SCHWEITZER-MAUDUIT INTERNATIONAL, INC v. DIRECTOR, DIVISION OF TAXATION

NOT FOR PUBLICATION WITHOUT THE

APPROVAL OF THE APPELLATE DIVISION

 

SUPERIOR COURT OF NEW JERSEY

APPELLATE DIVISION

DOCKET NO. A-3946-11T2

SCHWEITZER-MAUDUIT

INTERNATIONAL, INC.,

Plaintiff-Appellant,

v.

DIRECTOR, DIVISION OF

TAXATION,

Defendant-Respondent.

__________________________________

April 30, 2013

 

Argued March 18, 2013 - Decided

 

Before Judges Sabatino, Fasciale and Carroll.

 

On appeal from the Tax Court of New Jersey, Docket No. 7376-2005.

 

Robert S. Seguin argued the cause for appellant.

 

Jill C. McNally, Deputy Attorney General, argued the cause for respondent (Jeffrey S. Chiesa, Attorney General, attorney; Lewis A. Scheindlin, Assistant Attorney General, of counsel; Ms. McNally, on the brief).

PER CURIAM

Plaintiff, Schweitzer-Mauduit International, Inc., appeals from certain aspects of the Tax Court's final judgment dated April 13, 2012 determining after a trial that plaintiff owes the Division of Taxation ("the Division") $24,419.84 in net unpaid sales and use taxes, plus a penalty and interest. For the reasons recited in this opinion, we affirm the Tax Court's determination, subject to a slight modification to correct a $759.18 mathematical error.

I.

Plaintiff is a cigarette-paper manufacturer and wholesaler that owns and operates a production facility in Spotswood. The facility's main building houses a pulp mill, refinery, bleachery, converter, and six paper machines, each 250 feet long and two stories high. The facility produces inch-wide bobbins of cigarette paper from raw linseed flax. The facility operates around the clock, except for three or four days during the year when the entire plant is shut down to perform maintenance and repairs, and when the six paper machines are turned off for another few hours each month for the same purpose. Even the oldest of those machines, manufactured in the 1930s, is kept running about 96% of the time.

In 2000, the Division audited plaintiff for use tax liability covering the forty-two-month period from October 1995 to and including March 1999. The Division's auditor first examined all fixed-asset acquisitions for the full period. Based upon that review, the auditor calculated a tax underpayment of $38,577 attributable to the identified nonexempt items. As for expenses, on the other hand, the auditor examined only items exceeding $100 and incurred in October 1998, a sample month that had been agreed to at the outset by the parties.1

The auditor calculated plaintiff's tax liability on the items deemed nonexempt for the October 1998 sample month, excluding a handful identified as one-time expenses, and multiplied the result by forty-two to extrapolate an $83,284 liability on expenses for the full audit period. An additional underpayment of $3769 for certain one-time expenses brought the total due to $125,630. The Division issued an assessment for that amount, plus $43,223.89 in interest, on April 19, 2000.

Plaintiff protested the assessment on July 14, 2000. Simultaneously, plaintiff filed an application for a $371,559.89 refund of sales and use taxes that it contends it erroneously paid during the entire audit period. In estimating the overpayment, plaintiff identified the taxes it had paid on various exempt purchases from the October 1998 sample month, and then multiplied that total by forty-two, adding to that figure the one-time taxes it had paid on certain other fixed-asset expenses outside the sample month. The Division apparently opposed the refund request. The parties' disputes over the assessment and the refund were then referred to a conference with a "conferee."2

The conferee reviewed schedules of purchases and supporting materials provided by plaintiff. He also took two guided tours of the facility to learn the use of the disputed items. As a result of his review, the conferee eliminated a one-time expense and several fixed-asset acquisitions from the original audit calculation and reclassified another item as a one-time expense rather than an ordinary one, to reduce plaintiff's total use tax assessment to $99,133.42.

The conferee rejected many of the items in plaintiff's refund claim as taxable. However, as to the discrete expenses that the conferee did find to be exempt, he identified the taxes erroneously paid for those items. With respect to the tax erroneously paid on such items within the October 1998 sample month (totaling $1,518.82), the conferee multiplied that figure by forty-two, arriving at a refund subtotal of $63,790.54. The conferee then added to that subtotal one-time sales taxes of $5,139.56 erroneously paid to a vendor and another $2,741.72 erroneously paid to the Division, yielding a total refund of $71,671.82.

