PA Tax Law News - September 2013: Commonwealth Court Denies Manufacturing Exclusion to Service Provider


On August 6, 2013, in a case with possible implications for other providers of nontaxable services, Pennsylvania’s Commonwealth Court ruled, en banc, that a medical group’s MRI and CT scan equipment does not qualify for the manufacturing exclusion for Sales and Use Tax purposes. The Court affirmed the Board of Finance and Revenue’s denial of a refund claim filed by Tristan Radiology Specialists, P.C. (“Taxpayer”) for tax paid on such equipment. We expect the Taxpayer to appeal the Commonwealth Court’s decision in this case.


The Taxpayer argued that the process of producing an MRI or CT image constitutes the “manufacture” of “tangible personal property,” as those terms are defined in the Sales and Use Tax statute. The term “manufacture” is statutorily defined to include “operations, engaged in as a business, which place any tangible personal property in a form, composition or character different from that in which it is acquired….” See 72 P.S. § 7201(c). The Taxpayer’s argument was premised on the fact that the creation of an MRI or CT image, which is recorded on film, compact disc and/or a computer hard drive, constitutes the production of tangible personal property (an MRI or CT image) through operations which result in a transformation of tangible personal property acquired for use in the production process. The Sales and Use Tax manufacturing exclusion has been broadly construed by Pennsylvania’s appellate courts, and application of the exclusion to the production of MRI and CT images would arguably be consistent with the Commonwealth’s application of the exclusion to other types of operations not commonly perceived as “manufacturing.”


Somewhat surprisingly, the Court expressly declined to interpret the statutory definition of “manufacture” as applied to the production of MRI and CT images (other than to state that the statutory definition of “manufacture” is so broad that, if it were taken literally, it would produce an absurd result). Rather, the Court concluded that certain regulatory provisions, which are unrelated to the manufacturing exclusion, are controlling. The Court determined that the disputed equipment does not qualify for the manufacturing exclusion because the equipment is specifically subjected to tax under both 61 Pa. Code § 31.6 (“Persons rendering nontaxable services”) and 61 Pa. Code § 52.1 (“Purchases of medicines, medical supplies, medical equipment and prosthetic or therapeutic devices”). We believe the Court erroneously relied on these regulations because neither regulation was intended to restrict the scope of the manufacturing exclusion. In addition, the Court’s analysis arguably calls into question the applicability of the manufacturing exclusion, as well as other statutory exclusions and exemptions, to businesses rendering all types of nontaxable services - a result which likely was not intended by the Court.


Regulation § 31.6 merely explains the general rule that “[p]ersons rendering nontaxable services are consumers of the taxable personal property and services used in their business.” 61 Pa. Code § 31.6 (emphasis added). Regulation § 31.6 applies to all types of businesses that provide nontaxable services, and is not limited to services provided by “the learned professions.” We do not believe that this regulation can properly be interpreted to prohibit a service provider from claiming an exemption or exclusion, such as the manufacturing exclusion, to which it is otherwise entitled. Nevertheless, the Court’s analysis seems to do just that – by concluding that it was not necessary to consider whether the Taxpayer’s production of MRI and CT images constituted “manufacture” because tax was specifically imposed by Regulation § 31.6.


Notwithstanding Regulation § 31.6, service businesses have historically been permitted to claim the manufacturing exclusion for equipment used to produce “tangible personal property” for their own use. For example, service businesses could claim the manufacturing exclusion for equipment used in “in-house printing” operations or in the generation of electricity for their own use. Similarly, construction contractors could claim the manufacturing and processing exclusions for equipment used to produce prefabricated concrete, asphalt, cabinets, metal staircases and many other items for use in their own construction activities. The Court’s decision in this case could potentially be interpreted to deny the manufacturing and processing exclusions in these situations, and to all providers of nontaxable services who produce tangible personal property for their own use in the provision of nontaxable services.


Finally, Regulation § 52.1 clarifies the scope of the statutory exemption at 72 P.S. § 7204(17) for medical supplies and equipment. That regulation also has nothing to do with the scope of the manufacturing exclusion.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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