The opinion of the court was delivered by
Tаxpayer Alsop Sand Company, Inc., (Alsop) appealed the Kansas Department of Revenue’s (KDR) assessment of additional sales and use taxes on parts of machinery and equipment. Alsop contended that the items were exempt from taxation as “major components” of manufacturing machinery and equip
This dispute revolves around the interpretation of K.S.A. 79-3606(klc), specifically, whether Alsoр’s machinery and equipment parts are exempt from sales and compensating use taxation as "major components” of manufacturing machinery and equipment. The facts are concisely stated by the Court of Appeals as follows:
“Alsop operates sand dredging operations. Sand is a natural abrasive. During the audit period in question, June 1, 1989, to May 31, 1992, Alsop spent over $50,000 replacing pump parts, screws, screens, pipe flanges, pipe elbows, clamps, a winch, an impeller, and an electric motor on its dredges. Alsop expensed all of' the above expenditures and did not capitalize any.
“In September 1992, the KDR issued Alsop a notice of assessment of additional retailer sales and use taxes in the amounts of $49,011 and $3,673, including interest and penalties, for fuel purchases and the various equipment, machinery, and parts mentioned above for the period in question. The total assessments of additional taxes, including interest and penalties, were subsequently reduced to $9,893 and $3,510.
“On appeal to the Director of Taxation, an administrative law judge (ALJ) denied Alsop’s exemption request and found that the impeller, plates, sleeves, screens, pipe flanges, screws, pipe elbows, motor, and other pump parts did not qualify for the exemption stated in 79-3606(kk) because the items were not capitalized and were not used directly and primarily for manufacturing. The ALJ upheld the KDR’s assessments.
“On appeal to BOTA, BOTA found that the components at issue were exempt from taxation under K.S.A. 79-3606(mm) (now K.S.A. 1996 Supp. 79-3606[kk]) because the items were used in the production process. BOTA rejected the KDR’s contention, noting: ‘There exists no law or regulation which states that expensed items do not qualify whereas capitalized items will. The distinction may be easy to apply, but it does not appear in law.’ BOTA further noted that the size and cost of the items in issue were not determinative of whether the items constituted ‘major components’ for purposes of the exemption. BOTA found the appropriate tеst was to consider the importance of the equipment and its purpose in the production process, stating:
‘An exempt item would do its essential function on the processing machinery at some point before the final product is produced. In this case, the components are parts of the machinery used to produce the sand. Without these particularitems on the processing machinery the process would grind to a halt. These items are then integral to the process of producing salable sand. The evidence shows that these items transport, convey, or handle the sand before it reaches its final stage.’ ” 24 Kan. App. 2d at 528-29 .
The statute exempts the following from sales and use taxes:
“(kk)... [A]ll sales of machinery and equipment used directly and primarily for the purposes of manufacturing, assembling, processing, finishing, storing, warehousing or distributing articles of tangible personal property in this state intended for resale by a manufacturing or processing plant or facility or a storage, warehousing or distribution facility:
(2) For purposes of this subsection ‘machinery and equipment used directly and primarily’ shall include, but not be limited to:
(A) Mechanical machines or major components thereof contributing to a manufacturing, assembling or finishing process.” K.S.A. 79-3606(kk)(2)(A).
According to the Court of Appeals, “[t]he term ‘major components’ is not defined by statute or case law.”
The Court of Appeals noted that it was faced with a “disagreement between two administrative agencies as to the interpretation of a statute” and that it would consider the position of each.
KDR is the administrative agency charged with the responsibility of implementing and enforcing tax legislation. When properly promulgated by the administrative agency in accordance with K.S.A. 77-415
et seq.,
administrative rules and regulations have the
”
The Court of Appeals, despite KDR’s misplaced reliance on the “rule,” found its argument more convincing than Alsop’s:
“[W]e should not completely disregard the KDR’s interpretation of 79-3606(kk). The KDR interpretation establishes a bright line test that is easily applied and understood by taxpayers. By requiring an item to be a capital expenditure to qualify as a major component, the KDR’s test implicates a belief that those items with a useful life extending beyond the close of a taxable year are an integral part of the manufacturing process. See 26 U.S.C. § 263 (1994).
