REVENUE CABINET, COMMONWEALTH OF KENTUCKY V. KENTUCKY-AMERICAN WATER COMPANY
Annotate this Case
Download PDF
-
RENDERED: APRIL 22, 1999
MODIFIED:
AUGUST 26, 1999
TO BE PUBLISHED
98-SC-165-DG
REVENUE CABINET,
COMMONWEALTH OF KENTUCKY
ON REVIEW FROM COURT OF APPEALS
96-CA-2985-MR
HON. MARY C. NOBLE, JUDGE
FAYETTE CIRCUIT COURT
CIVIL ACTION NO. 95-CI-695
V.
KENTUCKY-AMERICAN
WATER
COMPANY
APPELLEE
OPINION OF THE COURT BY JUSTICE WINTERSHEIMER
REVERSING
This appeal is from a decision of the Court of Appeals which
affirmed the judgment of the circuit court holding that the 1,197
miles long new water distribution system from a water treatment
plant to private consumers was part of an integrated plant
manufacturing process entitling the water company to a sales and
use tax exemption.
The primary issue is whether the water distribution system
constitutes
statute.
an
integrated
plant
manufacturing
process
under
the
The necessary sub questions are whether the water
distribution system and related parts and service lines are
exempt from sales and use tax as machinery for new and expanded
industry and if the purchase of electricity used to pump water
through the distribution system after it leaves the water
treatment plants should be exempt as energy used in the cost of
manufacturing.
Stated another way, the question is whether the
water
mains,
company's
lines and meters are used directly in the
manufacturing process and are thus part of the plant facility
based on the integrated plant theory.
The
water
company
sells
domestic,
commercial,
industrial
and
public authority water service in six counties of Central
Kentucky.
The
water
company
distributes
treated
and
pressurized
water to individual customers through its system of water mains
and also sells treated water from its clear well to
municipalities
who,
residents
customers.
and
in
turn, distribute the water to their own
During the pertinent audit period,
treated water was also sold to water haulers from the treatment
plant on Richmond Road.
In June of 1986, the water company contracted with the
Commonwealth of Kentucky to build a new main to Georgetown,
Kentucky to support the development of the Toyota automobile
manufacturing
facility.
Upon completion of the new main, the
water company sought an exemption from sales and use tax pursuant
to KRS 139.480(l)
139.480(3)
and (2) and for the energy used under KRS
totaling
$543,970
plus
applicable
interest
for
the
audit period from January 1, 1986 through December 31, 1989.
Revenue
that
or
Cabinet
the
denied
distribution
processing
the
request
system
did
facility.
for
not
exemption,
constitute
a
determining
manufacturing
The water company appealed to the
Kentucky Board of Tax Appeals which upheld the decision of the
2
The
Revenue Cabinet after a hearing.
The water company then appealed
to the circuit court which reversed the decisions of the Board of
Tax Appeals and permitted the tax exemptions.
In a 2 to 1 vote,
a panel of t he Court of Appeals affirmed the decision of the
circuit
court.
This Court accepted discretionary review.
The water company has two water treatment plants, one at
River Station and the other at Richmond Road.
Raw water is taken
from either the Kentucky River or the Jacobson Park Reservoir and
treated in a series of steps.
The finished, purified water comes
to rest in the clear well where it is stored until it is sold to
water haulers or sent through the distribution system.
There
is
no dispute that the water treatment plants to and including the
clear well are not subject to sales and use taxation if it meets
the requirements of KRS
the
subject
of
this
139.170.
appeal.
Water treatment plants are not
The
water
distribution
system
consists of 1,197 miles of mains or pipes of varying sizes which
transports the water from the clear well to the customer.
The
water is finished, potable and suitable for sale. A water meter
measures the quantity of the water, but not its purity.
In 1986, the water company and the Commonwealth signed a
contract in which the water company agreed to build a 24-inch
main
to
Georgetown, Kentucky for the development of the Toyota
automobile
plant.
$5,480,876
for the entire contract, including $3,439,804
pipes,
valves
and
The Commonwealth paid the water company
fittings.
for
The water company included the sales
tax that it paid on this equipment in the contract price with the
state, and the state, in turn, paid the entire bill, including
sales and use tax.
Here, the water company is asking the
3
Commonwealth for a refund of the sales and use tax that the
Commonwealth,
as a water company customer, paid as part of the
contract to construct the Toyota facility.
401 KAR 6:040 defines water treatment plant and water
distribution
systems
separately.
The water treatment plant shall
mean that portion of the water supply system which is designed to
alter the physical, chemical
water.
401 KAR 6:040(10),
or
bacteriological
now amended.
The
quality
water
of
the
distribution
system shall mean that portion of the water supply system in
which the water is conveyed from the water treatment plant or
other supply point to the premises of the consumer.
6:040(11),
401 KAR
now amended.