On August 17, 2005, the Division issued a final decision adopting the conferee's determination, which established a revised tax liability for underpayments of $99,133.42 and an offsetting refund for overpayments of $71,671.82. The net tax due, representing the difference of those two figures, was $27,461.60, plus interest of $30,128.44.

Plaintiff appealed the Division's determination to the Tax Court, arguing that the underpayment had been calculated too high because the Division had incorrectly treated certain allegedly exempt expenditures as taxable. The parties thereafter entered into a pretrial order on January 15, 2010, narrowing the issues for trial. As part of that pretrial order, the Division conceded with respect to plaintiff's refund claim that nine additional expenditures from the October 1998 sample month, on which plaintiff had paid tax, were actually exempt.3 The Division further conceded that two fixed-asset purchases outside of the October 1998 sample month, on which $69.84 and $47.51 in taxes were respectively paid, also were exempt items. Due to an apparent computation error, these eleven items were mistakenly totaled in the pretrial order as $1085.04, but instead should have been totaled as $1844.22, a difference of $759.18. This mathematical error was not spotted, however, until this present appeal.

At trial, plaintiff presented testimony from Clifford Hogan, its tax consultant, and James Stairiker, its senior project engineer.

Stairiker, plaintiff's main fact witness, had worked in the paper manufacturing industry for decades and for plaintiff in particular for twenty-seven years. He testified comprehensively as to the operation of the mill and the manufacture of paper while narrating a video tour of the plant, and addressed each disputed item as to its function and useful life. In the latter respect, Stairiker indicated at the outset that the machines and their component parts had useful lives that "far exceed[ed] a year" and usually "at least two years," because equipment that failed with greater frequency would disrupt operation of the plant.

Stairiker acknowledged that certain purchased items, such as stainless steel belts, lasted less than a year. He asserted that others, however, such as roll covers, lasted "quite a few years." Stairiker seldom testified to a more specific timeframe, asserting that most of the items he addressed simply lasted "over a year," the statutory threshold for exemption under N.J.S.A. 54:32B-8.13. Stairiker acknowledged that he had not replaced any of the parts himself, nor had he kept any record of when any of them had been replaced. Instead, he based his testimony on his experience in the industry.

Hogan identified the contested invoices, briefly described the items purchased, and specified which exemption was sought for each. In that respect, Hogan explained how his analysis of taxability differed from that of the auditor and the conferee.

The Tax Court judge issued an initial written decision on February 14, 2012, and then a second amplified decision on March 20, 2012. In her initial decision, the judge comprehensively discussed the proofs. She concluded that, with two exceptions, plaintiff had "failed to overcome the statutory presumption that the services in question were taxable, and failed to prove its entitlement to exemption pursuant to N.J.S.A. 54:32B-3(b)(2)(v)." She also noted in her amplified decision that the Division had conceded that twelve other purchases eleven of them conceded prior to trial and the other one after trial qualified as exempt, as well.

Plaintiff argued that the refundable taxes on nine of the conceded items, which fell within the October 1998 sample month and had been classified as expenses on plaintiff's refund request schedules, should be multiplied by forty-two, as had been done for both the audit and refund request. In her March 20, 2012 supplemental opinion, the judge rejected that argument. The judge noted that a taxpayer must establish a right to a refund with proof of actual overpayments rather than by estimation. The judge therefore counted each refund item only once. Consequently, the Tax Court issued a final judgment for $24,419.84, with an amnesty penalty of $1220.99 and interest, through March 20, 2012, of $64,533.09.

 

 

II.

On appeal, plaintiff contends that the Tax Court erred with respect to both the Division's assessment of tax liability and as to the calculation of the refund. Having considered plaintiff's arguments, we discern no reason to set aside the court's ruling, except for the $759.18 computational error concerning the refund.

A.

Plaintiff generally asserts that it successfully proved that all of the disputed items were exempt from taxation. It does not challenge the audit methodology or argue that any items examined in the course of the audit or resolution of its refund request were mischaracterized, whether as fixed assets or expenses. Nor does it challenge any of the Director's or the trial court's legal conclusions. It asserts only that certain items deemed taxable by the auditor were proven exempt at trial, and that the judge inappropriately discredited Stairiker's testimony in finding otherwise.