“Alsop maintains the KDR’s test fails to consider the importance of each component or its role in the overall production process' and arbitrarily denies exemption to any item of property which is simply expensed by a taxpayer. Alsop argues the test allows the KDR to simply review a taxpayer’s federal income tax return to determine whether a particular component was capitalized and, thus, qualifies for the exemption. Alsop contends the KDR’s interpretation is too restrictive.
“We conclude that' the KDR’s position is rationally related to the legislature’s objective to reduce the impact state taxation has on the production of goods. The KDR’s position and definition provides a bright line for business planning and leaves much of the classification to the taxpayer. It takes the uncertainty out of business decisions and, potentially, will save on appeals, costs, attorney fees, penalties, and interest;”24 Kan. App. 2d at 530-31 .
"While various theories of market value appraisal have been used in other jurisdictions as a rationalization for considering components of expense such as freight and installation charges and sales tax, this does not dictate the same result in Kansas where ‘retail cost when new’ has replaced ‘fair market value.’ No other taxing jurisdiction in the United States, including the I.R.S., uses the terminology ‘retail cost when new.’ This term is unique to the State of Kansas. It is not the equivalent of ‘fair market value,’ ‘cost basis for federal income tax purposes,’ ‘cost basis for accounting purposes,’ or ‘cost approach to fair market value.’ The phrase ‘retail cost when new’ contains words which are commonly used and understood. Persons of common understanding would not expect to have to refer to definitions utilized by other states and the I.A.A.O. and I.R.S. to arrive at a definition of the term. Based upon this analysis, statutory definitions and case law from other jurisdictions are not persuasive.”261 Kan. at 914-15 .
This court’s opinion in
Board of Leavenworth County Comm’rs
does not rule out the possibility that federal income tax prоvisions
The legitimate point that Alsop makes with regard to Board of Leavenworth County Commrs and other cases is that ordinary words ought to be given their ordinary meanings. Thus, words that are commonly used and understood should not be removed from the realm of common understanding by construing them with reference to some external source. Alsop contends that the phrase “major component” is one of common usage and common understanding. It urges the court to make the following inquiry: “[H]ow would a person of common understanding interpret the term ‘major component’?” Alsop’s suggested answer, or more accurately lack of one, seems indicative of the weakness in its argument. Rather than saying how a person of common understanding would interpret “major component,” Alsop states that “such a person certainly would not be expected to be required to refer to the morass of laws, regulations and case law regarding what is and what is not a capital expenditure.” Alsop does not attempt to set out a definition of “major component” that would reflect the common understanding, and one senses that Alsop regards “major component” as one of those things one will know when one sees it.
Understandably, Alsop praises BOTA’s approach: “BOTA carefully reviewed the nature of Alsop’s operation and the role of the various components within the integrated manufacturing process before determining that those items were exempt as ‘major components’ of manufacturing equipment. This was the kind of case-by-case analysis which the legislature intended.”
Pertinent portions of BOTA’s decision are set out here:
“This Board conducted a hearing in this matter on July 6, 1995. After considering all of the evidence presented thereat, and being fully advised in the premises, the Board finds and concludes as follows:
“3. The Department issued an assessment against the Taxpayer for compensating use taxes in the amount of $2,276.00.. ..
“4 . . . [T]he amount of $2,075.79 in comрensating use tax is at issue....
“6. . . . $1,409.69 in sales tax assessments is at issue....
“7. The Taxpayer is the owner of sand mining operations .... The sand is mined by a dredge from pits in two basic types of operations . . . called the simple operation and the complex operation.
“14. The equipment consists of pumps, screens, sieve and pump parts such as impellers, plates, and sleeves.
“15. . . . [T]he impeller must be replaced once a year, the plates are replaced between 1 and 3 years, and the sleeves are replaced once a year. . . . The stationary screens are replaced as often as every eighteen hours. . . . The vibrating screens last аbout a year. . . .
“16. An electric motor used to blend sand in the pug mill was also purchased. The motor has a life of 10 years.. . .
“17. The Taxpayer has a dredge that was built in the 1940’s; however, every component on it has been changed out and replaced with new components.. . .
“18. The Taxpayer capitalizes the entire dredge, but not the replacement parts. Those replacement parts, such as sleeves, flanges, and so forth, are expensed. ..
“19. The hydraulic motors on the dredge have a life span of ten to fifteen years. . . .
