Appellants Reply Brief — Potomac Edison Co. v. Pennsylvania

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No. 80-1303 |

IN THE

Supreme Court of the United States

OCTOBER TERM, 1980

THE POTOMAC EDISON COMPANY, Appellant,

=

THE COMMONWEALTH OF PENNSYLVANIA, Appellee.

On Appeal From The Supreme Court Of Pennsylvania

APPELLANT'S BRIEF OPPOSING MOTION

TO DISMISS OR AFFIRM

LLoyp R. PERSUN

Counsel of Record

HoweELL C. METTE

SHEARER, METTE & WOODSIDE

Attorneys for Appellant

P.O. Box 729

1801 N. Front Street

Harrisburg, Pennsylvania 17108

(717) 232-6701

PRESS OF BYRON S. ADAMS PRINTING, INC., WASHINGTON, D.C.

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TABLE OF CONTENTS

The Equal Protection Argument, Which Is A Substantial

Federal Question, Is Properly Before The Supreme

CO Gee Oe RPUOOS. CONNOR ae ik cesedecatewscvenns 1

Pennsylvania Courts Have Not Followed The Definition

Which Was Used To Deny Appellant’s Claim To The

Manufacturing Exemption ..............ccccecececees 6

TN eR” OTM NP gi RS DY NOs Oy EISEN 7

TABLE OF AUTHORITIES

CASES: PAGE

Cumberland Coal Co. v. Board of Revision, Etc., 284

Se ERD 6 bk Wha Ka se bleaidee vianceouee ye

Great Northern Railway Co. v. Sunburst Oil & Refining

Co., 287 U.S. 358, 363, 366-367 (1932).......... 2, 4, 5

Kirks Milk Products, Inc. vy. Commonwealth of Penn-

sylvania, No. 1443 Commonwealth Docket 1976,

before the Commonwealth Court of Pennsylvania .. 6, 7

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IN THE

Supreme Court of the United States

OCTOBER TERM, 1980

No. 80-1303

THE PoTOMAC EDISON COMPANY, Appellant,

V.

THE COMMONWEALTH OF PENNSYLVANIA, Appellee.

On Appeal From The Supreme Court Of Pennsylvania

APPELLANT’S BRIEF OPPOSING MOTION

TO DISMISS OR AFFIRM

ARGUMENT

The Equal Protection Argument, Which Is A Substantial

Federal Question, Is Properly Before The Supreme Court Of

The United States.

Appellant erroneously argues that, even if the Court

finds that a substantial federal question is raised, the ap-

peal should be dismissed because the federal question

was not preserved properly. Appellant’s argument is in-

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apposite. Great Northern Railway Co. v. Sunburst Oil &

Refining Co., 287 U.S. 358, 363, 366-367 (1932);

Cumberland Coal Co. v. Board of Revision, Etc., 284

U.S. 23, 24-25 (1931).

The substantial federal question before this Court

was raised in paragraph 4 of Appellant’s application for

reargument which was filed with the Supreme Court of

Pennsylvania. In its application. for reargument, Appel-

lant contended, inter alia:

‘4. As a matter of law and fundamental

fairness, Appellant is entitled to have its appeal ad-

judged by the same definition of the term

‘manufacturing’ as consistently applied by your

Honorable Court to past tax litigants and as

repeatedly accepted by the General Assembly in ses-

sions, spanning more than 50 years. By failing to

adjudge Appellant’s claim according to its judicial

definition of ‘manufacturing’, your Honorable

Court failed to apply uniformly the manufacturing

exemption from franchise tax in violation of Article

IX, Section 1 of the Pennsylvania Constitution, and

also deprived Appellant equal protection of law in

violation of Section 1 of the Fourteenth Amend-

ment to the United States Constitution. Affirming

the Order of the Commonwealth Court imposes a

greater franchise tax liability against Appellant than

against other taxpayers whose franchise tax liability,

and exemption therefrom under the manufacturing

exemption, were previously adjudged by your Hon-

orable Court under its judicial definition of ‘manu-

facturing’.’’

