PURPOSE: Section 144.030.2(12), RSMo exempts from tax certain purchases of electrical energy used in primary or secondary manufacturing, processing, compounding, mining or producing a product, or used in material recovery processing. This rule explains when this exemption applies and how a taxpayer may claim the exemption at the time of purchase of the electrical energy.

1. (1) In general, electrical energy used in facilities owned or leased by the taxpayer in the actual primary manufacturing, processing, compounding, mining or producing of a product is exempt from tax if the cost of the electrical energy used exceeds ten percent (10%) of the total cost of the primary manufacturing, processing, compounding, mining or producing, exclusive of the cost of electrical energy so used. Electrical energy used in facilities owned or leased by the taxpayer in the actual secondary manufacturing, processing, compounding, mining or producing of a product is exempt from tax if the cost of the electrical energy used exceeds ten percent (10%) of the total cost of the secondary manufacturing, processing, compounding, mining or producing, exclusive of the cost of electrical energy so used. Electrical energy used in a material recovery processing plant owned or leased by the taxpayer is exempt from tax if the total cost of electric energy used in such processing exceeds ten percent (10%) of the total cost of the processing, exclusive of the cost of electrical energy so used. Electrical energy used in facilities owned or leased by the taxpayer in manufacturing, processing, compounding, mining or producing a product or in a material recovery processing plant is exempt if the raw materials used in such processing contain at least twenty-five percent (25%) recovered materials.

2. (2) Definition of Terms.

   1. (A) Compounding—Producing a product by combining two (2) or more ingredients or parts.
   2. (B) Fabrication—See 12 CSR 10- 111.010(2)(C).
   3. (C) Manufacturing—See 12 CSR 10- 111.010(2)(E).
   4. (D) Material recovery processing plant—A facility that converts recovered materials into a new product or into a different form that is used in producing a new product. It includes facilities or equipment used exclusively for the collection of recovered materials for delivery to a material recovery processing plant but does not include motor vehicles used on highways.
   5. (E) Mining—See 12 CSR 10- 111.010(2)(F).
   6. (F) Primary—Manufacturing, processing, compounding, mining or producing that results in the first marketable product.
   7. (G) Processing—Any mode of treatment, act or series of acts performed upon materials to transform and reduce them into an article with a use, identity and market value different from the use, identity and market value of the materials, and includes treatment necessary to maintain or preserve such processing by the producer at the production facility.
   8. (H) Producing—See 12 CSR 10- 111.010(2)(H).
   9. (I) Product—An item with a new identity, use and market value produced by the taxpayer’s efforts which is intended at the time of the production activity to be sold ultimately for final use or consumption. A product may be tangible personal property or a service, if the property or service is subject to state or local sales or use taxes, or any tax that is substantially equivalent thereto, in this state or any other state.
   10. (J) Production activity—Manufacturing, processing, compounding, mining, producing or fabricating.
   11. (K) Recovered materials—Materials that have been diverted or removed from the solid waste stream for sale, use, reuse or recycling, whether or not they require subsequent separation and processing.
   12. (L) Secondary—Further processing or fabricating of a marketable product that results in another marketable product.
   13. (M) Total cost—All allocated costs incurred in producing the product, including all elements of production cost in accordance with generally accepted accounting principles.

3. (3) Basic Application of Exemption.

   1. (A) A taxpayer may claim this exemption at the time of purchase of the electrical energy by presenting the seller with a direct pay certificate issued by the department. In order to obtain a direct pay certificate, the taxpayer must submit annually an electrical energy direct pay authorization application. The application must demonstrate, by the use of the previous calendar year’s data, a probable entitlement to the electrical energy exemption for the coming year. The taxpayer must file and remit the appropriate tax on energy purchases that do not qualify for this exemption on its sales tax return.
   2. (B) Every transformation of materials does not constitute a separate production activity. In order to be a separate production activity, the activity must create a new marketable product. If a taxpayer produces only one (1) marketable product, there can only be primary production activity. All production costs must be included in calculating the total cost of production. Secondary production activity can only exist when an already marketable product produced by the taxpayer undergoes subsequent production activity that produces a second marketable product. When there is secondary production activity, the production costs attributable to the primary production activity are not included in the total cost of production of the secondary production activity.

4. (4) Examples.