Appellate review of a court's decision following a bench trial is limited. Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., 65 N.J. 474, 484 (1974). A trial court's factual findings are entitled to deference so long as they are supported by "adequate, substantial and credible evidence" in the record. Ibid. Such deference is appropriate in light of the court's feel of the case and opportunity to evaluate the credibility of witnesses by first-hand observation of their testimony. N.J. Div. of Youth & Family Servs. v. L.L., 201 N.J. 210, 226 (2010). That is particularly so for the Tax Court, which has special, recognized expertise in taxation matters. Little Egg Harbor Twp. v. Bonsangue, 316 N.J. Super. 271, 285 (App. Div. 1998); Glenpointe Assocs. v. Twp. of Teaneck, 241 N.J. Super. 37, 46 (App. Div.), certif. denied, 122 N.J. 391 (1990).

Moreover, assessments imposed by the Division are presumed correct. Atlantic City Transp. Co. v. Dir., Div. of Taxation, 12 N.J. 130, 146 (1953). The taxpayer bears the burden of proving otherwise, and may do so only by evidence that is sufficiently "definite, positive and certain in quality and quantity to overcome the presumption." Aetna Life Ins. Co. v. Newark, 10 N.J. 99, 105 (1952). Claimed exemptions in particular must be narrowly construed, and all doubts resolved against the taxpayer. Quest Diagnostics, Inc. v. Dir., Div. of Taxation, 387 N.J. Super. 104, 109-10 (App. Div.), certif. denied, 188 N.J. 577 (2006).

The exemption provision that plaintiff invokes here,4 N.J.S.A. 54:32B-8.13(a), applies to "[s]ales of machinery, apparatus or equipment for use or consumption directly and primarily in the production of tangible personal property by manufacturing, processing, assembling or refining." Explicitly not exempt, however, are sales of items whose uses are merely "incidental" to production, "parts with a useful life of one year or less," and "tools or supplies used in connection with" items described in the provision. N.J.S.A. 54:32B-8.13.

The Division's applicable regulations define "machinery, apparatus, or equipment" as "any complex, mechanical, electrical or electronic device, mechanism or instrument which is adapted to the accomplishment of a production process, and which is designed to be used, and is used, in manufacturing, converting, processing, fabricating, assembling, or refining tangible personal property for sale." N.J.A.C. 18:24-4.2. Also included within that definition is a working "part" of such machinery, see Panta Astor, Inc. v. Taxation Div. Dir., 8 N.J. Tax 464, 473 (Tax 1986), defined as

an item used as a replacement for any portion of a machine and which is attached or affixed to the machine of which it is a part permanently or during periods of use. A part cannot accomplish the work for which it was designed independent of the machine of which it is intended to be a component.

 

[N.J.A.C. 18:24-4.2.]

 

A nonexempt "tool," on the other hand, is "a hand-held and manually operated work instrument which is simple in design and used in the performance of simple work functions." Ibid. Nonexempt "supplies," meanwhile, are

items of tangible personal property used in the maintenance of a building, work area, or machinery, apparatus, and equipment, and may include items of tangible personal property consumed or used in production whose uses are incidental to such production. Supplies include, but are not limited to, such items as lubricants, cleaning materials, boiler compounds and light bulbs.

 

[Ibid.]

 

Finally, insofar as exempt items must be used "directly and primarily" in "production," rather than have a use merely "incidental" to production, N.J.S.A. 54:32B-8.13, the regulations explain:

(b) Production is limited to those operations commencing with the introduction of raw materials into a systematic series of manufacturing, processing, assembling, or refining operations, and ceases when the product is in the form in which it will be sold to the ultimate consumer, and does not include any activities which are distributive in nature. For example, a machine which packs a product into shipping cases after the product is in the form in which it will be purchased by the ultimate consumer is not considered to be used in production.

 

(c) Machinery, apparatus, or equipment is considered to be directly used in production only when it is used to initiate, sustain or terminate the transformation of raw materials into finished products. In determining whether property consisting of machinery, apparatus or equipment is "directly" used, consideration must be given to the following factors:

 

1. The physical proximity of the property in question to the production process in which it is used[;]

 

2. The proximity of the time of use of the property in question to the time of use of other property used before and after it in the production process; and,

 

3. The active causal relationship between the use of the property in question and the production of a product. The fact that particular property may be considered essential to the conduct of manufacturing, processing, assembling or refining because its use is required either by law or practical necessity does not, of itself, mean that the property is used directly in manufacturing, processing, assembling or refining. For example, property used to prevent accidents, which may be required by law, is not considered directly used.