“38. . . . [T]he operation would quickly grind to a halt if the machinery and equipment at issue here were not present. The equipment at issue is usеd in the production process. Some of the items are small and inexpensive and some are larger and expensive. However, size and cost is not a determinative factor. . . . [T]he parts at issue are somehow in contact with the sand or are used with other parts which are in contact with the sand before it is in its final form.
“41. An exempt item would do its essential function on the processing machinery at some point before the final product is produced. In this case, the components are parts of the machinery used to produce the sand. Without these particular items on the processing machinery the process would grind to a halt. These items are thеn integral to the process of producing salable sand. The evidence shows that these items transport, convey, or handle the sand before it reaches its final stage.
“43. Therefore, the Board finds that the items of machinery and equipment and major components thereof are exempt from sales and use taxes under [K.S.A. 79-3606(kk).”
From these excerpts we can see that BOTA’s working definition for major components of machines that contribute to a manufacturing process disregards size and cost and focuses exclusively on indispensability. In BOTA's view, an exempt item would be “in
KDR contends that BOTA’s interpretation disregards the legislature’s intent to exempt only major components. According to KDR, “[t]he intent of the legislature was not to exempt every gasket, clamp, nut and bolt used to replace broken or worn out parts; only major components.” If the legislature’s intent had been to exempt every integral component, KDR’s argument continues, it would have used the phrase “important components” rather than “major components.” If the phrase “major components” is made up of ordinary words that should be given their ordinary meaning, as Alsop argues, there should be something major, as opposed to minor, about an exempt component.
KDR further argues that BOTA’s interpretation fails to take into consideration that when the legislature intended to exempt repair and replacement parts, it expressly identified them. For example, in K.S.A. 79-3606(g), the legislature exempted repair, modification, and replacement parts for aircraft used in interstate commerce. In addition, in 79-3606(t), repair and replacement parts for farm machinery and equipment are exempted. The implication KDR would have the court draw seems to be that the absence of the words “repair parts” or “replacement parts” in 79-3606(kk) excludes them from exemption under that subsection. This implication, howеver, would go far beyond KDR’s official position in excluding all repair/ replacement parts from exemption, regardless whether they are designated as capital expenditures for federal income tax purposes. In fact, in Information Guide 19-88-1, which KDR placed in the record, the following example is given of items which may qualify for exemption under 79-3606(kk): “repair and replacement parts that are necessary to and become part of manufacturing machinery and/or equipment if the cost of said repair and replacement parts are capitalized for federal income tax purposes.”
Alsop responds that in the absencе of either a statutory or regulatory definition of “major component,” BOTA’s interpretation should prevail. Alsop asserts that KDR “has adopted extensive regulations defining and interpreting the various exemptions contained in K.S.A. 79-3606.” A check of the Kansas Administrative
In the present case, KDR’s practice of treating “major components” as synonymous with capital expenditures for federal tax purposes appears to cany out the legislative intent. For federal tax purposes, the following classifications apply:
“Capital Expenditures. The deductibility of an expenditure as a business expense is based on the theory that such expenditure is properly part of the cost of operating the business for the year in which it was paid or incurred. If, however, an expenditure is paid or incurred to acquire an asset, the useful life of which is substantially longer than the taxable year, that expenditure is generally treated as a capital item and not аs a currently deductible business expense.” 6 Mertens, Law of Federal Income Taxation § 25.01, p. 6.
Expenses that are deducted in the year incurred would not qualify as major components of manufacturing machinery or equipment for sales tax exemption. Capital expenditures that are depreciated over several years of a useful life would. There is an undeniable logic in KDR’s position.
The Court of Appeals emphasized the practicality of KDR’s definition, stating that it “provides a bright line for business planning” and “takes the uncertainty out of business decisions.”
In determining legislative intent, we may consider the historical background of the enactment, the circumstances attending its passage, and the purpose to be accomplished.
State v. Le,
Another indication that routine maintenance and repair parts were not intended by the lеgislature to be exempted is that 79-3606 contains some express provisions for repair and replacement parts, but not in the subsection for manufacturing machinery and equipment. In determining the legislative intent, the court considers all parts of an act together rather than considering provisions in isolation.
Le,
In determining the legislative intent, the court presumes that the legislature intended for a statute to be given a reasonable construction so as to avoid unreasonable or absurd results.
We conclude that the application of the rules of statutory construction to K.S.A. 79-3606(kk)(2)(A) leads to the conclusion that the legislature intended to exempt major, but not non-major, components of manufacturing machinery and equipment. KDR’s easily applied test of the scope of “major” implements the legislative intent and makes the statute workable for the taxpayer as well as the enforcement agency.