The witness from the Division of Water of the Cabinet of
Natural
Resources
and
Environmental
Protection,
testified
to
the
effect that the pressurization of the water is the means by which
the water is delivered.
Natural
Resources
issues
two
separate
licenses to the water company; one, is for water treatment plants
and the second is for water distribution systems.
I
KRS 139.170 provides the definition of machinery for new and
expanded
industry.
It states in pertinent part:
Machinery for new and expanded industry shall mean that
machinery used directly in the manufacturing or
processing production process which is incorporated for
the first time into plant facilities established in
this state, and which does not replace machinery in
such plants.
Clearly
there
are
two
separate
statutory
requirements
in
order to qualify for an exemption from sales and use tax: 1) the
machinery must be used directly in a manufacturing or processing
4
production
plant
process, and 2) the machinery must be installed in a
facility.
The Revenue Cabinet argues that the water
distribution system is not part of the manufacturing process
because purified water is saleable from the clear well, which
marks the end of the manufacturing process.
The
distribution
lines are merely a means of transportation of the finished
product.
Ross v. Greene & Webb Lumber Co., Inc., Ky.,
567 S.W.2d 302
defined for sales tax purposes what a manufacturing
(19781,
process was and when the manufacturing process began and ended.
“To conform to the legislative intent, the
manufacturing
process
should begin when a raw material (logs, here) starts moving in a
chain of unbroken, integrated sequence into the plant or mill and
ends with a generally accepted saleable product.
The
machinery
necessary and exclusively used in this chain should make up the
machinery
sunra,
used
directly
at 304.
Here
in
the
the
manufacturing
manufacturing
process."
process
is
Ross,
water
purification and it ends with the saleable product, the purified
water, being deposited in a clear well or storage tank.
record
indicates
that
the
water
company
sold
finished
The
potable
water directly from the clear well to water haulers and to
residential
without
customers
who
pressurization.
lived
The
in
Board
proximity
of
Tax
to
elevated
Appeals
tanks
specifically
found that the water was saleable in the clear well.
The
circuit
court also found that the water was “technically saleable" in the
clear well.
However,
it also held that the processing continues
until such time as the customer turns on the tap.
Appeals relied on Burke v. Stitzell-Weller
676,
The Court of
Distillerv,
284
Ky.
145 S.W.2d 861 (1940) in holding that the water must be
5
pressurized before it can be utilized for its intended use. We
agree with the dissenting opinion by Judge Huddleston to the
effect that the Court of Appeals in this case vastly expanded the
intended use to include transportation and delivery of the
product to commercial and residential users.
This Court restated the definition of manufacturing for the
purposes of sales and use tax in Deoartment of Revenue. ex rel
Luckett v. Allied Drum Service, Inc., KY.,
561 S.W.2d
323 (19781,
as “material having no commercial value for its intended use
before processing has appreciable commercial value for its
intended
-,
use
processing
by
the
machinery."
Allied
specifically overruled Prestonsburs Water Companv
Prestonsburu
(1939),
after
Bd. of Suoervisors,
279
Ky.
Drum,
v,
551, 131 S.W.2d 451
because it did not meet such a test.
The court in Allied
Drum held that the purification of muddy water from the Big Sandy
River created an end product that was water fit for use.
Drum at 325.
Allied
The necessary inference is that purified water was
an end product because manufacturing terminated when the water
was
purified.
The water company admitted through the testimony of a plant
superintendent that the finished water in the clear well was a
saleable product and was sold to water haulers from the clear
well.
The testimony also indicated that a bulk customer such as
a city or water distribution company could directly access the
water company's own clear well to withdraw water.
The only
logical conclusion is that purified water is a finished product
suitable for sale before it enters the distribution system and
consequently a tax exemption is not applicable.
6
Revenue Cabinet v. James B. Beam Distilling Co., KY., 798
S.W.2d 134 (19901,
provides additional support for this approach
when it held that the distilling of whisky was a separate and
distinct operation that was not dependent on the bottling or
warehouse operations at the same location.
principal thrust of the Beam, sunra,
definition,
product,
Although
the
opinion was the one location
this Court stated that if Beam sells part of its
it must be marketable for its intended use without
regard to the other operations conducted at another site. a
Beam at 135.
In
addition, the water distribution system is not used
directly
in
manufacturing.
718 S.W.2d
KY-,
947 (19861,
Revenue Cabinet v. Amax Coal Co.,
holds that under the integrated plant
theory, machinery used in procedures “essential to the total
process of manufacturing" are used directly in the manufacturing
process. a
Luckett,
Schenlev Distillers. Inc. v. Commonwealth, ex
Ky. 467 S.W.2d
rel
598 (1971).
This case is distinguishable from Amax,
sunra, because the
independent water distribution companies and cities can and do
distribute
water
without
treating
it.