 

[N.J.A.C. 18:24-4.4.]

 

Here, the Tax Court judge reasonably concluded that, although Stairiker had "credibly" and "knowledgably" testified about the manufacturing process at the Spotswood facility, his testimony was "insufficient to establish the statutory requirements for exemption" of the disputed items. Some items, such as one identified by Stairiker as a cleanser, were plainly nonexempt supplies. Others, materials such as steel, fiberglass, cement, or tape used, for example, to hold up or insulate piping or construct platforms for access to plant machinery, did not fall within the definition of either machinery or parts, pursuant to the regulation.

As the judge recognized, some items in question "indisputably" did fall within the definition of machinery or parts, but the judge found no evidence that they were ever used directly or primarily in manufacturing. The judge noted that Stairiker had "regarded everything in the plant as part of the manufacturing process," and had seldom identified with any specificity where any of the items had been used. Many of them, such as surge protectors and chlorine gas detectors, moreover, had plainly not been used directly in paper manufacturing.

The judge generally did not credit Stairiker's testimony as to the useful life of parts and equipment. Although he was familiar with paper mill operations and with this plant in particular, the judge noted that Stairiker "rarely" explained how he knew that any of the hundreds of disputed items had a particular useful life. He admitted that plaintiff had kept no records as to the frequency of replacements or repairs, that he did not personally repair any of the machines, and that he was not aware of when parts were replaced. At times his testimony was ambiguous as to whether he was stating that a given part had a certain useful life, or that the whole machine did. Moreover, although plaintiff regularly maintained a sizable inventory of spare machine parts, the quantity of some of the parts that were purchased suggested to the court that they were replaced more frequently than Stairiker had testified.

Of particular relevance to the judge's analysis was plaintiff's tax accounting for the parts, which the regulations explicitly provide should be considered in determining an item's useful life. N.J.A.C. 18:24-4.3(a)(4). During the administrative protest of the audit, the conferee had written Hogan to ask whether the parts relating to the protest had been expensed or depreciated. At Hogan's request, the senior financial manager at the Spotswood facility replied:

Repair parts are typically expensed unless the asset they are being installed on is fully depreciated and the repair part is at least 50[%] or more of the original asset cost. Given that our paper machines have costs ranging from 10 to 25 million dollars it is unlikely any parts were capitalized.

 

[Emphasis added.]

 

This response further supported the Division's position that the disputed parts did not, in fact, have a useful life of over one year. N.J.S.A. 54:32B-8.13.

In addition, the court reasonably found Hogan's testimony too "conclusory" in many respects. Hogan never explained where or how any of the machine parts were used. It became clear from Hogan's cross-examination that he had no personal knowledge of what any of the items were, or their functions in the plant. Hogan had relied on information provided to him by plant engineers in forming an opinion as to the basis for each of the claimed exemptions. The judge did not find Hogan's testimony credible as to whether any of the purchases had been for machinery, apparatus, or equipment used directly or primarily in production. She also observed that he had offered no testimony at all bearing on the useful life of each item.

Other than the two purchases of machine parts mentioned above, the judge concluded that plaintiff had failed to carry its burden with respect to any of the disputed items. We defer to that determination, particularly because it is substantially predicated upon the judge's credibility findings. Rova Farms, supra, 65 N.J. at 484; see also Yilmaz, Inc. v. Dir., Div. of Taxation, 390 N.J. Super. 435, 443 (App. Div.) (noting that on appeal we only consider whether the tax judge's findings were supported by substantial credible evidence), certif. denied, 192 N.J. 69 (2007).

B.

Plaintiff argues that the court miscalculated the refund due on the nine items from the October 1998 sample month conceded as exempt by the Division. Plaintiff asserts that the tax overpayment on those items should be multiplied by forty-two, because all of those conceded overpayments fell within the audit sample month, and both the audit assessment and plaintiff's refund had been calculated in that manner. Failing to do so, plaintiff insists, would be inequitable, because plaintiff had "played by the rules" set by the Division for the audit, only to see those "rules" allegedly ignored later by the Division itself.

