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Manufacturer’s Corner: Missouri Supreme Court Limits Scope of Manufacturers’ Sales and Use Tax Exemption

Here is a troubling new case from the Missouri Supreme Court.  And I don’t mean troubling in the abstract sense of “oh maybe there could be liability down the road if you don’t do this,” which is pretty much the bread and butter of this column.  I mean troubling in the “you may have already botched this, so you better pull out the books and call the accountants and lawyers” sense.

By way of background, materials used in “the manufacturing . . . of any product” are exempt from sales and use taxes in Missouri.  A company called Fenix Construction Company sought refunds for sales and use taxes paid on materials it used to construct “tilt-up concrete walls.”  Those walls were built at the customer’s site according to the customer’s specific needs.  The testimony adduced at hearing suggested that, because the walls were built to suit a customer’s unique needs, the customer was the only likely buyer of any given wall.

The precise question presented in the case was whether these walls were “products” as that term was intended to be defined in the exemption statute.  A person might be inclined to say “yeah, of course they were, what a stupid question,” and I would suggest: (1) that’s absolutely correct, but (2) that person obviously has not spent much time around lawyers.  We look to how prior cases have defined things, and in this instance, prior cases have defined “product” as “an output with market value.” 

“Case closed!” you say with relish.  Fenix sold those walls, so obviously they were “output with market value.”  No!  We still need to know what “market” means in that definition that this very same Court writing this opinion came up with.  So the Court turned to a 1966 edition of Webster’s dictionary, because that’s what lawyers do when we need to find out what a word means if we are to give it a strict construction.[1]  “Market,” as it turns out, refers to “a sphere within which price-making forces operate and in which exchanges in title tend to be followed by actual movement of goods,” which is the kind of definition a lawyer will love.

The Court synthesized these definitions to hold that a “product,” as used in the exemption statute, has as a fundamental feature a price that is “set primarily by competing buyers and sellers.”  The Court went further: “[t]he fact that the price of a product is set primarily by competing buyers and sellers necessarily implies that a good or service only qualifies as a product if it can be marketed to various buyers.”

So, remember earlier when I said that any given Fenix wall had only one natural customer – the one who ordered the wall?  You can see the problem.  There’s only one buyer!   The wall is not a product because only one person wanted it.  Walls in standard sizes?  Clearly products, because they will naturally have multiple potential buyers.  But customize something, and then you have a problem.

Which means that manufacturers have a problem if they make custom products or, as we refer to them in the Uniform Commercial Code, specially manufactured goods.[2]   It is entirely possible that the hot pink triple king size mattress your customer ordered has no other potential buyers.  But would you expect that to box you out of the sales and use tax exemption?  Probably not.

So what can we do to avoid that outcome?  The first thing is unsatisfying but important: if there’s a hearing, give better testimony than Fenix did.  Fenix’s witness was duped into giving a bad answer to the question of whether there could be alternate buyers.  He was asked whether it was likely anyone would come and offer to pay double what the customer agreed to pay for any particular wall panel.  Of course not.  That’s silly.  But that doesn’t mean Fenix couldn’t find somebody to buy a particular wall panel for some price, even if it’s a small one.  Well, there’s your second buyer.  Or maybe the particular wall panel had scrap value (I don’t know if that’s true or not, but it could be!).  The point is, surely there was some other potential buyer out there.[3]

The second thing is also unsatisfying but important: the Webster’s definition the Court relied on referred to “price-making forces.”  The Court took that to mean multiple buyers, but it doesn’t have to mean that.  If you have a competitor, doesn’t that competition serve as a price-making force?  I’m not sure the Court fully thought that side of the issue through.

The third thing (I mean, they’re all unsatisfying, okay?) is to challenge the case law definition of “product.”  The Supreme Court just overruled its prior definition of “product” in 1997,[4] so it is not as though the current definition is immutable and incapable of change.

The fourth possibility is to request a letter ruling from the Missouri Department of Revenue, and essentially ask the Department to confirm that they don’t really intend to exclude custom manufactured goods from the sales and use tax exclusion.  You may not like what they have to say, but you won’t know unless you try.

The fifth option – again, unsatisfying – is to get the accountants and lawyers together to review your specific situation.  It may be that it’s worth asking the Court to revisit this issue.

[1] And yes, it has to be a strict construction.  The Court was absolutely right on that.  It just yields an absurd result, which suggests that the prior definition of “product” imposed by the Court should be revisited.

[2] Incidentally, it’s kind of funny in a sick way that this is a problem of special importance to manufacturers, because the whole point of that exemption is to provide relief for manufacturers.

[3] Posing a hypothetical buyer probably wouldn’t do the trick without more.  The Supreme Court correctly recognized that the burden rests on the taxpayer to prove application of the exemption, so it would be wise to know in advance of a hearing what you do with custom product that is not sold to the customer who ordered it.

[4] International Business Machines Corp. v. Dir. of Revenue, 958 S.W.2d 554, 557 (Mo. banc 1997).