Elias Bros. Restaurants, Inc. v. Treasury Department , 452 Mich. 144 ( 1996 )

Weaver, J.

Petitioner-appellee, Elias Brothers Restaurants, Inc., owns the Big Boy restaurant chain. Twenty-five percent of the Big Boy restaurants are company owned and operated. The remaining seventy-five percent are franchised. Food for both company-owned and franchised restaurants is produced at a facility called the Commissary, which Elias Brothers owns and operates.

We are asked to determine whether the cost of equipment and supplies used at Elias Brothers’ Commissary for production of food and beverages for its company-owned restaurants is exempt from use tax.¹ We find that Elias Brothers is exempt from use tax for these costs.²

The Department of Treasury allowed Elias Brothers’ industrial processing exemption claim only with regard to the equipment and supply costs attributable to its franchised restaurants.³ The department denied an exemption for the proportionate cost of equipment and supplies attributable to company-owned stores. It claimed such cost was incurred in the “preparation of food and beverages by a retailer for retail sale,”⁴ which is specifically excluded from the industrial processing exemption.

In response to the department’s assessment, Elias Brothers filed a use tax assessment appeal.⁵ The Tax Tribunal canceled the tax assessments by the department and found that Elias Brothers could claim an industrial processing exemption with respect to the cost of the food processing equipment and related supplies attributable to production of goods for company-owned restaurants.

The department appealed the Tax Tribunal’s opinion in the Court of Appeals. In an unpublished opinion per curiam, the Court of Appeals affirmed.⁶

We hold that Elias Brothers is entitled to an industrial processing exemption for the cost of equipment and supplies used by the Commissary and attributable to company-owned restaurants. Accordingly, we affirm the decision of the Court of Appeals.⁷

I

The Commissary is a 250,000 square foot food processing and distribution facility located in Warren, Michigan. The Commissary produces virtually all the food and beverages prepared and ultimately sold to consumers at both company-owned and retail restaurants.⁸ The food-processing equipment used by the Commissary is of a type and size not found in a typical restaurant, but in a food-processing business that sells to retail establishments.

The department concedes that Elias Brothers is an industrial processor with respect to the Commissary’s production for franchised restaurants.

Elias Brothers treats the Commissary as a distinct operation and profit center, separate from its company-owned restaurants. It is physically separate and distinct from any individual restaurant. Elias Brothers maintains separate billing records, income statements, and asset listings for the Commissary.

The Commissary’s internal procedures and operations are the same both for company-owned and franchised restaurants. Its ordering, processing, handling, delivery, invoicing, billing, and sales procedures are identical for company-owned and franchised restaurants. The two types of restaurants pay the same price for the food and beverages processed by the Commissary.

The department asserts that Elias Brothers cannot claim an industrial processing exemption when it produces food and beverages at the Commissary and then transfers them to customers in company-owned restaurants. According to the department, when Elias Brothers “sells” or transfers to itself, it is merely a “retailer” preparing its own food for retail sale and, therefore, is specifically excluded from the industrial processing exemption.

n

Whether the cost of equipment and supplies used by the Commissary attributable to company-owned restaurants is exempt under the “industrial processing” exemption or excluded from the exemption by the restaurant food preparation exclusion, as the “preparation of food and beverages by a retailer for retail sale,” both contained in § 4(g)(1) of the Use Tax Act, is a question of statutory interpretation.

