Combining food ingredients to create frozen meals is not manufacturing entitled to a tax exemption, according to the Pennsylvania Commonwealth Court.
The court held December 29 in Quality Driven Copack Inc. v. Pennsylvania that the company’s activity of packaging ready-to-eat meals does not qualify as the kind of pronounced and lasting change on food that would entitle the company to a sales and use tax exemption, but the court found enough proof that the company should not have been taxed on its use of contract labor.
“Although it is true that Taxpayer takes individual food products and transforms them into prepackaged, ready-to-use, full meals, this process does not result in the kind of substantive change necessary to qualify for the tax exemption it seeks,” the commonwealth court said. “We reverse the [board of finance and review’s] determination that sales and use tax was properly assessed” on the company's “use of help supply services,” it added.
Quality Driven Copack Inc. (Copack) assembles precooked ingredients into frozen sandwiches, entrees, and meals. Following an audit, the Department of Revenue issued the company a total assessment of nearly $2 million in state and local use tax, penalties, and interest for 2007 through 2010 for its machinery, equipment, repair parts, and use of “help supply services” for its labor.
The DOR’s Board of Appeals and Board of Finance and Review both affirmed the assessment, although not the penalties, and Copack appealed.
Manufacturing Exemption
The DOR claimed that Copack’s activities do not qualify for a manufacturing and processing sales and use tax exemption under 72 P.S. 7201 and 61 Pa. Code section 32.1, which require that a change in form, composition, and character of raw materials result in an end product. The DOR argued that the company's products begin and end with precooked frozen foods, so no change results, and no manufacturing takes place.
The DOR also argued that even if some refrigerated food ends up frozen, that fact does not change the result, because Copack is simply combining and packaging food ingredients, without exacting a chemical change.
Copack countered that its activities qualified for the exemption because ingredients that entered its facilities were “transformed into prepackaged meals” by its “skill and technical expertise,” therefore taking on a different “form, composition or character.”
The commonwealth court concluded that Copack “is not a manufacturer engaged in manufacturing here for purposes of a sales and use tax exemption as contemplated by the Tax Code,” although the court acknowledged that “the distinctions are often very narrow” in these determinations.
The court likened Copack’s activities to a company combining oil, salt, and unpopped corn into bags for the consumer to pop at home, or a company chopping and placing vegetables in bags with dressing to create coleslaw — activities that are not considered manufacturing for purposes of the tax exemption.
Copack is not making a “pronounced and lasting change to the starting material(s),” wrote the court, and is not entitled to the tax exemption.
Contract Labor
The DOR had also assessed use tax on Copack’s contract labor workers, which the agency had classified as taxable “help supply services.” Under 72 P.S. section 7201(cc) and 61 Pa. Code section 60.4(a)(ii), help supply workers are workers provided by and paid through an outside vendor, who are then supervised by the company that uses the workers.
The DOR argued that Copack used those staffing services to provide workers and that it retained control over those workers by employing a plant manager to oversee all plant activities.
Copack agreed that it had used staffing services to provide its workers but claimed that it had not provided the supervision of them. The company alleged that the supervision and control of the workers had been addressed in contracts with the staffing agencies, and not provided directly by Copack.
The court clarified that in order for the labor to be considered taxable help supply services, the supervision of the vendor’s workers would have to be directly though the company using the workers or through a supervisor provided by the vendor. But in the case of a vendor-provided supervisor, that supervisor would have to be “implementing directions of the purchaser, not simply directing the activities as he sees fit,” the court said.
Copack provided testimony from a supervisor for one of the staffing agencies. The supervisor claimed that he, not Copack, ran the floor services for the workers. The company would inform the supervisor of the “nature of the products that were to be manufactured in its facility” but would provide “no further instruction,” the supervisor testified. He claimed he would convey this information to the workers, as “nearly all of the employees . . . other than [himself], did not speak English.”
The commonwealth court noted that the “distinction in each case is the actual degree of authority exercised by the taxpayer,” and that an “analysis must include a close assessment of the degree of ground-level direction provided by the contractor versus the level of direction retained by the subject taxpayer/manufacturer.”
The court found that Copack had provided evidence that “its contractors worked independently on the plant floor with very little hands-on oversight by the Taxpayer,” so the court “cannot say that Taxpayer provided the requisite level of direction for the third-party labor services to be considered help supply services.”
Because of the degree of uncertainty, the court concluded that it “cannot say Taxpayer was required to pay tax on those services” and reversed the administrative boards’ determination that Copack owed sales and use tax on those services.
In Quality Driven Copack Inc. v. Pennsylvania (No. 862 F.R. 2013 and No. 879 F.R. 2013), the taxpayer was represented by attorneys with Tucker Arensberg PC and Robert O. Lampl Law Office.