Plant Growing Process Is Not Manufacturing

UILC: 144.01-10

LEGEND:

[2] Whether a facility used for the growing of plants is engaged in manufacturing within the meaning of I.R.C. section 144(a)(12)(C).

CONCLUSION

[3] The operations of the facility, which appear to be agricultural in nature, do not meet the definition of manufacturing within the meaning of I.R.C. section 144(a)(12)(C).

FACTS

[4] Corporation is engaged in the business of growing garden plants for both the wholesale and retail market. Corporation holds a patent for a growing process that purportedly results in faster- growing and more durable plants than conventional growing methods.

[5] Corporation's operations are conducted on a c acre facility ("the Facility") in City. The Facility produces approximately d plants annually. The patented growing process begins with the germination of plants in state-of-the-art greenhouses equipped with heated floors, robotic watering systems and retractable roofs. Seedlings are placed in bottomless pots which alters the growth process. After several weeks, the seedlings are transplanted to fields for approximately one year. At the correct time of the year, the plants are harvested. While some plants are sold after harvesting, many are transferred to cold storage facilities where they are kept in a dormant state until they are packaged and shipped to buyers. The dormant state permits nationwide delivery of plants regardless of the season.

[6] On Date 1, Issuer issued e of revenue bonds (the "Bond"). The Bond proceeds were used to construct f acres of state-of-the-art greenhouses as described above and a g square foot cold storage building located at the Facility. The greenhouses and the cold storage facility are used in the growing process described above.

LAW AND ANALYSIS

[7] Section 103(a) of the Internal Revenue Code provides that gross income does not include interest on a State or local bond. Section 103(b)(1) provides that section 103(a) does not apply to any private activity bond, unless it is a qualified bond. Section 141 (e)(1)(D) provides that a qualified small issue bond is a qualified bond.

[8] Section 144(a)(1) provides that the term "qualified small issue bond" means any bond issued as part of an issue the aggregate authorized face amount of which is $1,000,000 or less and 95 percent or more of the net proceeds of which are to be used for the acquisition, construction, reconstruction, or improvement of land or property of a character subject to the allowance for depreciation, or to redeem a prior issue that was used for those purposes. Under section 144(a)(4), the issuer may elect to increase the $1,000,000 limitation to $10,000,000 provided certain other requirements are also met. The proceeds, however, are still required to be used in the manner described in section 144(a)(1).

[9] Section 144(a)(12) provides, in part, that section 144(a) does not apply to any bond issued after December 31, 1986, unless 95 percent or more of the net bond proceeds are used to provide any manufacturing facility or any land or property in accordance with section 147(c)(2) relating to first-time farmers.

[10] The exception for first-time farmers may apply if the land financed is to be used for farming purposes and is acquired by an individual who is a first-time farmer, who will be the principal user of such land, and who will materially and substantially participate on the farm of which such land is a part in the operation of such farm. I.R.C. section 147(c)(2)(B). For purposes of this section, "farm" has the meaning given such term by section 6420(C)(2). Section 6420(c)(2) defines farm to include "nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards."

[11] By permitting either manufacturing facilities or specified farming activities, section 144(a)(12)(B) establishes a distinction between manufacturing and agriculture for purposes of the qualified small issue bond rules. In the instant case, it is apparently undisputed that the exception for first-time farmers does not apply. Rather, Issuer and Corporation contend that Corporation is engaged in a manufacturing activity within the meaning of section 144(a)(12)(C)

[12] Section 144(a)(12)(C) states that the term "manufacturing facility" means any facility which is used in the manufacturing or production of tangible personal property (including the processing resulting in a change in the condition of such property). The term "manufacturing facility" includes facilities which are directly related and ancillary to a manufacturing facility (determined without regard to this sentence) if -- (i) such facilities are located on the same site as the manufacturing facility, and (ii) not more than 25 percent of the net proceeds of the issue are used to provide such facilities.

[13] While Corporation's growing process may require a high degree of technology and automation, they do not appear to be manufacturing facilities. The property financed with the Bond proceeds include greenhouses and other structures that are used primarily for the raising of garden plants, an agricultural commodity. While these facilities appear to meet the definition of farming under section 6420, the Issuer and Corporation apparently concede the exception for first-time farmers under sections 144(a)(12)(B)(ii) and 147(c)(2) does not apply. Thus, based on the information provided, it does not appear that the Bond proceeds were used for a qualified purpose under section 144(a).

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATION

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[14] Please call if you have any further questions.

                               By: JOEL E. HELKE