The court’s consideration of this issue is guided by the following principles stated in
Peden v. Kansas Dept. of Revenue,
“A statute is presumed constitutional and all doubts must be resolved in favor of its validity. If there is any reasonable way to construe a statute as constitutionally valid, the court must do so. A statute must clearly violate the constitution before it may be struck down. This court not only has the authority, but also the duty, to construe a statute in such a manner that it is constitutional if the same can be done within the apparent intent of the legislature in passing the statute.” Syl. ¶2.
“Equal protection is implicated when a statute treats ‘arguably indistinguishable’ classes of people differently. Single and married taxpayers are arguably indistinguishable in a legal sense, and the Kansas Income Tax Act treats single and married taxpayers differently in regard to the tax rates applicable to each group. Thus, the Kansas Income Tax Act implicates equal protection.” Syl. ¶ 3.
“The rational basis standard (sometimes referred to as the reasonable basis test) applies to laws which rеsult in some economic inequality. Under this standard, a law is constitutional, despite some unequal classification of citizens, if the classification bears a reasonable relationship to a valid legislative objective.” Syl. ¶ 4.
“The reasonable basis test is violated only if the statutory classification rests on grounds wholly irrelevant to the achievement of the State’s legitimate objective. The state legislature is presumed to have acted within its constitutional power, even if the statute results in some inequality. Under the reasonable basis test, a statutory discrimination will not be set aside if any state of facts reasonably may be conceived to justify it.” Syl. ¶ 5.
“A plaintiff asserting the unconstitutionality of a statute under the rational basis standard has the burden to negate every conceivable basis which might support the classification.” Syl. ¶ 6.
“In taxation, even more than in other fields, legislatures possess the greatest freedom in classification.” Syl. ¶ 7.
Although Alsop contends that the statute is unconstitutional because it discriminates between similarly situated taxpayers, it does not really spell out how the discrimination operates. We presume that Alsop has in mind that taxpayers who capitalize and taxpayers who expense are similarly situated. This premise is questionable. As we have seen, capitalized items tend to be assets with useful lives considerably longer than the tax year. Alsop argues that “no consideration is given to whether a particular item is
eligible
to be capitalized or expensed.” The answer to this argument would seem to be that items that are capitalized are eligible to be capitalized and, when a taxpayer elects to expense items that are eligible to be capitalized, there must be an advantage to doing so. Because the designation would be a matter of election, the taxpayer presumably
One final argument is made by Alsop based upon the legislature’s recent amendment to 79-3606(kk). That amendment is contained in L. 1998, ch. 188, § 7, which was signed into law by Governor Graves on May 18, 1998, approximately 1 week prior to oral argument in this case. The amendment dеletes “major” in 79-3606(kk)(2)(A) and specifically includes “all sales of repair and replacement parts and accessories” within the exemption defined in 79-3606(kk). Alsop contends that under the statute as amended, all the items at issue in this case are exempt. Alsop further contends that because the legislature left intact die original effective date exempting such sales on or after January 1, 1989, it is a clear indication the legislature intended the amendment to be retroactive and include all sales occurring after January 1,1989. We agree with the first contention but not the latter one.
In
State v. Ford,
This court stated the fundamental rule of statutory construction that a statute operates prospectively unless its language clearly indicates that the legislature intended it to opеrate retroactively. An exception to the rule has been recognized where the statutory
“establishes commission of the crime as the controlling event, and it establishes that'crimes committed on or after July 1,1993, will be punished according to the sentencing guidelines. Hence, if the legislature had changed the date in the language prefacing the drug grid to coincide with the effective date of the 1996 amendment, the resulting provision might have been construed to restrict application of the sentencing guidelines to crimes committed on or after July 1,1996. By not changing the date in K.S.A. 1996 Supp. 21-4705(a), the legislature maintained July 1,1993, as the date on or after which a crime had to be committed in order for the sentencing guidelines to govern punishment.”262 Kan. at 209 .
The basic rationale applied in Ford is controlling in the present case. The effective date of the amendment is July 1, 1998, and there is no clear indication by the legislature that it should be applied retroactively; thus, its application is prospective.
The judgment of the Court of Appeals reversing the Board of Tax Appeals is affirmed. The order of the Board of Tax Appeals is reversed.