Appellant was not able to raise this question until its

application for reargument.

The federal question arose from the decision of the

Supreme Court of Pennsylvania to adjudge Appellant’s

claim to the manufacturing exemption from Penn-

sylvania franchise tax by a different definition of the

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term ‘‘manufacturing”’ than uniformly applied for over

50 years to all other taxpayers, foreign and domestic,

which claimed the exemption from franchise tax and

capital stock tax, since no basis exists for the difference

and the Pennsylvania Supreme Court stated no reason

for the difference.

Because the capital stock tax and franchise tax

legislation contains no definition of the term ‘“‘manufac-

turing’, the Supreme Court of Pennsylvania judicially

defined that term over 50 years ago. Without reason and

without explanation, the Commonwealth Court of Penn-

sylvania departed from the judicial definition of the

term. Jurisdictional Statement at 14-19. Because the

Supreme Court of Pennsylvania, as the ultimate arbiter

of Pennsylvania law, judicially pronounced the defini-

tion of the term ‘‘manufacturing’’, Appellant sought

that Court’s decision to correct the lower Court’s im-

proper departure from the judicial definition. The

Supreme Court of Pennsylvania failed to do so, issuing

only a per curiam Order affirming the decision of the

Commonwealth Court of Pennsylvania, the lower court.

Neither the Supreme Court of Pennsylvania nor the

Commonwealth Court of Pennsylvania explained the

departure from the definition in Appellant’s case,

although Appellee’s persistent, improper remarks' about

the admittedly adverse fiscal impact on the Com-

monwealth of Pennsylvania if Appellant receives the

manufacturing exemption appear to have influenced the

Pennsylvania Supreme Court’s decision to affirm

without issuing an opinion.

oe

' Appellant repeatedly objected and excepted to these remarks at

trial and at oral argument. E.g., Exceptions ¢ 12; Motion to

Dismiss or Affirm at 24.

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The Supreme Court of Pennsylvania failed to in-

dicate whether the judicial definition of the term

‘“‘manufacturing’”’ ‘was overruled or modified. The per

curiam opinion of the Supreme Court of Pennsylvania

presented Appellant with its first opportunity — by ap-

plication for reargument — to raise the federal question

involved in this appeal. Appellant did so in paragraph 4

of its application for reargument. The Supreme Court of

Pennsylvania denied the application for reargument. If,

as in the instant case, the decision of the state supreme

court supplies a new basis for the defeated party’s

claiming the denial of a federal right, then the general

rule cited by Appellee in its motion? is not applicable.

Great Northern Railway Co., supra. Without any ex-

planation, the Supreme Court of Pennsylvania failed to

apply to Appellant’s claim its own case law defining the

term ‘‘manufacturing’’ for the purposes of the manufac-

turing exemption from franchise tax and capital stock

tax. In so acting, the Supreme Court of Pennsylvania,

itself, created, for the first time in this case, the federal

question before this Court. Under similar circumstances,

the Great Northern Court ruled:

‘‘The rule, general as it is, does not extend to

cases where the constitutional question, however

tardily raised, is considered and decided (Con-

solidated Turnpike Co. v. Norfolk & O. V. Ry.

Co., 228 U.S. 326, 334; Cumberland Coal Co. v.

Board, 284 U.S. 23), nor does it apply where the

grounds of the decision supply a new and unex-

pected basis for a claim by the defeated party of the

denial of a federal right. Brinkerhoff-Faris Trust &

Savings Co. v. Hill, 281 U.S. 673, 678; Missouri ex

rel. Missouri Insurance Co. v. Gehner, 281 U.S.

313, 320; American Surety Co. v. Baldwin, supra.

? Appellee’s Motion to Dismiss or Affirm at 17-19.

5

This case is clearly with the second of these excep-

tions, if it is not also within the first. We have seen

that the assault upon the judgment is made along

two lines. The first is a challenge to the constitu-

tional validity of the ruling in the Doney case, and

involves a misconception of the decision in Arizona

Grocery Co. v. Atchison, T. & S. F. Ry. Co.,

supra. The second is a challenge to the constitu-

tional validity of the ruling in this case whereby the

statute is adjudged to mean one thing for some

cases and another thing for others. This latter ob-

jection the petitioner could not make in advance of

the event. 287 U.S. at 367 (Emphasis added).

