Indiana Tax Court Serves a Sales Tax Exemption To Restaurant Chain for Electricity Used to Warm Food

Electricity used by Qdoba Mexican Restaurants to keep food warm before final preparation and sale was found exempt from sales tax by the Indiana Tax Court.  On June 23, 2015, the Indiana Tax Court in Aztec Partners, LLC v. Indiana Department of State Revenue granted the refund claims filed by Aztec Partners, LLC, which operates nineteen of the restaurants in the State. The restaurants use food warmers, hot food cabinets, and other equipment to hold and to preserve the temperature of food items such as salsa, chicken, lettuce and rice until they are combined into entrées sold to customers.  After first concluding that it had jurisdiction to hear the refund claims, the Court analyzed whether the electricity used to power the equipment was exempt from sales tax under the consumption exemption, which exempts electricity acquired “for direct consumption as a material to be consumed in the direct production of other tangible personal property.”  To qualify for the exemption, the Court explained, Aztec had to show that (1) it is engaged in production, (2) it has an integrated production process, and (3) the electricity is essential and integral to its integrated production process.

Preparing entrées was productionNoting the “iron-clad rule” that “without production there can be no exemption,” the Court observed that “production” is defined broadly. In deciding whether production occurs, the focus is on whether a marketable good is created. Aztec engaged in production, because its preparation and combination of food items into entrées substantially changed the individual food items into new, marketable products – entrées – that have a character and form different from the food items originally acquired.

Combining food created a marketable productAztec’s marketable finished products were the entrées, not the individual food items.  (No evidence showed that food items were individually sold.) Entrées were not ready for sale until this final step was completed.  According to Aztec, combining food items was the last of several steps within its integrated production process.  The electricity was consumed in this process.

Electricity essential to creating entrées. Without the electricity, the individual food items could not have been properly preserved for combination into marketable products. Aztec did not need to show the electricity had a transformational effect on the food items to prove it was essential and integral to producing the entrées.  Aztec’s purchases of the electricity were exempt.

Department takes one more bite.  The Department filed a petition for rehearing in which it claimed, in part, that Aztec’s refund claims were ambiguous, so it never filed adequate claims and thereafter never invoked the Court’s jurisdiction.  In a July 30th order, the Court ruled that Aztec’s refund claims were proper, as they were filed on the Department’s designated form and described the basis for the claims.  Furthermore, the Department had sufficient information to process the claims, denying them in part and granting them in part.  The refund claims, therefore, were not ambiguous.

The Department of Revenue often seeks to narrow the scope of what is considered production and to restrict the availability of the consumption exemption.  However, as this decision shows, electricity used to create a final, marketable product – whether tacos, tanks, or turbines – is likely exempt.