United States: Tennessee Releases Sales And Use Tax Administrative Rulings Covering Variety Of Topics, Including Industrial Exemptions And Web-Based Services

On January 8, the Tennessee Department of Revenue released a number of 2012 revenue and letter rulings addressing a variety of sales and use tax issues, including the applicability of the industrial materials and machinery exemptions to various fact patterns, and the scope of the exemption for Web-based services. The Department's rulings also address the taxability of wireless replacement phones provided to subscribers of wireless plans under an insurance policy, and a wireless customer's redemption of loyalty points for a reduction in the purchase price of taxable goods or services.

Industrial Machinery Exemption

The Department issued a revenue ruling that determined whether certain items purchased by a manufacturer, through its contractor, qualified for the "industrial machinery exemption" from sales and use tax.1 According to the Department, in order for an item to qualify for the exemption, four requirements must be met: (i) the use must be by a manufacturer; (ii) the item must be machinery, apparatus or equipment; (iii) the item must be necessary to the fabrication or processing of the products sold by the manufacturer; and (iv) the item must be primarily for the fabrication of the products sold by the manufacturer.2 Items that are not necessarily machinery themselves, but become a part of qualifying machinery, can also qualify for the exemption. Moreover, equipment used to transport materials from storage to the manufacturing process or to transport the finished product to storage after the manufacturing process, and machines used to distribute electricity to the machinery are exempt as "industrial machinery."3 Further, any necessary repair or installation labor performed on the machinery becoming part of the real property qualifies for the exemption as well.4

The Department also addressed the taxability of demolition, excavation and backfill, heavy haul, optical alignment, nondestructive examination (NDE) testing and engineering services. Under the state's statutory provisions, these services, which are not sold in conjunction with taxable tangible personal property, are not enumerated as taxable services and as such, the Department held that they are not subject to the sales or use tax.5

Finally, the Department ruled that contractors are not permitted to use the manufacturer's industrial machinery authorization number to make exempt purchases of qualified industrial machinery. In order to purchase the machinery tax-free for the manufacturer's project, a contractor must apply for its own exemption authorization number. This separate authorization number issued to the contractor will only permit the contractor to purchase machinery on an exempt basis for the manufacturer's particular project, and not on a continuous basis.

Industrial Materials Exemption

The Department ruled that certain charges made by a third-party contractor to the taxpayer, a manufacturer with manufacturing facilities in Tennessee, were exempt from the sales and use tax as "sales of industrial materials or supplies."6 Under Tennessee law, an exemption from sales and use tax applies to "industrial materials . . . for future processing, manufacture or conversion into articles of tangible personal property for resale where the industrial materials . . . become a component part of the finished product or are used directly in fabricating, dislodging, or sizing."7 According to the Department, the following charges by a third-party contractor8 fall under this exemption: (i) charges for the fabrication of tangible personal property that will be used by the manufacturer for the manufacture of articles of tangible personal property for resale; (ii) charges for the installation of tangible personal property that becomes a supply used in the manufacture of tangible personal property for resale; (iii) charges for preproduction rework that involves the reworking, cleaning and repairing of defective parts that are to be component parts of the manufactured items for resale; and (iv) charges for repair and cleaning services that are used by the manufacturer incidental to its manufacturing process. However, charges for repairing and cleaning items after completion of the manufacturing process are taxable.

Pollution Control Facilities Exemption

The Department considered the same "industrial machinery exemption" issues discussed in the first ruling above with respect to a taxpayer that expanded its manufacturing facility.9 For this particular manufacturer-taxpayer, however, the Department also considered whether certain items constituted exempt "pollution control facilities," a specific type of qualifying industrial machinery.10 It concluded that the taxpayer's vacuum stacks, grating trench, and underground piping were part of its system for cleaning the air or water generated during the manufacturing process, and thus, qualified as exempt pollution control facilities.

Moreover, the Department determined that the following items that become part of the facility or building typically do not qualify for the industrial machinery exemption: pilings; concrete; rebar accessories; and structural steel.

Web-Based Services

A taxpayer's sales of Web-based services that allowed either: (i) a customer to provide remote technical support to its employees and/or its own customers; or (ii) a customer's employee to access his or her computer remotely, were not subject to the state sales and use taxes because the true object of the transactions was to obtain non-taxable services, and not the use of computer software.11 While these Web-based services were tax-exempt, the taxpayer's Web-based services that allowed customers to conduct online meetings or training sessions were taxable. The distinction in treatment was based on the reasoning that the services enabling online meetings and training sessions constituted taxable "ancillary services" associated with the provision of telecommunication services.12 Specifically, they served as "conference bridging services," which fall under the term "ancillary services."13

Notably, the taxpayer did not sell, transfer or license software in Tennessee, and did not maintain its data centers or equipment in Tennessee. Rather, a customer merely downloaded an applet, free of charge, to access the Web-based services over a secure connection and the customer paid the taxpayer on a per-user subscription basis.