Moreover, as in the instant case, if the federal ques-

tion is raised by application or petition for reargument

to the state supreme court and the state supreme court

rejects the federal question, then the general rule cited

by Appellee also is inapplicable, regardless of when the

federal question might have been raised in the state pro-

ceedings. Great Northern Railway Co., supra;

Cumberland Coal Co., supra. In Cumberland, the tax-

payer first raised the federal question by petition for

reargument (now known as an application for reargu-

ment) filed with the Supreme Court of Pennsylvania.

The petition for reargument was denied, rejecting the

federal question. The taxpayer could have raised the

federal question at any time in the state proceeding

before filing its petition for reargument. Noting this ex-

ception to the general rule, the Supreme Court of the

United States heard the case on the federal question,

reversing the Pennsylvania Supreme Court. 284 U.S. at

24-30. This exception also applies at bar.

Appellant raised the federal question in its excep-

tions filed in the Commonwealth Court of Pennsylvania,

by excepting to that Court’s failure to apply to Ap-

pellant’s claim the judicial definition of the term

6

‘‘manufacturing’’ as applied to franchise and capital

stock taxpayers in other Pennsylvania cases. Exceptions

41 3, 4, 5; Motion to Dismiss or Affirm at 21-22. Ap-

pellant sought to have the Pennsylvania Supreme Court

correct this error, because that Court established the

definition more than 50 years ago and thereafter applied

the definition uniformly to all taxpayers claiming the

manufacturing exemption, except Appellant. Instead,

the Pennsylvania Supreme Court unexpectedly ignored

the error without offering any reason for doing so.

Pennsylvania Courts Have Not Followed The Definition

Which Was Used To Deny Appellant’s Claim To The

Manufacturing Exemption.

In denying Appellant’s claim to the manufacturing

exemption, the Commonwealth Court of Pennsylvania

grafted to the judicial definition of the term ‘‘manufac-

turing’’ a requirement that ‘‘molecules of the original

raw material sugyive in the final product’’. 411 A.2d at

1290, 1291: Jurisdictional Statement at 12a (Appendix

C). Before and after the decision in Appellant’s case,

this requirement was not part of the judicial definition

of the term ‘‘manufacturing’’. Jurisdiction Statement at

14-20, 23a-24a (Appendix F); Kirks Milk Products, Inc.

v. Commonwealth of Pennsylvania, No. 1443 Com-

monwealth Docket 1976, before the Commonwealth

Court of Pennsylvania (opinion filed April 3, 1981.° In

Kirks Milk, the Commonwealth Court of Pennsylvania,

without referring to its Potomac Edison opinion, held

that a taxpayer’s operations in producing skim milk

powder and buttermilk powder by evaporation qualify

for the manufacturing exemption. Although the Kirks

? The Kirks Milk Opinion is reproduced, in its entirety, infra, in

Appendix A.

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Milk Court noted that the judicial definition was derived

more than 50 years ago, the Court made no reference to

any supposed requirement that ‘‘molecules of the

Original raw material survive in the final product’’ in

order to qualify for the manufacturing exemption under

that definition.

The Kirks Milk opinion was issued on April 3,

1981. Research reveals that Kirks Milk is the only

manufacturing exemption case decided by Pennsylvania

courts after Potomac Edison.

CONCLUSION

For the foregoing reasons, Appellee’s motion to

dismiss or affirm must be denied; probable jurisdiction

should be noted; and the order of the Supreme Court of

Pennsylvania must be reversed.

Respectfully submitted,

LLoyp R. PERSUN

HOWELL C. METTE

SHEARER, METTE & WOODSIDE

Attorneys for Appellant

P.O. Box 729

1801 North Front Street

Harrisburg, Pennsylvania 17108

(717) 232-6701

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IN THE COMMONWEALTH COURT

OF PENNSYLVANIA

No. 1443 C.D. 1976

Kirxs Mik Propucts, INC., Petitioner

Vv.