To be sure, there is a conceptual inconsistency with the conferee's determination on the refund claim in which he multiplied several identified tax overpayments in the October 1998 sample month by forty-two and the failure of the Tax Court to similarly apply a forty-two-month multiplier to the nine additional October 1998 items that the Division later conceded in the pretrial order to be overpayments.

As we have already noted, the conferee calculated the refund by multiplying $1,518.82 in October 1998 taxes "paid in error" by forty-two, yielding a refund subtotal of $63,790.54, plus $7,881.28 for overpaid taxes on fixed expenses outside of the sample month. Plaintiff contends that the same extrapolation logically should be performed as to the nine additional overpaid October 1998 items conceded by the Division. Plaintiff urges that it is thereby entitled to an additional refund, which would amount to $72,528.54, representing the $1,726.87 total of overpaid tax for those nine October 1998 items, times forty-two.

We acknowledge that there is a surface appeal to plaintiff's argument for consistency. Our review of that argument is complicated by the fact that, unfortunately, the conferee failed to explain in his report or otherwise document why he followed the audit calculation methodology when addressing plaintiff's refund request.5 Whatever the reason, though, it remains that potential underpayments were the exclusive focus of the audit, and potential overpayments, such as the items at issue, were the exclusive focus of the refund request. As such, the trial judge properly concluded, as a matter of law, that plaintiff was not entitled to any extrapolation as to those items.

As the trial judge appropriately noted, audit assessments and resolutions of refund applications are separate endeavors governed by separate statutory provisions, compare N.J.S.A. 54:32B-19 with N.J.S.A. 54:32B-20, and while assessments may be estimated, N.J.S.A. 54:32B-19, refunds ordinarily are not, N.J.A.C. 18:2-5.8(d)(3). As a matter of law, plaintiff was entitled to a refund only on the overpayments it could demonstrate it had actually made. "A taxpayer challenging the Director's determination bears the burden of proof." United Parcel Serv. Gen'l Servs. Co. v. Dir., Div. of Taxation, 430 N.J. Super. 1, 8 (App. Div. 2013). Plaintiff demonstrated that it had paid taxes on these nine items only once, i.e., in October 1998, and so was entitled to the refunds no more than once.

The pertinent regulations make clear that "[r]efund claims of Sales and Use Tax shall include documentation of all transactions to substantiate the tangible personal property or service that is the subject of the refund claim and the amount requested." N.J.A.C. 18:2-5.8(d)(3) (emphasis added); see also N.J.A.C. 18:2-5.8(g) (reiterating that "[a] refund claim must include documentation sufficient to establish an overpayment that entitles the taxpayer to a refund" (emphasis added)). Those regulations implement the statute's mandate to refund only those taxes proven to have been actually "collected or paid" erroneously. N.J.S.A. 54:32B-20(a). This principle makes sense, for otherwise a dishonest taxpayer hypothetically could destroy all of its records for all but a sample month, and then demand the Division to extrapolate its refund for other time periods as to which those records no longer exist and its entitlement to a refund beyond verification. The trial judge was correct in concluding that plaintiff was not legally entitled to a refund on any items for which it had not proven an overpayment.

We also must note that plaintiff's request for an additional refund based upon an extropolation theory was untimely in substantial part. Plaintiff did not submit a refund request until July 2000. N.J.S.A. 54:32B-20(a) requires that refund applications be made within four years from payment. By that time, plaintiff was barred from seeking any refund on overpayments made prior to July 1996, which covers roughly the first ten months of the audit period. Indeed, plaintiff appears to have advanced its refund theory only as a litigational reaction to the Division's assessment of unpaid taxes.

In the pretrial order of January 2010 there is no express indication of plaintiff's claim for extrapolation of the nine October 1998 conceded overpayments, other than a generic reference that plaintiff had "claimed a refund of $475,516.69 in sales and use taxes, of which [the Division] approved $71,671.82." Although we do not construe plaintiff to have waived its extrapolation claim, its intention to press such a claim surely could have been documented much more clearly in the pretrial order.

We do not know why the conferee chose to extrapolate certain overpayments for the October 1998 sample month to all forty-two months. The record is bereft of any indication of why the conferee chose to do so. The judge's two opinions are essentially silent on that point.