Wireless Replacement Phones

The Department also ruled that wireless replacement phones provided to subscribers of wireless plans under a special phone replacement program were taxable retail sales.14 The taxpayer requesting the ruling, an out-of-state holding company with subsidiaries, provided wireless telecommunications services within the state. The taxpayer offered its customers who subscribed to an "enhanced plan" with a non-optional phone replacement program, a combination of a wireless handset service contract and an insurance policy.15 While the Department held that the replacement phones were not taxable when provided to customers free of charge under the service contract, it determined that replacement phones provided to customers under the insurance policy were taxable retail sales to the insurance company. This was based on the view that the service contract was deemed a taxable "warranty,"16 while the insurance policy was not. In addition, the Department noted that the insurance company used the phones to fulfill its contractual obligations under the insurance policy.

Customer Loyalty Incentive Program

Finally, the Department examined the taxability of several elements of a customer loyalty incentive program provided by an out-of-state holding company with subsidiaries that provided wireless telecommunications services within the state.17 With respect to a wireless monthly fee imposed on its customers, the Department held that the sales price of such fee: (i) was not decreased by the imputed value of loyalty points issued to the customer; and (ii) was decreased by the discount for automatically paying online and accepting paperless billing. With respect to the exchange of loyalty points for discounted telecommunications items and services subject to the sales tax, the Department held that: (i) the sales price of the items equaled the net amount of cash paid by the customer for the item or service; and (ii) the use tax was not imposed on the taxpayer with respect to such item or service, but the taxpayer would be responsible for paying sales tax if it failed to collect and remit the tax from its customer. Finally, the Department held that the sales and use tax is not imposed on the redemption of loyalty points for non-taxable goods or services unless they are bundled with taxable goods or services for a single charge.


While the Department's recently released sales and use tax rulings with respect to the manufacturing exemptions do not necessarily cover new ground, its other rulings are insightful to a broad group of taxpayers selling or purchasing Web-based services or telecommunications services. Interestingly, unlike other states that have addressed Web-based services that facilitate online meetings or training, Tennessee classified these services as taxable "ancillary services associated with telecommunications services" and applied a state-specific statutory provision to rule that these services were taxable. As for the taxability of loyalty point programs, the guidance provided by the Department treats the redemption of points in line with the sales and use tax treatment of in-store coupons.


1 Revenue Ruling No. 12-02, Tennessee Department of Revenue, April 30, 2012, released Jan. 8, 2013.

2 See TENN. CODE ANN. § 67-6-102(46)(A)(i). The Department found that the following items did not qualify for the exemption because they were not necessary to or primarily for the fabrication of products sold by the manufacturer: floor coating, exterior wall siding, safety showers, piping labels, fire stop and light fixtures. Each of these items served a primary purpose beyond manufacturing.

3 See TENN. CODE ANN. § 67-6-102(46)(D)(i), (ii).

4 See TENN. COMP R. & REGS. 1320-5-1-.27(2).

5 The general rule is that services are exempt unless specifically enumerated as taxable.

6 Letter Ruling No. 12-12, Tennessee Department of Revenue, July 24, 2012, released Jan. 8, 2013.

7 TENN. CODE ANN. § 67-6-329(a)(12).

8 The contractor must be a "supplier of materials, supplies, equipment, or services."

9 Revenue Ruling No. 12-24, Tennessee Department of Revenue, Oct. 31, 2012, released Jan. 8, 2013.

10 As defined in TENN. CODE ANN. § 67-6-102(46)(A)(ii).

11 Revenue Ruling No. 12-25, Tennessee Department of Revenue, Oct. 31, 2012, released Jan. 8, 2013.

12 The term "telecommunications services" is defined in TENN. CODE ANN. § 67-6-102(92)(A).

13 See TENN. CODE ANN. § 67-6-102(7).

14 Letter Ruling No. 12-29, Tennessee Department of Revenue, Nov. 21, 2012, released Jan. 8, 2013.

15 The insurance premiums were paid by the taxpayer on behalf of its subscribers.

16 The tax is considered to be paid on the warranty when the subscriber initially pays for the bundled phone and wireless plan, and any subsequent repairs to the phone for which there is no charge to the customer are tax-exempt.

17 Letter Ruling No. 12-30, Tennessee Department of Revenue, Nov. 21, 2012, released Jan. 8, 2013.

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