COMMONWEALTH OF PENNSYLVANIA, Respondent

BEFORE: HONORABLE JAMES C. CRUMLISH, President Judge

HONORABLE ROY WILKINSON, JR. Judge

HONORABLE GLENN E. MENCER, Judge

HONORABLE THEODORE D. Rocurs, Judge

HONORABLE Davip W. CRAIG, Judge

HONORABLE ROBERT W. WILLIAMS, JR., Judge

HONORABLE MADALINE PALLADINO, Judge

ARGUED: December 9, 1980

OPINION

Opinion by President Judge Crumlish Filed: April 3, 1981

Kirks Milk Products, Inc., appeals from a Board of

Revenue and Finance determination that the production of

skim milk powder and buttermilk powder does not constitute

' “‘manufacturing’’' or ‘‘processing’’? within the capital stock

tax exemption. We reverse.

The stipulated facts follow: Kirks Milk Products, Inc.

(Taxpayer) is a Pennsylvania corporation engaged in the

storage, production, and wholesale-retail purchase and sale of

milk, cream, butter, cheese and, for our purposes, buttermilk

powder and skim milk powder. The taxpayer’s total powdered

dairy products output, approximately 91% powdered skim

milk and 9% powdered buttermilk, is sold at wholesale and

constitutes $566,008 and $54,041, respectively, of $1,763,880

in total gross receipts’ for the tax period, November 1, 1973

through October 31, 1974.

2a

Filing its Capital Stock Tax Report to reflect tax liability

of $207.11, taxpayer asserted that buttermilk and skim milk

powders were produced through ‘“‘manufacturing,’’ concluded

that receipts therefrom were derived from the use of exempt

assets, and reported its tax liability based only upon its non-

manufacturing gross receipts or the raw milk purchased and

resold at wholesale. However, the Department of Revenue set-

tled the capital stock tax liability in the amount of $1,201.48

by denying exempt status for certain assets and adding in

gross receipts for skim milk powder, buttermilk powder, and

cream to taxable assets.

Since the sole question involved in this case is whether

Taxpayer’s production of buttermilk powder and skim milk

powder constitutes ‘‘processing’’ or manufacturing’”’ for pur-

poses of exemption under Article VI of the Tax Reform Code

of 1971, a discussion of the legal background will be followed

by a detailed review of the production process.

Discussion

For nearly 100 years, the assets of Pennsylvania corpora-

tions engaged in manufacturing have enjoyed an exemption

from capital stock taxation. See Norris Brothers v. The Com-

monwealth, 27 Pa. 494 (1856). More recently, our Supreme

Court in Commonwealth v. Deitch Co., 449 Pa. 88, 94, 295

A.2d 834, 838 (1972), expressed the purpose of the manufac-

turing ¢xemption as created ‘‘to establish a favorable climate

in Penasylvania for manufacturers and thus encourage the

development of industry. Additionally, there was a desire not

to put domestic manufacturers at a competitive disadvantage

with out of state industries[,]’’ who enjoyed tax exempt status

in their adjoining home states. And see Commonwealth v.

Northern Electric Light and Power Co., 145 Pa. 105, 120, 22

A. 839, 841 (1891).

Since the tax laws fail to provide definitional guidelines,

the judicial meaning and the corresponding practical inter-

pretation of the term ‘‘manufacturing’’ becomes most impor-

3a

tant. In Armour and Co. v. Pittsburgh, 363 Pa. 109, 116, 69

A.2d 405, 408-09 (1949), our Supreme Court summarized

business activities which qualify for the exemption:

