC would only be entitled to the Mill
Machinery Exemption if it sold to third parties at least 51% of the HMA it produced.
FSC contends that neither the actual language of section 105-187.51 nor any decision
from our appellate courts supports the Department’s interpretation. Ultimately,
FSC’s position is that as long as it purchased the TPP at issue in order to produce
7 The Court observes that the Department asserted several additional arguments before the
OAH that it has not advanced in this appeal.
HMA that it then proceeded to use for any business-related purpose, it should be
deemed a “manufacturing industry or plant” for purposes of the exemption. Thus,
under FSC’s interpretation, it need not have sold any of its HMA to third parties in
order to qualify for the Mill Machinery Exemption.
39. Although there is a small handful of cases from our appellate courts that
have analyzed issues bearing some relation to the present question, there is no case
entirely—or even mostly—on point. However, the Department’s argument is based
primarily upon its interpretation of our Supreme Court’s decision in In re Clayton-
Marcus Co., 286 N.C. 215 (1974).
40. Clayton-Marcus required the Supreme Court to determine whether a
company qualified for a then-existing manufacturing exemption from the sales and
use tax. The taxpayer, Clayton-Marcus, was a manufacturer of furniture. For
promotional purposes, it assembled swatch books of fabrics that were to be
distributed for free to potential customers. It argued that its use of the fabrics to
make the swatch books constituted “manufacturing” so as to entitle it to the
manufacturing exemption. Id. at 218–22.
Clayton-Marcus . . . contends that even if its handling of the fabric in
the compilation of the swatch books here in question is a “use” of the
fabric, within the meaning of the Sales and Use Tax Act, it is exempted
from the use tax by G.S. 105-164.13, which provides:
“Retail Sales and Use Tax.[”] -- The sale at retail, the use, storage or
consumption in this State of the following tangible personal property is
specifically exempted from the tax imposed by this Article:
****
“(8) Sales of tangible property to a manufacturer which enters into or
becomes an ingredient or component part of tangible personal property
which is manufactured.”
Id. at 222–23 (quoting former N.C.G.S. § 105-164.13).
41. The Supreme Court then summarized the Department’s opposing
argument:
The State contends that Clayton-Marcus is a manufacturer of furniture,
so that its use of so much of the fabric as becomes a component part of
furniture is not subject to the Use Tax, but that Clayton-Marcus is not
a manufacturer of the swatch books, which it distributes to its
customers, because it gives those swatch books to its customers without
charge. That is, the State contends that one is not a manufacturer of
articles which he makes for the purpose of distribution without charge,
but is merely a consumer or user of the materials from which he makes
such article.
Id. at 223.
42. The Supreme Court framed the key issue in the case as “whether
Clayton-Marcus is a ‘manufacturer’ of the swatch books involved in this appeal.” Id.
43. Applying its prior definition of the term “manufacture” as set out in
Duke Power, the Supreme Court recognized that a swatch book “is a new and different
article from the fabrics.” Id. at 224. Nevertheless, the Court ultimately concluded
that Clayton-Marcus did not “manufacture” the swatch books within the meaning of
the exemption. The Supreme Court articulated its rationale as follows:
In our opinion, a swatch book or sample book is a new and different
article from the fabrics in the respective samples contained therein.
Thus, nothing else appearing, Clayton-Marcus has “manufactured”
these swatch books . . . . In the construction of this statutory exemption,
however, we should not press the word “manufactured” to its dryly
logical extreme in disregard of the obvious purpose of the Sales and Use
Tax Act. It is clear that the purpose of the Act, as a whole, is to impose
a use tax (credited with a sales tax previously paid by the user) upon the
consumer or user of tangible personal property in this State.
As the State points out in its brief, a lady who bakes a cake, or makes a
child’s dress, for the purpose of giving it to a neighbor is not a
“manufacturer” within the meaning of G.S. 105-164.13(8),
notwithstanding the fact that, by the application of skill and labor to
raw materials, she has created a new and different article. To hold
otherwise would defeat the purpose of the Use Tax Act by giving the
word “manufactured” a meaning which it does not have in its ordinary
usage. The distinction between such a lady and the commercial bakery
or the commercial dress shop is not, however, confined to the fact that
she makes no charge for her product. We are not required, in this
instance, to determine whether one who devotes a substantial plant to
the preparation of food or clothing, which he donates to a charitable
agency, should be deemed a “manufacturer” within the meaning of this
exemption statute.
In the present instance, Clayton-Marcus is not distributing the swatch
books in question to its potential customers as gifts. It is distributing
them as advertising matter for the purpose of soliciting sales of its
furniture. It is as if Clayton-Marcus had purchased paper, ink and other
printing materials from which it produced, in its own plant, catalogues,
containing pictures and descriptions of furniture manufactured by it for
sale, and had distributed such catalogues among potential customers for
its furniture. The purpose of the producer of such catalogue or swatch
book is thereby to increase its own business, not to benefit the recipient
of the book. The catalogue or the swatch book is created for use (by
distribution) by the producer itself as an instrumentality in the conduct
of the producer’s own business.