As currently written, § 4(g) (i) provides, in relevant part:

The tax levied does not apply to the following:

(g) Property sold to the following:

(i) An industrial processor for use or consumption in industrial processing .... Industrial processing does not include ... the preparation of food and beverages by a retailer for retail sale. As used in this subdivision, “industrial processor” means a person who transforms, alters, or modifies tangible personal property by changing the form, composition, or character of the property for ultimate, sale at retail or sale to another industrial processor to be further processed for ultimate sale at retail.1⁹1

Because tax exemptions are disfavored, the burden of proving entitlement to an exemption rests on Elias Brothers, the party asserting the right to the exemption. Tercheck v Treasury Dep’t, 171 Mich App 508, 510-511; 431 NW2d 208 (1988). While we recognize that tax exemptions are strictly construed against the taxpayer because exemptions represent the antithesis of tax equality, we interpret statutory language according to common and approved usage,¹⁰ unless such construction is inconsistent with the manifest intent of the Legislature.¹¹

Understanding the purpose of, and the distinction between, the industrial processing exemption and the restaurant food preparation exclusion is crucial to the resolution of the controversy before this Court. Because the act fails to define key terms within the statute, and because the application of the statute to the facts presented is ambiguous, it is necessary to ascertain the legislative intent behind the industrial processing exemption:¹²

The act does not define the terms “retailer” or “retail sale.” Neither does it explain the distinction between industrial processing and the mere act of food and beverage “preparation,” which falls under the restaurant food preparation exclusion.¹³

Having no statutory definition of “retailer,” the department has broadly defined the term to include “all persons who sell to the last or final buyer, user or consumer.”¹⁴ Such administrative interpretations are accorded deference. However, the department’s definition of retailer, as applied in this case, would unfairly broaden the scope of the restaurant food preparation exclusion¹⁵ and, ultimately, contravene legislative intent, as shown below.

The industrial processing exemption is, in part, the product of a targeted legislative effort to avoid double taxation of the end product offered for retail sale or, in other terms, to avoid “pyramiding the use and sales tax.”¹⁶ Pyramiding occurs when both use and sales taxes are imposed on the production and sale of retail goods. A 1987 Senate Fiscal Agency bill analysis described the purpose of the industrial processing exemption as follows:

[I]f the end product is taxed, the components used or consumed in its production are not taxed so that the product is not subject to double taxation.'¹⁷1

If this Court were to apply the department’s definition literally, Elias Brothers would be subject both to sales and use tax on each food item or beverage sold at the company-owned restaurants. However, production costs and sales to franchisees would not be subject to such tax “pyramiding” despite the identical prices charged and procedures employed by the Commissary, such as in production, invoicing, and delivery. Because there was no showing that Elias Brothers would gain an unfair competitive advantage or a windfall if exempted, the department’s assessment appears to contravene the clear and fundamental legislative intent to avoid a pyramiding of sales and use tax.

m

Because the Use Tax Act fails to define terms central to the inquiry, it is instructive to look to the Sales Tax Act.¹⁸ The provisions in the Sales Tax Act are relevant to use tax determinations because the sales and use tax provisions are complementary and supplementary.¹⁹ Both statutes contain a “recognition in each of the provisions and operation of the other.” Don McCullagh, Inc v Revenue Dep’t, 354 Mich 413, 425; 93 NW2d 252 (1958).²⁰

The Sales Tax Act has an industrial processing exemption identical to the industrial processing exemption for the use tax.²¹ The Sales Tax Act defines a “sale at retail” as:

[A] transaction by which the ownership of tangible personal property is transferred for consideration, if .the trans- • fer is made in the ordinary course of the transferor’s business and is made to the transferee for consumption or use, or for any purpose other than for resale . . . J²²1

Because the company-owned restaurants purchase the Commissary’s goods for the sole purpose of resale to customers, the Commissary’s transfer to company-owned stores is not a sale at retail under this provision.

Under the Sales Tax Act, the right to an exemption is not decided by “what type of business the taxpayer is engaged in, but rather upon what use his patron or customer makes of the product which the taxpayer sells.” Int’l Research & Development Corp v Revenue Dep’t, 25 Mich App 8, 11; 181 NW2d 53 (1970). In this case, both company-owned and franchised restaurants purchase almost all wholesale items from the Commissary at the same price and for subsequent retail sale to patrons. Both company-owned and franchised restaurant patrons constitute “the last or final buyer, user, or consumer.”²³ Consequently, Elias Brothers is not a retailer and does not make a sale at retail when its Commissary produces goods and transfers them to company-owned restaurants.