It was said in Commonwealth v. Weiland Packing Co.,

292 Pa. 447, 450, 451, 141 A. 148, 149, that ‘the process

of manufacture brings about the production of some new

article by the application of skill and labor to the original

substance or material out of which such new product

emerges. If however there is merely a superficial change

in the original materials or substances and no substantial

and well signalized transformation in form, qualities and

adaptability in use, quite different from the originals, it

cannot properly and with reason be held that a new arti-

cle or object has emerged — a new production been

created.’ Nor is it of legal significance in this connection

that the operations thus conducted require large and ex-

tensive plants and organizations, trained men and in-

tricate machinery, for even though the labor be skilled,

the operations delicate, a large plant involved, and expen-

sive machinery utilized, such factors, neither individually

nor collectively, covert what is essentially a mere process-

ing Operation into a manufacturing one: of, Rieck-

McJunkin Dairy Co. v. Pittsburgh School District, 362

Pa. 13, 23, 66, A. 2d 295, 299.

Over the years, our courts have not only been consistent

in narrowly defining the term ‘‘manufacture’’, but reluctant

to grant the manufacturing exemption with respect to opera-

tions performed by taxpayers in the production of foods. Ear-

ly on our Supreme Court held that the purchase, slaughter,

cleaning, washing, sorting and resale of meat, hides, heads,

and horns was not manufacturing within the capital stock tax

exemption. Commonwealth v. Consolidated Pressed Beef Co.,

242 Pa. 163, 88 A.975 (1913). See also Commonwealth v.

Weiland Packing Co., 292 Pa. 447, 141 A. 148 (1928), where

*‘manufacturing’’ status was denied pickled and dry salt pork,

smoked hams and other pressed meat products.

?»

4a

A number of years later, the Supreme Court addressed

the ‘‘manufacturing’’ status of milk products. In Rieck-

McJunkin Dairy Co. v. Pittsburgh School District, 362 Pa.

13, 66 A.2d 295 (1949), the milk dealers’ status as ‘‘manufac-

turers’? under the mercantile tax exemption was questioned

with respect to the production of pasteurized and homogeniz-

ed milk and cream, butter, pasteurized cultured buttermilk,

pasteurized skimmed milk, and our subject, skimmed milk

powder. Classifying the milk dealers as manufacturers with

respect to making ice cream, cottage cheese, and butter, our

Supreme Court held that ‘‘[w]hile these articles are made from

milk, they are ‘a new and different article’ from the milk

Originally purchased,’’ but concluded that ‘‘[c]ondensed,

evaporated and powdered milks are produced by boiling off,

under controlled conditions, a portion of the water content of

the milk; this is a variation of the process of reducing a raw

material to its constituent parts for purposes of distribution.”’

Id. at 22-23, 66 A.2d at 299.

However, certain methods of food production have fared

well. In Commonwealth, v. Snyder’s Bakery, 348 Pa. 308, 35

A.2d 260 (1944), the taxpayer’s production of potato chips

from raw whole potatoes, hot fat, vegetable oils, and salt con-

stituted ‘‘manufacturing”’ for mercantile license tax purposes.

The Court held that the manufacure of potato chips, con-

sisting of storing raw potatoes at a given temperature for a

specified period, testing, storing at increased temperature,

cleaning, slicing, washing, drying, immersing in hot fat and

vegetable oils, draining and drying, and salting and packag-

ing, resulted in a product adapted to an entirely different use

from the raw potato, the form and content of the finished

product being entirely different.

In Pillsbury Mills, Inc. v. Pittsburgh School District, 408

Pa. 369, 372, 184 A.2d 236, 237 (1962), the milling of wheat

into flour was held to be ‘‘manufacturing’’ for mecrcantile

license tax purposes — ‘‘an intricate technologically

sophisticated process. ... The milling operation includes the

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grinding, blending and processing of the many types of wheat

into flour of varying characteristics which will be used for

countless. purposes.”’

Even in the case of Commonwealth v. Berio Vending

Co., 415 Pa. 101, 105-06, 202 A.2d 94, 96 (1964), where the

production of popcorn was denied manufacturing status for

franchise tax exemption purposes, the Supreme Court after

discussion drew an important distinction:

‘T]he production of popcorn, even though on an ex-

panded scale, should not achieve the status of manufac-

turing as that term is popularly considered. The popping

of corn does not require any sepcific skill or elaborate

machinery. It can be done in the home by a child in a

smaller scope in the same manner as appellant ac-

complishes in its plant. There is no application of labor,

skill, art or science to provide a well signalized change as

those terms are known. There can be little doubt that the

courts have required a certain degree of skill, art or

science be employed.