Id. at 224–25.
44. Based on this reasoning, the Supreme Court concluded that the swatch
books were not “manufactured” within the meaning of the exemption. Id. at 225.
We hold that the exemption provided in G.S. 105-164.13(8) was not
intended by the Legislature to apply, and does not apply, to use of
material by a manufacturer in the production of an article intended for
use by the manufacturer, itself, through its distribution to potential
customers as sales promotional material.
Thus, we hold that the use, in North Carolina, by Clayton-Marcus of
fabric in the production of swatch books for distribution, without charge,
to its potential customers, in or out of this State, is not exempted by G.S.
105-164.13(8) from the Use Tax imposed by G.S. 105-164.6.
Id. at 226. 8
45. The Department also attempts to rely on our Court of Appeals’ decision
in Oscar Miller Contractor, Inc. v. N.C. Tax Review Bd., 61 N.C. App. 725 (1982).
However, although Oscar Miller was based on facts resembling those presented here
and a similarly worded prior version of the Mill Machinery Exemption, the Court of
Appeals’ resolution of the case was based on a regulation from the Secretary of
Revenue that was repealed prior to the time period at issue in the present case. Id.
at 729–30. Therefore, the Court of Appeals did not actually address the question at
issue here and, for this reason, Oscar Miller provides little assistance in resolving the
issue presently before the Court.
46. Nevertheless, the Department points to the following statement by the
Court of Appeals in Oscar Miller attempting to summarize the reasoning employed
by the Supreme Court in Clayton-Marcus:
Our Supreme Court said it is clear that the purpose of the Sales and Use
Tax Act is to impose a use tax, credited with any sales tax previously
paid, upon the user of any tangible personal property in this state. If
the property is used to produce something which will add to the
taxpayer’s profit but the thing produced will not be sold subject to the
sales tax, the sale of the property is not a sale to a manufacturer within
the meaning of the Sales and Use Tax Act.
Id. at 729.
8 However, the Supreme Court ultimately determined that Clayton-Marcus was not, in fact,
liable for the tax assessed because the use of the fabrics in the swatch books was not a “use”
within the definition contained in the Act. Id. at 226.
47. As an initial matter, Clayton-Marcus undercuts the Department’s
argument that the phrase “manufacturing industry or plant” in section 105-
187.51(a)(1) is ambiguous. Although the Supreme Court noted that the statutory
definition of a separate term—the word “storage”—contained in the Sales and Use
Tax Act was ambiguous, 286 N.C. at 221, the Supreme Court made no accompanying
finding of ambiguity in the words “manufacturer” or “manufactured.” Instead, the
Supreme Court applied the definition of “manufacture” as previously articulated in
Duke Power and proceeded to analyze the taxpayer’s entitlement to the
manufacturing exemption utilizing that definition. 9
48. The Department asks this Court to infer from the Supreme Court’s
reasoning in Clayton-Marcus a requirement that in order to qualify for the Mill
Machinery Exemption a taxpayer must use the TPP it purchases to produce a product
(in this case, HMA) for the primary or principal purpose of selling it to third parties.
49. The Court declines to accept the Department’s request. The Court has
carefully read—and reread—Clayton-Marcus and is unable to find support therein
for the Department’s interpretation.
50. Moreover, nothing in the statutory language of section 105-187.51(a)(1)
contains such a requirement or otherwise suggests that the General Assembly
intended to create one. It is axiomatic that courts generally refrain from judicially
9 Although the Court of Appeals commented in Oscar Miller after reaching its result that
“[t]he statute in this case is ambiguous and there has not been a square holding by a court
which defines it[,]” 61 N.C. App. at 730, that statement is clearly dicta and therefore lacks
precedential value. See State v. Scoggin, 236 N.C. 1, 13 (1952) (stating that “[t]he various
statements in the Court’s opinion which were not necessary to the decision of that precise
question constitute obiter dicta, and have no effect as declaring the law”).
inserting language in a statute that the legislature did not see fit to include. See, e.g.,
Lunsford v. Mills, 367 N.C. 618, 623 (2014) (“[I]n effectuating legislative intent, it is
our duty to give effect to the words actually used in a statute and not to delete words
used or insert words not used.”) (cleaned up).
51. By way of comparison, in several other provisions of North Carolina’s
tax statutes, the General Assembly has expressly added to the statutory text the sort
of “principal or primary” language the Department asks the Court to engraft here.