Nevertheless, the department claims Elias Brothers is a retailer when its Commissary transfers to company-owned restaurants because intracorporate sales are not taxable events. It further claims the only “sale,” the character of which determines whether the Commissary’s activity falls under the industrial processing exemption or the restaurant food preparation exclusion, occurs when Elias Brothers’ company-owned restaurants make retail sales to their customers. We disagree. Nowhere in the statute is there a requirement that there must be a “sale” by the industrial processor to qualify for this exemption.²⁴ Nonetheless, Elias Brothers has established that transfers to company stores do not go unrecognized, but are accounted for and effectuated in the same manner as transfers or sales to franchised restaurants.²⁵ Given the statutory language and the facts of this case, the department’s distinction between the Commissary’s transfer to company-owned restaurants and franchisees is not relevant.

Contrary to the position of the department, the industrial processing exemption does not depend on the nature or existence of a transaction between the processor and the retailer. Rather, the application of the industrial processing exemption depends on the use to which equipment is put. The intent of the Legislature in enacting the restaurant food preparation exclusion supports this conclusion. In 1969 the department and the Senate Taxation Committee adopted a bill analysis that made the following comment regarding the purpose of the restaurant food preparation exclusion:

■ The purpose of this amendment is to limit the exemption to persons who are actually engaged in the manufacturing of a product for resale!²⁶1

This bill analysis indicates that the cost of equipment and supplies purchased by manufacturers is exempt only if used for activities that are integral in industrial processing. The bill analysis in no way suggests that the restaurant food preparation exclusion should apply to a company simply because that company has a retailing division.

Thus, to determine whether the industrial processing exemption applies, it is necessary to consider the activity in which the equipment is engaged and not the character of the equipment-owner’s business. The department admits that Elias Brothers is entitled to the industrial processing exemption for the portion of production dedicated to franchisees. Elias Brothers’ Commissary uses equipment in the same manner and for the same purpose when it prepares goods that are identical for its company-owned restaurants and franchised restaurants. This Court finds that when Elias Brothers processes and transfers to company-owned restaurants, it uses the Commissary’s equipment in a manner covered by the industrial processing exemption, rather than the restaurant food preparation exclusion.²⁷

Finally, because this Court finds that Elias Brothers’ Commissary is an entirely separate and distinct operation, the exemption applies to the Commissary’s equipment “actually engaged in the manufacturing of a product for eventual resale”²⁸ to company-owned restaurants. Michigan common law recognizes that taxpayers often engage in both taxable and nontaxable transactions. As long as taxpayers operate and substantiate the nontaxable activity in a distinct, identifiable, and clearly severable manner, Michigan courts uphold exemptions for the portion of exempt activity. See RCA Service Co Div v Treasury Dep’t, 135 Mich App 807; 355 NW2d 679 (1984). See also Kal-Aero v Treasury Dep’t, 123 Mich App 46; 333 NW2d 171 (1983). Elias Brothers engages in both industrial processing and retail sales with respect to its ownership and operation of company-owned restaurants. While Elias Brothers is a single corporate entity, the Commissary is physically, operationally, and financially distinct and separate from Elias Brothers’ company-owned restaurants.²⁹ The distinct, iden-tillable, and clearly severable activity of the Commissary entitles Elias Brothers to an industrial processing exemption for equipment and supply costs associated with production for company-owned, restaurants.

iv

Given the particular circumstances of this taxpayer and the legislative intent of the industrial processing exemption, we hold that Elias Brothers is entitled to the industrial processing exemption for the cost of equipment and supplies used by the Commissary in production for company-owned restaurants. Accordingly, we affirm the decision of the Court of Appeals.

Brickley, C.J., and Levin and Riley, JJ., concurred with Weaver, J.