* * *

While the court below expressed doubt as to the cur-

rent validity of the Snyder’s Bakery case, we need express

no view as to that observation. Jt is quite clear that the

production of popcorn involves far less control factors,

skill and science than does the production of potato

chips.’’ (footnote omitted) (emphasis added).

Consequently, we must examine the production methods used

for both buttermilk and skim milk powders, and ascertain

first, that a high degree of skill, science and labor has been

applied to the liquid buttermilk and skim milk, and second,

that a substantial transformation in form, qualities and adap-

tability in use has made the powdered milk a new, different

and useful article.

Aside from arguing that the taxpayer’s operation does

not constitute ‘‘processing’’ within that added statutory ex-

emption, the Commonwealth contends that the simple extrac-

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tion of water has neither popularly nor judicially been re-

garded as manufacturing. See Rieck-McJunkin Dairy Co, v.

Pittsburgh School District, supra (milk products); Com-

monwealth v, Glendora Products Co., 297 Pa. 305, 146 A.896

(1929) (roasting coffee), and Commonwealth v. Babcock

Lumber Co., 1 Pa. Commonwealth Ct. 45, 272 a.2d 522

(1971) (kiln drying pre-cut green lumber). While the produc-

tion of powdered milk is clearly not ‘‘processing’’ withia the

exemption, we must disagree with the Commonwealth’s

‘*manufacturing’’ position.

In the Rieck-McJunkin case, our Supreme Court seems to

have had no informed opportunity to examine evidence re-

garding either the taxpayer’s machinery or production

methods or the -distinctive characteristics of the subject

powdered miik. Although evidence was produced by the tax-

payer, the chancellor made no findings of fact with respect to

the taxpayer’s production methods. In addition, the Rieck-

McJunkin decision has lost much of its impact upon milk pro-

ducts in light of the recent processing exemption to the capital

stock tax. As for Glendora Products, supra, and Babcock

Lumber, supra, the manufacturing processbefore us goes far

beyond roasting coffee and drying out lumber.

A. Skill, Science and Labor

Taxpayer utilizes an elaborate ‘‘Lo-Temp’’ evaporation

system with a three-cycle process, identified by refrigeration,

product, and spray drying stages, in the production of butter-

milk and skim milk powders.

Operating on the evaoration principle, the initial

‘‘refrigeration’’ cycle removes water from the milk by using

two vacuum chambers through which tubes carrying pressuriz-

ed ammonia vapors act as a heating agent. These ‘“‘first

effect’’ and ‘“‘second effect’’ chambers work hand in hand to

create a condensed or concentrated, but still liquid, buttermilk

or skim milk product. In the “‘first effect’? chamber, since the

milk is vacuum heated over the ammonia vapor tubes,

7a

evaporation of the water content occurs at a relatively low

temperature. The water vapor extracted from milk in the

‘*first effect’? chamber is then utilized as the heating agent in

the ‘“‘second effect’? chamber, where the milk product is

heated to a higher temperature under a vacuum and is concen-

trated or condensed still furt':er as additional water is remov-

ed by evaporation.

In the second or ‘‘product’’ cycle of the Lo-Temp

system, partially concentrated liquid buttermilk or skim milk

products from the ‘‘second effect’? chamber are pumped back

into the ‘‘first effect’? chamber. As the product flows down

the tubes of the ‘‘first effect’? chamber, its temperature is in-

creased to between 165°F/73.9°C and 185°F/85°C, and addi-

tional water is removed by evaporation and pumped off by a

condensate pump. Completion of this ‘‘product’’ cycle leaves

a product which contains 42% to 48% milk solids by volume.