These
independent
water
distribution systems deliver the purified water to their
customers by means of their own distribution systems.
addition,
this case differs from Amax
In
because the potable water
is sold to water hauling customers without ever entering the
water
distribution
system.
The Public Service Commission and the Natural Resources
Cabinet separately regulate and license the water distribution
system
and
water
treatment
plants.
7
There is no requirement that
the
water
company
deliver
the
water.
The license to distribute
water is not directly related to a license to treat the water.
Consequently,
the Amax
test that tied the mandatory federal and
state reclamation requirements for the mining of coal is not
satisfied
in
this
situation.
It is important to recognize that water treatment and water
distribution are separately regulated and licensed.
A
company
may distribute water and therefore pressurize it without
processing
it.
The pressurization used by the water company to
transport the water to customers is not part of the manufacturing
process in this case because the water is finished and saleable
in the clear well and because the water distribution companies
that
do
their
not
manufacture
water, pressurize water to deliver it to
customers.
We realize that the Revenue Cabinet has consistently
interpreted KRS 139.480(8)
exemption
to
pipes,
so as to refuse a sales and use tax
valves, fittings and meters for both water
distribution systems and local utilities that deliver gas. We
find no reason that this policy should differ in regard to water.
We further acknowledge that long standing statutory construction
of a law by an administrative agency charged with its
interpretation should be honored by a reviewing court.
Subsidiaries v.
Hacran v. Farris,
Seaaram
Revenue Cabinet, KY.,
KY.,
807 S.W.2d
GTE
889 S.W.2d 788 (1994);
488 (1991); Alllshin v. Joseoh E,
& Sons, Inc., KY., 294 S.W.2d
515 (1956).
We find no
reason to disturb the interpretation followed by the Revenue
Cabinet
in
such
matters.
II
The decision of this Court in Kentuckv Electric Co. V.
Buechel,
the
146
type
Appeals,
of
Ky. 660, 143 S.W. 58 (1912),
situation
presented
here.
is still applicable to
Neither the Court of
nor the circuit court, has the authority to declare that
decisions of the Supreme Court of Kentucky or its predecessor
court have implicitly been overruled because of age.
1.030(8).
Buechel, sunra,
SCR
considered the definition of
manufacturing plant for ad valorem
tax purposes and determined
that an electric generating plant was a manufacturing plant.
The
Court specifically refused to include the distribution system as
part
of
the
manufacturing
plant.
The Court noted in pertinent
part
Its poles, conduits, lines, wires, etc., are not
used in any way whatever in the manufacture of the
electricity, but their use is to dispose of the
manufactured product, . . . While they may be
necessary to make the business a success, still
they are not necessary to manufacture the
product....
Kentuckv
Electric
at
62.
An even older case, Covinuton Gas-Light Co. v, Citv of
Covington,
84 Ky. 94, 8 K.L.R. 442 (1886), held that a gas
manufacturing plant did not include the pipes, meters and lamp
posts because if it did, the entire city would be converted into
a workshop belonging in part, at least, to this corporation.
reasoning of Buechel and Citv
of
Covinqton,
sunra,
The
is still sound
in light of the clear intention of the legislature to limit this
kind of exemption to items incorporated in a plant facility. KRS
139.480(8)
has the same purpose as the ad valorem
9
exemption for
manufacturing now found in KRS 132.200(4).
U.
Commonwealth, ex
rel Luckett v. WLEX-TV Inc., KY., 438 S.W.2d 520 (1969).
When construing the tax laws, including exemptions
therefrom,
this Court must give deference to the interpretation
of such terms as they are commonly used or understood.
meaning of terms such as “distribution
“pressurization"
means
that
they
are
system"
not
part
The
plain
and
of
the
manufacturing plant process and consequently not exempt from
sales and use tax.
E. WLEX-TV. Inc., suora;
v. Lexington Leader Co., 193 Ky. 107, 235
The
Kentucky
Board
of
Tax
S.W.
Citv of Lexington
31
(1921).
Appeals, in affirming the decision
by the Revenue Cabinet to deny tax exemption, relied on the
testimony of two witnesses who were employees of the Public
Service Commission and the Department of Natural Resources,
respectively.
Their testimony was that pressurization is used to
move the water and that the treatment plants are regulated
separately
literature,
and
from
the
distribution
system.
The water company's
published to explain how water purification plants
distribution
systems
work, refers
to
the
two
separately.
The
Court of Appeals erroneously determined that the manufacturing
process continues until the water is transported to an ultimate
customer.
Such fact finding ignores the reality that the water
company has three types of customers who receive water service in
three
different
manners.
The Court of Appeals and circuit court
decision reach an erroneous result because no additional product,
in this case, finished saleable water, is created by adding
distribution
facilities.