1 Michigan Use Tax Act, 1937 PA 94, MCL 205.91 et seq.; MSA 7.555(1) et seq. The Use Tax Act, as amended, is an “excise” or “privilege” tax that covers transactions not subject to the general sales tax. Tercheck v Treasury Dep’t, 171 Mich App 508, 510; 431 NW2d 208 (1988). Use tax is imposed on the privilege of “using, storing, or consuming tangible personal property” in Michigan. MCL 205.93(1); MSA 7.555(3).

2 While the partial dissent claims to agree with this Court’s disposition of the case, the following statement by the partial dissent seems to call for a remand to allow the trial court to make more detailed findings of fact:

What the Department of Treasury and the majority have failed to address is whether all the instant taxpayer’s activities are really “changing the form, composition, or character” of the food products with which it starts into something different, as required by the statute. [Post at 163.]

3 Elias Brothers claimed an exemption under MCL 205.94(g); MSA 7.555(4)(g) of the Use Tax Act for the entire cost of the Commissary’s production equipment and related supplies. MCL 205.91 et seq.; MSA 7.555(1) et seq. See full text, post at 149.

4 MCL 205.94(g) (i); MSA 7.555(4)(g)(i).

5 The appeal was heard on December 18, 1991, by the Michigan Tax Tribunal, and its decision was filed on April 6, 1992. This case actually involves two distinct assessments, one for May 1, 1981, through December 31, 1984, for $19,079 plus interest (Docket No. 112177), the second, from January 1, 1986, through June 30, 1989, for $167,659 plus a penalty of $7,573 plus interest (Docket No. 144938).

6 Issued October 10, 1994 (Docket No. 151490).

7 Because we find that Elias Brothers is exempt from use tax on the portion of equipment used to produce food and beverages for company-owned stores under the industrial processing exception of the Use Tax Act, we do not address the issue of apportionment.

8 Neither party provided this Court with a copy of a franchise agreement, which would determine the degree, if any, to which franchisees are free to purchase food and beverages from wholesalers other than the Commissary.

9 MCL 205.94(g)(i); MSA 7.555(4)(g)(i) (emphasis added). This.provision became effective on July 24, 1987, as 1987 PA 141, midway between the two assessments at issue. Earlier, § 4(g) provided, in relevant part:

The tax levied shall not apply to:

(g) Property sold to a person for use or consumption in industrial processing. Industrial processing shall not include . . . the preparation of food and beverages by a rptailer for retail sale. [MCL 205.94; MSA 7.555(4), as amended by 1984 PA 288, § 1, effective December 20, 1984.]

The Court of Appeals based its determination on the statute as amended in 1987. This Court bases its opinion on the amended language because neither party contests its use and because the department conceded that Elias Brothers’ Commissary is an “industrial processor” as defined by the amended language. The question before this Court is whether Elias Brothers is an industrial processor engaged in industrial processing, or is a mere retailer, when its Commissary processes goods for company-owned stores.

10 MCL 8.3a; MSA 2.212(1).

11 MCL 8.3; MSA 2.212.

12 The fundamental role of statutoiy construction is to ascertain legislative intent. 21 Michigan Law & Practice, Statutes, § 82, pp 82-86.

13 The partial dissent cites the following case to explain what it perceives as an inherent difference between manufacturing and restaurant food preparation: Phillips Harborplace, Inc v State Dep’t of Assessments & Taxation, 65 Md App 461, 465-468; 501 A2d 92 (1985), post at 164-165. In discussing this case, however, the partial dissent neglects to mention the following unique policy objectives of the Maryland Legislature, as interpreted by the Maryland Court of Special Appeals:

To grant an exemption,in order to induce a manufacturer to operate in Maryland — a manufacturer who might conduct its business anywhere — serves the policy underlying § 9A(c)(l). To grant that exemption to a restaurant that must in any case operate where its patrons are to be found — here, in Baltimore — does not serve that purpose .... [Id. at 469.]