Attendant are various physical and extremely complicated

chemical changes in the liquid skim milk and liquid buttermilk

as a result of the heating and concentration which took place

during the ‘‘refrigeration’’ and ‘‘product’’ cycles. Serum pro-

teins and cascine are denatured, the acidity of the product

changes due to changes in chemical salt balances, the ‘‘heat

stability’’ of the product is increased, and the product

becomes increasingly viscous or ‘‘sticky.’’

The final stage of skim and buttermilk powder produc-

tion is identified as the ‘‘Spray Drying’’ Cycle. The heated

and concentrated product is forced at high pressure through

an atomizing nozzle located at the top of a precipitating

chamber. The atomized particles or droplets are exposed to a

controlled air flow heated by a direct fired furnace, and upon

reaching a temperature of 185°F/85°C, instantly release their

remaining water content in the form of vapor. Dry buttermilk

or skim milk particles, separate from but mixed with water

vapor, pass into the primary collector where they are

separated by ‘‘cyclonic’’ action. The powder is further cooled

by air as it passes progressively through secondary and final

production collectors and is finally sifted and placed in sealed

containers.

8a

Surely, that degree of skill, science and labor which

‘‘manufactured’’ potato chips in Snyder’s Bakery and flour in

Pillsbury Mills can be attributed to the elaborate Lo-Temp

evaporation systems’s three cycle production of buttermilk

and skim milk powders.

_B. New, different and useful product

Addressing the second prong of the ‘‘manufacturing’’

test, we conclude that resulting buttermilk and skim milk

powders are new and useful product, substantially different in

form, qualities and adaptability in use. In ‘‘form,’’ the con-

version from liquid to crystalline or solid is obvious. In terms

of ‘‘qualities’’ and ‘‘adaptability in use,’’ the record and

stipulated facts speak for themselves. Aside from the

‘‘lactose’’ or crystalline reaction and the ‘‘browning’’ or

chemical heat reactions, the resulting powders have almost in-

definite ‘‘keeping’’ qualities, none of the coagulent, curding

or enzyme properties, increased blending ability and greater

flavor stability than do either buttermilk or skim milk. The

principal commercial uses of buttermilk and skim milk

powder are as ingredients in special dried foods and prepared

dry mixes such as dry cake or biscuit mixes, dry soup mixes,

prepared dry cereals, dry infant formulas and prepared dry

dog and other animal foods, where it is not possible to use the

liquid milks. Buttermilk and skim milk products are used ex-

tensively in the baking and confection industries as ingredients

because of their unique ability to blend with sugar and cane

syrups and flavorings at high processing temperatures without

coagulating or resulting in undesirable flavor characteristics.

Liquid milks have been found commercially infeasible because

of such undesirable characteristics as flavor changes, inability

to withstand the high cooking temperatures required coagula-

tion or curding and the inability to produce a smooth viscous

mixture of the candy product. Buttermilk and skim milk

powders are also used extensively in virtually all areas of the

prepared food industry in products such as canned or frozen

soups, frozen dinners, frozen casseroles, meat sausages, cann-

ed meats, and canned gravies and sauces because of their

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superior ‘‘keeping’’ characteristics, blending characteristics

and flavor stability. In addition, aside from general use in the

production of glue and adhesive materials, the powdered

milks may be ‘“‘reconstituted’’ and used as a beverage for

human consumption with characteristics quite different from

their liquid counterparts.

Having determined that taxpayer is entitled to the capital

stock tax’s manufacturing exemption for the fiscal year ending

October 31, 1974, we reverse the decision and order of the

Board of Finance and Revenue, and enter judgment in accor-

dance with stipulation of Fact 41 in favor of the Com-

monwealth and against taxpayer in the amount of $207.11.

The judgment shall be marked ‘‘satisfied’’ upon payment of

docket costs by taxpayer and a credit of $994.37 shall be

entered in favor of taxpayer on the proper books and records

of the Department of Revenue.

Reversed.

Date: April 3, 1981 /s/ JAMES C. CRUMLISH

James C. Crumlish

President Judge

Judges Wilkinson, Jr., and Rogers dissent.