Given the taxpayer's statutory obligation to provide specific month-by-month evidence of overpayments to substantiate any refund, it may well be that the $63,790.54 portion of the refund that the conferee granted provided a large windfall here to the taxpayer. The Division did not, however, remove that calculated refund in its final administrative decision, and it thus would be unfair under the circumstances to deprive plaintiff of it at this juncture. However, we discern no legal or equitable basis to extend the conferee's apparent error of extrapolation to the nine additional overpayments identified from the sample month. The court justifiably treated those nine items as one-time overpayments, as plaintiff tendered no evidence that such overpayments had been similarly made in all of the other forty-one months of the audit period.

That being the case, we reject plaintiff's arguments based upon principles of equitable estoppel, which is a doctrine applied against taxing authorities only in very limited and extreme situations. See Airwork Serv. Div. v. Dir., Div. of Taxation, 97 N.J. 290, 297 (1984), cert. denied, 471 U.S. 1127, 105 S. Ct. 2662, 86 L. Ed. 2d 278 (1985). Plaintiff fails to explain how it detrimentally altered its trial strategy, nor any other conduct it took in alleged reliance upon any assurances from the Division about extrapolation.

We also reject plaintiff's invocation of the "square corners" doctrine, which disfavors the government conducting itself "so as to achieve or preserve any kind of bargaining or litigational advantage" with the public. See F.M.C. Stores Co. v. Borough of Morris Plains, 100 N.J. 418, 426-27 (1985). The Division cannot fairly be said to have secured any improper advantage here merely by putting plaintiff to its proofs as to its refund claims. If anything, the Division simply declined to continue giving plaintiff the benefit of a full refund on less than the proof that is ordinarily required. To the extent that abandoning the conferee's extrapolation method made more onerous plaintiff's burden of proof at trial on its refund claim, doing so raises no inequity. That burden of proof is established by law.

Plaintiff points to nothing in the record suggesting that, even were these items legitimately classifiable as expenses, they were anything other than one-time expenses, which would not have been subject to the multiplier.6 Thus, even if the conferee's extrapolation methodology had been applied, plaintiff has shown no basis in the record for applying the multiplier to the tax paid on these particular exempt purchases.

III.

The judgment of the Tax Court is affirmed, subject to the $759.18 modification we have noted in this opinion. The Tax Court shall issue a corrected judgment, with recalculated interest and penalty, within thirty days, consistent with this opinion.

1 Notably, there is no contemporaneous documentation in the record explaining why October 1998 was selected as a sample month. The auditor's report merely states that "[o]riginally a two[-]month sample for expenses was discussed," but that "based on volume" an audit of only one sample month was ultimately performed.

2 As the Tax Court judge noted in her opinion:

A conferee is an employee of the Division within its Conference and Appeals Branch, and is charged with reviewing taxpayer protests and issuing a final determination [on] behalf of the Director. The position is similar to that of an administrative hearing officer. The Division's administrative hearings are known as conferences. The Division's regulations regarding conferences are currently codified at N.J.A.C. 18:32-1.1 to -1.8.

 

See also Clorox Products Mfg. Co. v. Dir., Div. of Taxation, 24 N.J. Tax 223, 227 n.6 (App. Div. 2008) (similarly defining a conferee). The conferee's report results in a final determination by the Division that confirms, modifies or vacates the finding or assessment under review. N.J.A.C. 18:32-1.1. That final determination is then judicially reviewable in the Tax Court. Ibid. The initial conferee involved in the present case became ill and was succeeded by the conferee whose report became at issue in the ensuing trial.

3 These nine items were October 1998 purchases from Precision Roll Grinders ($18.02, $35.71, $15.02, and $14.88 in overpaid tax); Wrangler Systems Corp. ($601.87), Miller Energy ($73.68), and National Roof Coaters ($236.71, $260.82, and $470.16).

4 Plaintiff unsuccessfully made further claims for exemption in the trial court, but abandons them on appeal.

5 We encourage the Division to document carefully the methodology employed for an audit or refund request and whether or to what extent that methodology is the product of an agreement with the taxpayer.

6 As just one example, the roofing purchases from National Roof Coaters seem particularly unlikely to have been representative of recurring monthly expenses.