See e.g., N.C.G.S. § 105-187.51B(a)(2) (“A company primarily engaged at the
establishment in research and development activities in the physical, engineering,
and life sciences”) (emphasis added); N.C.G.S. § 105-187.51B(a)(4) (“A company
primarily engaged at the establishment in industrial machinery refurbishing
activities”) (emphasis added); N.C.G.S. § 105-187.51D (“For the purposes of this
section, a ‘large manufacturing and distribution facility’ is a facility that is to be used
primarily for manufacturing or assembling products and distributing finished
products”) (emphasis added). Indeed, the General Assembly did so as well in one of
the two listed exceptions in N.C.G.S. § 105-187.51(a)(1) itself. See N.C.G.S. § 105-
187.51(a)(1)a. (“A manufacturing industry or plant does not include the following: A
delicatessen, cafe, cafeteria, restaurant, or another similar retailer that is principally
engaged in the retail sale of foods prepared by it for consumption on or off its
premises.”) (emphasis added).
52. The Department cites a tax case—Midrex Techs. v. N.C. Dep’t of
Revenue, 369 N.C. 250 (2016)—addressing an entirely separate issue for the
proposition that courts sometimes judicially infer a “principal or primary”
requirement when interpreting a statute. For the reasons set out below, however,
the Court finds Midrex to be materially distinguishable.
53. In Midrex, our Supreme Court determined the applicability of the single-
factor tax allocation formula authorized by N.C.G.S. § 105-140.4(r) to a corporate
taxpayer, which hinged on whether the taxpayer was a “building or construction
contractor” within the meaning of that statute. The taxpayer, Midrex Technologies,
Inc. (“Midrex”), initially “filed North Carolina C Corporation Tax Returns with the
Department of Revenue that apportioned its income using the standard three-factor
formula provided for in N.C.G.S. § 105-130.4(a)(4) (2016).” Id. at 253. Subsequently,
Midrex filed amended corporate tax returns that utilized the more advantageous
single-factor formula in apportioning its income and sought a refund of $3,303,703
from the Department for allegedly overpaid income taxes. Id. Midrex argued that it
was eligible for the preferable single-factor formula because it was “engaged in
business as a building or construction contractor.” Id. (citing N.C.G.S. § 105-
130.4(a)(4) (2016)).
54. Midrex conceded that it was primarily engaged in the business of selling
“Midrex Plants” and “ha[d] only limited involvement in the actual, physical
construction of a Midrex Plant.” Id. at 251, 260. The evidence established that “the
client, rather than Midrex ha[d] ultimate responsibility for obtaining the physical
construction of a Midrex Plant, with Midrex being responsible for providing
scheduling, oversight, and other sorts of technical assistance and advice.” Id. at 261.
55. Midrex nevertheless contended that it was entitled to be classified as a
building or construction contractor within the meaning of the statute “as long as it
was engaged in any non-incidental amount of building or construction work.” Id. at
263.
56. In analyzing Midrex’s argument, the Supreme Court stated that “the
validity of Midrex’s claim to be a ‘building or construction contractor’ depends upon
the extent to which the work performed by Midrex’s employees involves the act of
building or constructing a physical asset, such as a Midrex Plant.” Id. at 259.
57. Although there was some evidence that Midrex’s employees engaged in
construction management and performed a limited amount of hands-on construction
activities, the Supreme Court determined that this evidence was insufficient to
permit Midrex to be deemed a “building or construction contractor.”
As Midrex notes, construction management activities are included
within the NAICS construction classification. In light of that fact,
Midrex argues that it should be deemed a construction company for
NAICS-related purposes given that it performs what amounts to
construction management services for its clients and that it should be
deemed to be a “building or construction contractor” for that reason.
Midrex’s argument to this effect fails, however, because an NAICS
classification determination is supposed to be premised upon the
identification of an entity’s primary business activity. Although the
record does contain evidence tending to show that Midrex performs a
certain amount of construction management work, the record does not
provide any support for an assertion that the provision of such services
constitutes Midrex’s primary business activity. For that reason, Midrex
could not properly be classified as a construction manager for purposes
of the NAICS classification system given that construction management
was not its primary line of business during the relevant time period. As
a result, the fact that Midrex performs a certain amount of construction
management work does not justify a decision in Midrex’s favor in this
case.
...
In other words, acceptance of Midrex’s argument hinges on the
proposition that the company is not required to be primarily “engaged
in business as a building or construction contractor.” Admittedly, as
Midrex notes, the word “primarily” does not appear in the relevant
statutory language. See N.C.G.S. § 105-130.4(a)(4). The absence of the
word “primarily” from N.C.G.S. § 105-130.4(a)(4), while relevant, is not,
however, dispositive in light of the rule of statutory construction to the
effect that the fact “[t]hat a legislature declined to enact a statute with
specific language does not indicate the legislature intended the exact
opposite.” N.C. Dep’t of Corr. v. N.C. Med. Bd., 363 N.C. 189, 202, 675
S.E.2d 641, 650 (2009) (citation omitted). Thus, the ultimate issue for
our consideration remains what the relevant statutory language, when
read in context and in its entirety, should be understood to mean.