This decision was reached prior to the expiration of the term

of Judge Wilkinson, Jr.

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FOOTNOTES

| Section 602(a) of the Tax Reform Code of 1971, Act of March

4, 1971, P.L. 6, as amended, 72 P.S. §7602(a), provides in pertinent

part:

(a) That every domestic corporation ... shall be subject to,

and pay into the treasury of the Commonwealth annually,

through the Department of Revenue, a tax at the rate of ten

mills, upon each dollar of the actual value of its whole capital

stock of all kinds . . . provided, That the provisions of this sec-

tion shall not apply to the taxation of the capital stock of cor-

porations, limited partnerships and joint-stock associations

organized for manufacturing, processing, research or develop-

ment purposes, which is invested in and actually and exclusively

employed in carrying on manufacturing, processing, research or

development within the State .. . . (Emphasis added.)

2 Section 602(c)(7), 72 P.S. §7602(c)(7), specifically provides a

‘*processing’’ exemption to the capital stock tax:

(c) The term processing, as used in this section, shall mean

and be limited to the following activities when engaged in as a

business pose

* *

(7) The production, processing and bottling of nonalcoholic

beverages for wholesale distribution.

The exemption did much to alleviate the restrictive interpretation

which had been placed upon ‘‘manufacturing’’ specifically relative

to milk products. See Rieck-McJunkin Dairy Co. v. Pittsburgh

School District, 362 Pa. 13, 66 A.2d 295 (1949).

Taxpayer’s total gross receipts of $1,763,880 during the taxable

period were derived from the sale of raw milk purchases and resold

at wholesale ($315,892), cream ($123,698), butter ($175,161) and

cheese ($529,080), buttermilk powder ($54,041) and skim milk

powder ($566,008). [sic]

* [sic] For background purposes, we note that the exempt ‘‘pro-

cessing’ of separated and pasteurized liquid cream and skim milk

occurs in two stages. In the initial stage of production, the ‘‘separa-

tion phase,’’ raw whole milk is heated in large tanks, pumped into a

continuous centrifuge, and separated into it constitutent parts — li-

quid skim milk and liquid cream. The second stage or ‘‘pasteuriza-

tion phase’’ finds both the milk and cream heated under controlled

conditions in a pasteurizer in order to retard the fermentation of

milk sugars, prevent the formation of toxic substances, and general-

ly destroy harmful bacteria.

>.

lla

The pasteurized cream is then utilized to produce butter and

buttermilk through a third stage, an agitaiton or ‘‘churning

process.’’ Here, liquid cream containing 30% to 33% butter fat is

placed in a low temperature mechanical churn and rotated until the

‘*breaking point’ is reached and butter ‘‘granules’’ are formed.

Thin production of butter indisputably constitutes ‘‘manufacturing’’

within the scope of the capital stock tax exemption. However, the

remaining liquid, a by-product of butter production, is drawn off

and subsequently used in the production of buttermilk powder,

Taxpayer’s entire production of liquid buttermilk and skim

milk is then completely utilized in the production of buttermilk and

skim milk powders.

-)

y%

12a

IN THE COMMONWEALTH COURT OF PENNSYLVANIA

No. 1443 C.D. 1976

Kirxs MILK Propucts, INc., Petitioner

v.

COMMONWEALTH OF PENNSYLVANIA, Respondent

ORDER

The Board of Finance and Revenue order, dated July 30,

1976, Board Docket No. R-1610, is hereby reversed, and judg-

ment is directed :o be entered in accordance with Stipulation

of Fact 41 in favor of the Commonwealth and against Kirks

Milk Products, Inc. in the amount of $207.11. The judgment

shall be marked ‘‘satisfied’’ upon payment of docket costs by

taxpayer and a credit of $994.37 shall be entered in favor of

taxpayer on the proper books and records of the Department

of Revenue unless exceptions are filed hereto within thirty [30]

days.

Dated April 3, 1981 /s/ James C. CRUMLISH,

James C. Crumlish,

President

Judge

FraANcIs C. BARBUSH

Cheif Clerk