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Walther v. Carrothers Construction Co. of Arkansas, LLC

Supreme Court of Arkansas

May 19, 2016



          Jeffrey Weber, Arkansas Dep't of Finance and Administration, for appellant.

          Sayre & Brockett, by: Christopher D. Brockett; and Taylor & Taylor Law Firm, P.A., by: Andrew M. Taylor and Tasha C. Taylor, for appellee.

          HOWARD W. BRILL, Chief Justice

         The Illinois Bayou begins on the south slopes of the Ozarks in the Boston Mountains. Its four forks merge and provide Class II/III whitewater canoeing. On its downstream route through Pope County, it passes near the communities of Hector, Scottsville, and Dover before joining Lake Dardanelle in the Arkansas River. Although ideal for canoeing and bass fishing, the waters of the Illinois Bayou and the Huckleberry Creek Reservoir are not suitable for drinking by the residents of Russellville. The waters must first be cleaned. Thus begins this tax litigation.

         I. Facts

         The City of Russellville created the City Corporation to operate, maintain, and improve the city's municipal waterworks system. The City Corporation manages a water-treatment plant that provides potable drinking water to the residents of Russellville. At the water-treatment plant, a three-phase process includes the pretreatment, clarification, and final filtration of surface water that is transformed into potable drinking water.

         In 1998, Carrothers Construction Company of Arkansas, LLC (Carrothers), a limited liability company headquartered in Kansas, constructed an expansion of the water-treatment plant. Carrothers purchased several items of machinery and equipment for the project. Carrothers installed this machinery and equipment for the extensive three-phase water-treatment process at the Russellville plant.

         In July 2004, the auditor for the Arkansas Department of Finance and Administration (DFA) conducted an audit of Carrothers's records pertaining to its activities and purchases in 1999 and 2000 in performing its contractual obligations to expand the Russellville water-treatment plant. Carrothers claimed $1, 266, 463.35 as expenditures exempt from state and local sales taxes and compensating-use taxes. The auditor determined that Carrothers purchased personal property from out-of-state vendors and that these purchases were subjected to Arkansas's state and local use taxes, plus interest. As a result of three separate audits, DFA proposed to assess $56, 006.78 in state use taxes, $3674.57 in local use taxes, and $27, 482.33 in interest against Carrothers. Carrothers objected to the assessments. After determining that some assessments were barred by the statute of limitations, on December 8, 2005, DFA issued a final assessment of $94, 994.89 and a demand for payment. Carrothers paid a portion of these taxes in the amount of $5191.16 to DFA.

         On October 25, 2010, Carrothers filed a complaint against Larry Walther in his official capacity as the director of DFA. Carrothers alleged that it was entitled to a refund of additional use taxes, to an order requiring the abatement of the unpaid portions of the final assessment, and to a court ruling "ordering the abatement of any portion of the disputed assessment by DFA attributable to items of tangible personal property not utilized in Arkansas or double included in the auditor's determinations."

         On July 1, 2014, Carrothers filed a motion for summary judgment asserting that there were no genuine issues of material fact and that, as a matter of law, it qualified for a manufacturing exemption.[1] In its motion, Carrothers asserted that its purchases of tangible personal property, particularly the piping used to carry chemicals within the water-treatment plant and the concrete for the holding tanks, were exempt from taxation because those items were used in the plant's expansion. Attached to Carrothers's motion for summary judgment was an affidavit of Michael Morrand, owner and president of Carrothers, who described the extensive three-stage mechanical and chemical water-treatment process utilizing Carrothers's equipment.

         The first phase of the water-treatment process begins with the raw surface water's pretreatment process known as "trash or debris removal." According to Morrand, the raw surface water is directed by gravity flow or pumped through intake structures where large items, such as logs, branches, leaves, and trash, are screened and removed. Morrand stated that a "number of chemicals are injected into the 'raw surface water' at this point for the purpose of removing contaminants that would affect the taste and odor of the final drinking water ('potable') product." Morrand explained that Carrothers constructed a chemical holding facility, with numerous tanks and piping, to facilitate this process.

         During the second phase, known as the flocculation process, the water from the first phase is subjected to several additional chemical applications "designed to settle out microscopic particles and to clarify the partially treated 'raw surface water.'" Morrand stated that coagulant chemicals are injected at a "Rapid Mix Facility" and a second "SuperPulsator Clarifier, " installed by Carrothers during the expansion, that removes "color, turbidity, and organic materials from the chemically treated 'raw surface water.'"

         Lastly, Morrand stated that during the final water-treatment phase, the water is purified by exposing the water to chemicals, typically chlorine, lime, and fluoride, before it passes from a "Backwash Tank" into the "Final Filter Tanks." Morrand concluded that "many of [Carrothers's] purchases of items of tangible personal property (e.g., all of the piping used to carry the influent and the processing chemicals within this drinking water treatment plant, as well as the concrete for the holding tanks, etc.)" were exempt from Arkansas state and local sales-and-use taxes.

         In response to Carrothers's motion for summary judgment, DFA contended that Russellville's water-treatment facility was not a manufacturer of water, but instead merely cleaned the water for human consumption.

         On June 22, 2015, the circuit court granted Carrothers's motion for summary judgment and ruled that Carrothers was entitled to the manufacturing exemption set forth in Arkansas Code Annotated section 26-52-402(a)(1)(A). As a basis for its ruling, the circuit court found that the "extensive mechanical and chemical treatment process turns a raw material into a finished product that is an article of commerce that is available for end users for drinking and other hygienic purposes." The circuit court ordered the abatement of the unpaid portions of sales and use taxes, penalties and interest assessed by DFA against Carrothers as set forth in the final assessment, and a refund of the portion of compensating-use taxes in the amount of $5191.16 that Carrothers paid to DFA because of the audit. DFA timely ...

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