...
Acceptance of the construction of the relevant statutory language
contended for by Midrex would have the effect of
allowing any corporation that performed some building or construction
work to take advantage of the single-factor formula made available by
N.C.G.S. § 105-130.4(r), despite the fact that the General Assembly
clearly intended that the single-factor formula was only to be made
available to a limited class of corporate taxpayers, with the remaining
corporate taxpayers being required to use the three-factor formula. Any
decision that would have the effect of vastly expanding the number of
entities entitled to use the single-factor test would appear to conflict
with the apparent legislative intent.
...
Thus, for the reasons set forth above, we conclude that the
administrative law judge and the trial court properly determined that
Midrex was not a “building or construction contractor” for purposes of
N.C.G.S. § 105-130.4(a)(4).
Id. at 261–264.
58. This Court does not find Midrex to be suggestive of an intent by our
Supreme Court to judicially impose a “primary or principal use” requirement across
the board in every tax statute providing special treatment for a taxpayer who is
engaged in certain activity. To the contrary, Midrex suggests the employment of a
case-by-case approach. 10 Based on the facts in Midrex, it was logical for the Supreme
Court to impose such a requirement in that case. After all, it would make little sense
to allow an entity that only rarely engaged in the work of contracting to take
advantage of a taxation formula applicable only to building or construction
contractors.
59. Here, conversely, FSC “manufactured” extremely large quantities of
HMA throughout the relevant period. Indeed, the record discloses that FSC produced
450,907 tons in 2012, 513,064 tons in 2013, and 704,996 tons in 2014. (R., at
RP_0006.) It did so by utilizing the process that our Supreme Court has repeatedly
described as manufacturing—i.e., “the producing of a new article or use or ornament
by the application of skill and labor to the raw materials of which it is composed.”
Duke Power, 274 N.C. at 513. In short, there is simply no valid comparison between
the extent of FSC’s manufacturing of HMA and the extent of Midrex’s actual work (or
lack thereof) as a building or construction contractor.
60. In reaching its conclusion that FSC is entitled to the Mill Machinery
Exemption, the Court need not—and does not—address FSC’s argument that nothing
in section 105-187.51(a)(1) requires it to have sold any portion of the HMA it created
to third parties as long as it used 100% of its HMA in fulfilling its construction
contracts (or for some other business-related purpose). It is true, as FSC asserts, that
Clayton-Marcus does not overtly state a requirement that some designated portion of
10 As FSC states in its brief, “Midrex dealt with a statute entirely unrelated to N.C.G.S. §
105-187.51, with different public policy implications and legislative goals.” (Resp’t’s Br. Opp.,
at 20.)
the created product at issue must have been sold to third parties in order for a
manufacturing exemption to apply. But even if—as Oscar Miller suggests—that
proposition is, in fact, implicit in the Supreme Court’s reasoning in Clayton-Marcus,
any such requirement has been satisfied here. It is undisputed that during the
relevant period, FSC sold to third parties over 300,000 tons of HMA—a quantity that
even the Department’s counsel conceded at the 14 December hearing was “not
insignificant.”
61. The Department has failed to adequately explain why a ruling in favor
of FSC on these facts would constitute an absurd result or—to use the language of
Clayton-Marcus—“press the word ‘manufactured’ to its dryly logical extreme in
disregard of the obvious purpose of the Sales and Use Tax Act[.]” Clayton-Marcus,
286 N.C. at 224.
62. Finally, the Department attempts to argue that various provisions of the
North Carolina Administrative Code along with certain Technical Bulletins
promulgated by the Department compel a ruling in the Department’s favor in this
case. 11
63. However, the Court has carefully reviewed each of these provisions and
finds that they do not impact its analysis or resolution of this issue. As the
Department conceded at the 14 December hearing, not a single one of these provisions
addresses the key issue presented here—that is, whether an entity such as FSC who
uses portions of the product it manufactures from the TPP it has purchased to fulfill
11 These provisions include 17 NCAC 07B.2602; 17 NCAC 07B.2603; and N.C. Sales and Use
Tax Technical Bulletins 31-1 and 31-4.
its own contracts and sells the remainder to third parties is entitled to the Mill
Machinery Exemption under section 105-187.51(a)(1).
CONCLUSION
64. For the reasons set out above, the Court hereby AFFIRMS the Final
Decision.
SO ORDERED, this 30th day of January, 2023.
/s/ Mark A. Davis
Mark A. Davis
Special Superior Court Judge
for Complex Business Cases