   1. (A) A manufacturing firm produces extruded sheet plastic. The automated production line is a closed system connected together by use of vacuum feed-pipe. When an order is received, the computer controlled production line first blends the necessary raw materials. After blending, the mix is conveyed through vacuum pipe to be dried, and then to the extruder, where the mix is heated to meltdown and rolled into sheets by the extruder rollers. These sheets are the end product. The cost of raw materials is 95% of the total cost of producing the end product. The cost of electrical energy is 99% of the cost of drying and extruding the blended raw materials. The plastic sheet is the only marketable product produced by this continuous, indivisible operation. None of the electrical energy is exempt because it does not exceed 10% of the total cost of producing the end product.
   2. (B) A manufacturer produces glass bottles to be used as packaging. The manufacturer combines raw materials, including recycled glass, which is then melted under extreme heat. The molten glass is then formed into bottles, which are the manufacturer’s only product. The electrical energy costs exceed 10% of the total cost of production; therefore the manufacturer qualifies for the exemption. If the manufacturer’s raw materials include at least 25% recycled material, the manufacturer may avoid the time and cost involved in the calculations necessary to support the exemption under the 10% threshold and claim the exemption based on its use of recycled materials.
   3. (C) A business contracts with manufacturers of frozen food products to receive fresh or partially frozen food products, reduce the temperature to zero degrees or below, and release the fully frozen food product back to the manufacturer for distribution. The frozen food products that the business produces have a new and different identity from the fresh or partially frozen products that it receives. Frozen foods have a longer shelf life and a broader distribution system than refrigerated foods. The business qualifies for the exemption if the electricity used in the freezing process exceeds 10% of the cost of producing the fully frozen food products from the fresh or partially frozen food products. The business does not have to include the cost of its customer’s production of the fresh or partially frozen products because the fresh or partially frozen food is a separate marketable product from the frozen food.
   4. (D) A frozen food manufacturer uses $100,000 of electricity in manufacturing its products. The manufacturer also uses $150,000 of electricity in its on-premises, refrigerated warehouse to maintain its products at the necessary temperature prior to shipping. Total cost of producing the products, excluding electricity, is $2,000,000. The combined electricity cost of $250,000 exceeds 10% of the $2,000,000 cost of production. The manufacturer qualifies for the exemption because processing includes any treatment by the producer at the production facility that is necessary to maintain the product.
   5. (E) A paper manufacturer uses recycled paper to produce rolls of newsprint. The newsprint includes more than 25% recovered paper and qualifies for the electrical energy exemption. The newsprint is subsequently cut into sheets for sale to a book printer. The cost of electricity to cut the sheets does not exceed 10% of the total cost of producing the cut sheets. The electrical energy used to produce the final product is exempt because the manufacturer uses at least 25% recovered materials.

AUTHORITY: section 144.270, RSMo 2000.* Original rule filed July 25, 2001, effective Feb. 28, 2002. Original authority: 144.270, RSMo 1939, amended 1941, 1943, 1945, 1947, 1955, 1961. Mid America Dairymen, Inc. v. Director of Revenue, 924 S.W.2d 280 (Mo. banc 1996). Processing consists of the alteration or physical change of an object or material that produces an article with a use, identity and market value different from the use, identity and market value of the original. The primary product need not actually be marketed, as long as it is marketable. It is incumbent on the taxpayer to prove the existence of a market. If there is not a market for all of the output, the taxpayer may not claim secondary processing exists for the portion of the output for which there is no market. When a taxpayer produces only one marketable product, there can only be primary processing. Secondary processing exists only when there is a second marketable product that results from further processing of an already marketable product. Assuming production stages can properly be split into primary and secondary, a taxpayer may allocate its total production costs accordingly. Hudson Foods, Inc. v. Director of Revenue, 924 S.W.2d 277 (Mo. banc 1996). The taxpayer received live poultry. After the poultry was killed and dressed it was chilled (temperature reduced to 40°), crusted (temperature reduced to 28°) or frozen solid. The court held that chilling, crusting and freezing were all processing. The taxpayer did not merely maintain a temperature, but actually reduced the temperature to decrease spoilage and extend shelf life. McKinley Iron v. Director of Revenue, 888 S.W.2d 705 (Mo. banc 1994). The taxpayer operated a scrap metal processing plant that processed raw scrap metal into densified scrap metal. Approximately 10-20% of the raw scrap metal was marketable after the initial processing. The remainder was processed further before sale. The court found that densified scrap metal was the only product produced by the taxpayer. Even though the initial processing enhanced the value and marketability of the scrap metal, it was not a separate process. The court also held that “total cost of production” is all-inclusive and the 12 CSR 10-110 cost of materials must be included. [Note: In 1998, the exemption was expanded to include a material recovery processing plant that uses more than 25% recovered materials.] Wetterau, Inc. v. Director of Revenue, 843 S.W.2d 365 (Mo. banc 1992). The taxpayer stored and maintained frozen and refrigerated foods as a business. The court held maintaining food in a frozen state is not processing. Union Electric Co. v. Goldberg, 578 S.W.2d 921 (Mo. banc 1979). The taxpayer mined and processed ore. The total cost of electricity used in the combined operations did not exceed 10% of the total cost of production. However, the total cost of electricity used in the processing did exceed 10% of the total cost of the processing. The court held that the taxpayer was engaged in primary mining and secondary processing, and was entitled to the exemption for the electricity used in the processing. Bridgeton Refrigerated Warehouse v. Director of Revenue (AHC 1998). The taxpayer contracted with manufacturers of frozen food products to receive the products, reduce the temperature to zero degrees or below, and releases the product back to the manufacturer for distribution. The Commission held that freezing the food constituted secondary processing. NF Properties L.P. v. Director of Revenue (AHC 1997). The taxpayer leased a refrigerated warehouse to a meat distributor. The distributor processed the meat into frozen meat patties. The Commission held that the refrigeration provided by the taxpayer to the distributor was not a marketable product and the taxpayer was not entitled to the exemption. Hazelwood Farms Bakeries, Inc. v. Director of Revenue (AHC 1994). The taxpayer was a commercial baker. Typically, the taxpayer mixed the ingredients of products and froze the mixture. The taxpayer would ship the products to its customers, which baked and sold them. The Commission found that the products were marketable before freezing and that the frozen product had a use, identity and market value different from the unfrozen products. Therefore, the taxpayer was entitled to the exemption for electricity used in the secondary process of freezing the products, which exceeded 10% of the total cost of the freezing process.