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KBTA Upholds Denial of Refund Request for Sales and Utilities Gross Receipts License Tax Paid Related to Energy Exemption

06.12.2012

In Ohio Valley Aluminum Co., LLC v. Dep’t of Revenue, File Nos. K-10-R-35 and K-10-R-36, Order No. K-22086 (KBTA May 22, 2012), the Kentucky Board of Tax Appeals (“Board”) upheld the Kentucky Department of Revenue’s (“Department”) denial of Ohio Valley Aluminum Company, LLC’s (“Ohio Valley”) refund request for an exemption from Kentucky Sales and Use Tax and Utilities Gross Receipts License Tax (“UGRLT”) paid on the cost of energy used in its tolling operations (“Energy Exemption”) by holding that Ohio Valley must include the cost of materials that it processes, but does not own, in its cost of production calculation for purposes of the Energy Exemption.

By way of background, Kentucky provides an exemption on the cost of all energy or energy-producing fuels used in the course of manufacturing, processing, mining or refining to the extent that the cost thereof exceeds three percent (3%) of a taxpayer’s “cost of production.” KRS 139.480(3); KRS 160.613(1). The term “cost of production” is defined by 103 KAR 30:140 as “the total of all costs, according to accepted accounting principles, incurred in the manufacturing, mining, processing or refining of tangible personal property computed on the basis of ‘plant facilities’ [defined as being all permanent structures affixed to real property at one location].” Further, in computing the “cost of production” for purposes of the Energy Exemption, 103 KAR 30:140 requires a taxpayer to include only those costs “normally” incurred in the activity for which it claims the exemption.

Ohio Valley is a processor that heats scrap aluminum metal into aluminum billets at its plant located in Kentucky. In 2007, Ohio Valley restructured its business and created a wholly-owned subsidiary, OVACO, LLC (“OVACO”), for the purpose of purchasing scrap aluminum and performing financial hedging and speculating of aluminum prices on the national commodities market. In connection with the restructuring, Ohio Valley transferred ownership of all of its all of its inventory, i.e., raw materials (scrap metal) and finished goods (aluminum billets), to OVACO and entered into a tolling agreement with OVACO. Pursuant to the tolling agreement, Ohio Valley would process (heat) aluminum scrap purchased and owned by OVACO, for a fee, into aluminum billets.

Based on this restructuring and tolling agreement, Ohio Valley argued that it was a toller, as it processed materials purchased and owned by OVACO, and thus, was entitled to exclude the cost of the scrap aluminum from its “cost of production” calculation under KRS 139.480(3), KRS 160.613(1) and 103 KAR 30:140, as such costs were actually incurred by OVACO. The Department denied Ohio Valley’s refund requests for Sales Tax and UGRLT under the Energy Exemption by arguing that OVACO was merely a paper or holding company, and thus, Ohio Valley was required to include the costs related to the materials it processed.

Despite recognizing that OVACO was the purchaser and owner of the raw materials and finished goods, the Board upheld the Department’s denial. The Board looked to the substance rather than the form of the restructuring and found that the operations of Ohio Valley and OVACO constituted one operation at one plant facility and that Ohio Valley’s operation was dependent upon OVACO for the materials it processes. Thus, the Board found that Ohio Valley could not allocate the cost of the raw materials and finished goods to OVACO, but must instead include the cost of these materials in its own cost of production calculation for purposes of the Energy Exemption.

Ohio Valley recently appealed the Board’s decision to the Shelby County Circuit Court on June 11, 2012. The authors represent the Taxpayer in this matter.

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