10
Although it may be the purpose of tax exemptions for'
machinery in new and expanded industry to make that industry more
competitive,
such a principle is not applicable here because the
water company is a fully regulated monopoly which has no
competition.
Thus, we must reverse the Court of Appeals and reinstate the
decision of the Board of Tax Appeals that defines the water
distribution system as it is commonly used in the industry, that
is, separate
from
the
manufacturing
plant
facility.
III
The proper standard for appellate review of findings of fact
is whether such findings of fact are supported by substantial
evidence.
Mullikin,
KRS
131.370. Trimble Countv Bd. of Suoervisors v.
KY., 438 S.W.2d
524 (19681,
states that the legislature
intended to limit review of orders of the Board of Tax Appeals on
findings
of
fact, as in most other appeals from orders of
administrative
fact
are
agencies, to determining whether the findings of
supported
by
substantial
evidence.
The opinion cited CR
52.01 and Board of Education of Ashland School District v.
Chattin,
Core.
KY., 376 S.W.2d
693 (1964) and American Beautv Homes
v. Louisville and Jefferson Countv Planning
Commission et al., KY.,
379 S.W.2d
and
Zoninq
450 (1964).
In this case, the Board of Tax Appeals found as a fact that
the water was sold from clear wells to water haulers.
The water
company argues that it was selling pressurized water and this
altered
the
nature
of
the
finished
product.
The Board of Tax
Appeals also found that some water is delivered by means of
gravity
flow
and
not
pressure.
There was testimony that the
11
water did not change its character because of the pressurization.
The Board of Tax Appeals was within its authority to accept such
testimony,
even when there was conflicting evidence presented.
One witness testified that the purpose of pressurization was
to maintain the purity of the water as well as deliver it.
Another
witness
disputed
the
water
company's
argument
about
kinetic energy being used for the purpose of pressurization. A
company witness testified that pressurization was necessary for a
proper
consumer
use.
The findings by the Board of Tax Appeals
that the pressurization was used primarily to transport the water
were
supported
by
substantial
evidence.
The circuit court did not find that the determination by the
Board of Tax Appeals was not supported by substantial evidence,
rather it erroneously construed this as a legal issue and not as
a factual one.
that
The
pressurization
process.
circuit
is
a
court
spontaneously
continuation
In doing so, the
circuit
of
court
the
took
the
position
manufacturing
improperly
substituted
its own determination of the facts in place of that of the Board
of Tax Appeals.
The Court of Appeals compounded the error by
affirming the decision of the circuit court.
We reaffirm the
position that a reviewing court may not disturb findings of fact
by an administrative agency if those findings of fact are
supported
by
substantial
evidence.
Mulliken,
sunra.
IV
The Court of Appeals erred when it held that the 1,197 miles
long water distribution system was one location and thereby met
the statutory requirement for an exemption for energy used in
manufacturing.
KRS 139.480(3)
requires that the energy be used
12
in the course of manufacturing to processing in order to obtain
an
exemption.
The
water
company's
distribution
system
is
not
engaged in manufacturing or processing as earlier determined and
the distribution system does not constitute a plant facility at
one
location.
Moreover,
KRS 139.480(3)
requires that the plant
facility be a permanent structure affixed to real property at one
The determination that remote booster pumps scattered
location.
over a six county area is one location is not supported by legal
authority
which
can
validate
such
a
conclusion.
For the reasons set out above, the decision of the Court of
Appeals is reversed and the order of the Board of Tax Appeals
denying an exemption to the water distribution system from sales
and use tax for machinery used in new and expanded industry is
reinstated.
All
ATTORNEY
concur.
FOR
APPELLANT:
Cathy Cravens Snell
Division of Legal Services
Revenue Cabinet
P.O. Box 423
Frankfort, KY 40602
ATTORNEYS
FOR
APPELLEE:
Douglas P. Romaine
Melissa A. Stewart
Roger W. Madden
Stall Keenon & Park, LLP
201 East Main Street, Ste
Lexington, KY 40507
1000
13
98-SC-0165DG
REVENUE CABINET,
COMMONWEALTH OF KENTUCKY
APPELLANT
ON REVIEW FROM COURT OF APPEALS
96-CA-2985MR
(FAYETTE CIRCUIT COURT NO. 9X1-695)
V.
KENTUCKY-AMERICAN WATER COMPANY
APPELLEE
ORDER GRANTING PETITION FOR MODIFICATION
The Appellant’s petition for modification is granted. The Opinion of the Court
rendered in the above-styled action on April 22, 1999, is modified and the attached
pages 1 and 5 are substituted in lieu of the original pages 1 and 5. Said modifications
do not affect finality of the original Opinion and are made only for clarification purposes.
All concur.
Entered: August 26, 1999.
Some case metadata and case summaries were written with the help of AI, which can produce inaccuracies. You should read the full case before relying on it for legal research purposes.
This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.