This interpretation of legislative intent illustrates the danger of imposing another jurisdiction’s interpretation of its own statute on Michigan’s industrial processing exemption. It also exemplifies how the distinction between manufacturing and preparation turns on considerations other than common sense and an inherent difference in processes.

Arguably, the language and title of Michigan’s industrial processing exemption evidences a legislative intent to induce a broader range of industry, manufacturers as well as processors, to operate in this state. Furthermore, Michigan’s restaurant food preparation exclusion does not subject all restaurant food preparation to use tax, but only that preparation done by a “retailer” for “retail sale.” See full text supra at 149.

14 1979 AC, R 205.6.

15 See n 23 and corresponding text.

16 Int’l Research & Development Corp v Revenue Dep’t, 25 Mich App 8, 13; 181 NW2d 53 (1970). In Int’l Research, the Court of Appeals held that the industrial processing exemption applied to the cost of testing compounds for manufacturing clients because, in part, such tests “are ‘an essential part of the process of manufacture.’ ”

17 Senate Fiscal Agency Analysis, SB 323, June 2, 1987.

18 MCL 205.51 et seq.; MSA 7.521 et seq.

19 Southeastern Michigan Transportation Authority v Secretary of State, 104 Mich App 390, 399; 304 NW2d 846 (1981). See also Western Electric Co v Revenue Dep’t, 312 Mich 582, 596; 20 NW2d 734 (1945). Generally, property, on which Michigan use tax has been paid, is exempted from the imposition of Michigan sales tax. Similarly, the use tax provisions except property acquired in a transaction in this state on which a sales tax has been paid in this state or a sales tax has been paid in another state for the same transaction or property. MCL 205.94; MSA 7.555(4).

20 In fact, apportionment of use tax has been authorized by impliedly applying the apportionment authorized by the Sales Tax Act, MCL 205.52; MSA 7.522, to the imposition of a use tax. See Kal-Aero v Treasury Dep’t, 123 Mich App 46; 333 NW2d 171 (1983). See also RCA Service Co Div v Treasury Dep’t, 135 Mich App 807; 355 NW2d 679 (1984).

21 Section 4a(g)(i) of the Sales Tax Act provides:

An industrial processor for use or consumption in industrial processing. . . . Industrial processing does not include ... the preparation of food and beverages by a retailer for retail sale. As used in this subdivision, “industrial processor” means a person who transforms, alters, or modifies tangible personal property by changing the form, composition, or character of the property for ultimate sale at retail or sale to another industrial processor to be further processed for ultimate sale at retail. [MCL 205.54a(g)(i); MSA 7.525(g)®.]

22 MCL 205.51(b); MSA 7.521(b) (emphasis added).

23 1979 AC, E 205.6.

24 Wlüle the department provided this Court with ample definitions of the term “sale,” recourse to such definitions “is unnecessary when the legislative intent . . . may be so readily gathered from a reading of the statute itself.” Renown Stove Co v Unemployment Compensation Comm, 328 Mich 436, 440; 44 NW2d 1 (1950). This logic is particularly apt where the statute nowhere employs or imposes a transfer by means of a “sale” in the relevant portions of the industrial processing exemption.

The department offered no Michigan statute or applicable common law that would require a sale by the industrial processor under § 4(g) of the act. Instead, the department argued that because sales and use taxes are generally applicable to intercompany transfers, even if beneficial ownership of those companies is identical, the law should not recognize intracompany transfers for purposes of the industrial processing exemption. We do not find this inverse logic persuasive or necessary when § 4(g) does not require a sale by the industrial processor to the ultimate retailer. The exception only requires that the processing condition a raw material or product for “later sale” at retail. Edison v Dep’t of Revenue, 362 Mich 158, 161; 106 NW2d 802 (1961). See also Bay Bottled Gas Co v Dep’t of Revenue, 344 Mich 326; 74 NW2d 37 (1955).

Indeed, the General Sales Tax Act only requires that the taxpayer who engages in both taxable and nontaxable activity maintain accurate records to adequately distinguish between these distinct pursuits. MCL 205.52; MSA 7.522.

25 The finance manager for Elias Brothers testified that the Commissary “sells,” and not merely transfers, the processed food and beverages to both company-owned and franchised restaurants in the same manner and for the same price.

By way of reference, sales tax is measured by gross proceeds that include “the amount received in money, credits, subsidies, property, or other money’s worth in consideration . . . .” MCL 205.51(h); MSA 7.521(h). During oral argument, counsel for the department stated that the transfer to company-owned stores was reflected by an “internal accounting procedure,” which could have been a credit/debit between corporate divisions; he did not believe there was an exchange of money.

26 Executive Legislative Analyses, SB 1092 and 1093, November 7, 1969, p 5. This bill analysis was issued in support of SB 1092 and 1093, which added, among other items, the exception for “the preparation of food and beverages by a retailer for retail sale.”

27 This Court refuses to hold that “for all practical purposes” industrial processing is “synonymous with the term ‘manufacturing.’ ” Post at 162. Our Legislature has deliberately chosen to use the term “industrial processing” and has defined an industrial processor in the text of statute. MCL 205.94(g); MSA 7.555(4)(g). We find no need to revert to treatises or case law from other jurisdictions to further define the term where, in this case, the department has conceded that Elias Brothers’ Commissary is an industrial processor and actually engages in industrial processing with respect to production for franchisees.

We would also note that the case law relied on by the partial dissent is distinguishable because of significant differences in statutory language, facts or issues before the respective courts. See, generally, HED, Inc v Powers, 84 NC App 292; 352 SE2d 265 (1987) (equipment used to prepare food items sold on premises of individual restaurant was not exempt from use tax); McDonald’s Corp v Oklahoma Tax Comm, 563 P2d 635, 636 (Okla, 1977) (shake station, central island counter drink dispenser, and soda factory, grills, toasters, french fry assembly, etc., were not equipment used “in manufacturing or processing”). See also n 29.

In fact, the following cases, relied upon by the dissent, distinguish between the act of manufacturing and processing: McDonald’s Corp, supra at 637-639; Wilson & Co, Inc v Dep’t of Revenue, 531 SW2d 752, 754 (Mo, 1976).

28 See n 26.

29 The partial dissent cites the following case to support its assertion that taxpayers cannot avoid tax liability by creating a paper trail and moving taxable activity to a different site: In re Marriott Family Restaurants v New York Tax Appeals Tribunal, 174 AD2d 805; 570 NYS2d 741 (1991). The New York court’s determination was based on New York State Tax Law 1115(a)(12), which exempts from use tax, in relevant part:

(m)achinery or equipment for use or consumption directly and predominantly in the production of tangible personal property . . . for sale, by manufacturing .... [Emphasis added.]

That court held that the requisite sale occurred only at retail stores at which time processed goods were “restaurant food,” which, under New York common law, was not “tangible personal property.” Id. at 806. Therefore, the court denied any exemption from use tax for the cost of equipment and supplies, but allowed a twenty-four percent deduction for the cost of electricity, etc., used in producing goods sold to independent restaurants.

Michigan’s industrial processing exemption is significantly different from New York’s exemption, and, if applied to similar facts, would arguably dictate a different outcome. Michigan’s industrial processing exemption does not require “direct and predominant use” of “equipment” in production. Michigan’s industrial processing exemption applies to costs for equipment and supplies used, at some point, in the production process. Michigan’s exemption requires an “ultimate sale,” as distinguished from New York’s requirement that there be a direct “sale, by manufacturing.” Finally, Michigan' law does not currently impose a strict distinction between restaurant food processing and tangible personal property. See, generally, In re Burger King, Inc v State Tax Comm, 51 NY2d 614; 435 NYS2d 689; 416 NE2d 1024 (1980).