February 4, 2014

Rance Morton

CliftonLarsonAllen LLP

5001 Spring Valley Road, Suite 600W

Dallas, TX 75244

RE: Merchant Investments Inc. Retail Sales Tax Protest

Docket No. 2012-300-2-0411

Dear Mr. Morton:

The Department has reviewed your response to the Department’s position letter dated November 22, 2013. The main focus of your letter is whether Jimmy John’s restaurants qualify as manufacturers and, specifically, whether they are “combining different materials” which would meet the qualifications of a manufacturer under Iowa Code §428.20.

The Department’s position, as detailed in its November 22^nd letter, is that Jimmy John’s restaurants are not manufacturers and do not perform manufacturing activities that would allow a retailer such as Jimmy John’s to meet the qualifications for a machinery and equipment exemption set forth in section 423.3(47). The combining of various food components into a sandwich by Jimmy John’s employees does not constitute a manufacturing activity contemplated by section 428.20.

In an effort to counter the Department’s argument, you cite Iowa Code §423.3(57)“f”(2) and the examples in rule IAC 701—231.5(2). You state that while the Iowa Code and rules do not specifically define “combine,” its use in the code section and examples you reference provides sufficient context such that the term need not be further defined with respect to its use in section 428.20. You state in your letter that the examples presented in rule IAC 701—231.5(2) are “exactly on point” and that the term “combined” is “not ambiguous in this context.”

The term “combined” as used in the statute and rules that you reference concerns whether certain food items qualify as prepared food or are merely food ingredients. This is an essential distinction as prepared food is subject to sales tax in Iowa while food ingredients generally are not. The examples you reference are not on point with respect to whether Jimmy John’s qualifies as a manufacturer under Iowa Code §428.20 or is performing a manufacturing activity.

The general dictionary definition of “combine” is “to bring into such close relationship as to obscure individual characters: MERGE b: to cause to unite into a chemical compound . . . INTERMIX, BLEND . . .” Webster’s Ninth New Collegiate Dictionary. In sherwin-williams v. Department of Revenue, 789 N.W.2d 417,419 (Iowa 2010), the Court found that the retailer in that case was combining or mixing colorants with its base paint to create a saleable paint. It was the equipment used in this part of the “decentralized manufacturing process” performed at the retailer’s location that the Court found qualified for the machinery and equipment exemption. This is the type of activity that fits the generally understood meaning of the term “combine” or “combining” which occurs as part of a manufacturing process. The Department’s position is that the activity of Jimmy John’s employees of bringing together meat, cheese, bread, condiments, etc. to make prepared food is not “combining of different materials” as that term is commonly understood in a manufacturing operation under section 428.20.

Also, the decision in the Sherwin-Williams case does not hold that retailers who may perform manufacturing activities are manufacturers. It only provides that the machinery and equipment exemption for manufacturers is also available to retailers if the claimed equipment is being used in the same manner as a manufacturer in order to produce a finished product. As stated in the Department’s previous letter, to be eligible for the machinery and equipment exemption discussed in section 423.3(47), the equipment itself must be performing the “manufacturing, refining, purifying, combining of different materials, or the packing of meats” as required in section 428.20. The equipment and tools listed in your refund claims do not perform any of these functions. Therefore, your protest must be denied.

Please advise the Department of your position in light of the enclosed findings within thirty days of the date of this letter. If you agree, or choose not to pursue the protest, please inform the Department in writing. Your letter will serve as authority for the Director to close the protest.

If you disagree with the Department’s findings and choose to pursue the protest, the Department will file an Answer as required by rule IAC 701—7.12. Thereafter, formal contested case proceedings can be initiated.

If no response is received within thirty days of the date of this letter, the Department will construe this inaction as failure to pursue the protest and will request dismissal of the protest pursuant to departmental rule IAC 701—7.11(2).

If you have any questions regarding this matter, please do not hesitate to contact me.

Sincerely,

Steve Campbell, Technical Tax Specialist

Policy and Communications Division

Audit Services Section

Telephone: 515-242-6049

Fax: 515-242-6040

Email: Steve.Campbell@iowa.gov

November 22, 2013

Kelly Smith

Clifton Larson Allen LLP

9339 Priority Way West Drive, Suite 200

Indianapolis, IN 46240

RE: Merchant Investments Inc. Retail Sales Tax Protest

Docket No. 2012-300-2-0411

Dear Ms. Smith:

The Review Unit of the Iowa Department of Revenue has considered the above-referenced protest. After reviewing the facts and evidence presented and the laws which apply to the protest, the Review Unit denies the protest for the following reasons.

Iowa Code §428.20 defines manufacturer as “a person who purchases, receives, or holds personal property of any description for the purpose of adding to its value by a process of manufacturing, refining, purifying, combining of different materials, or by the packing of meats, with a view to selling the property for gain or profit.” This definition is discussed at length in the Iowa Supreme Court’s ruling in The sherwin-williams Company v. Iowa Department of Revenue, 789 N.W. 2d 417 (Iowa 2010), which held that a retailer may qualify for a manufacturing exemption when it uses equipment “in the same manner and for the same purpose as such equipment would be used by a taxpayer whose principal business is manufacturing.”

Merchant’s position that it qualifies for the manufacturing exemption is based upon the decision made in the Sherwin-Williams case. The protest claims that Merchant meets the statutory definition of manufacturer because they purchase ingredients and combine them for the purpose of adding value with the view of selling the property for gain or profit and, therefore, the machinery, tools, and equipment included in Merchant’s refund claim qualify for the machinery and equipment exemption discussed in Iowa Code §423.3(47).

The Department disagrees with your position. The term “combine,” under which Merchant claims it meets the definition of manufacturer, is not defined in Iowa’s sales tax statutes or rules. However, Merriam-Webster’s dictionary defines the term as “to bring into such close relationship as to obscure individual characters.”

The Department believes that the facts involved in the Sherwin-Williams case are distinguishable from those of Merchant. The equipment involved in the Sherwin-Williams case determined the formula for the customer’s desired paint color, dispensed the proper amount of colorant into the can of base paint, and mixed the two components into marketable tangible personal property. The combining of the colorant and the base paint resulted in a product that could not then be separated back into its individual components.

In Merchant’s situation, the ingredients you claim are being combined remain readily identifiable as their individual component parts after this process is completed. Because of this distinction, the Department believes that the activity of “combining different materials,” written as one of the requirements of being classified as a manufacturer in Iowa Code §428.20, has not been met by Merchant. Merchant makes no argument that it performs any other activities that constitute manufacturing, refining, purifying, or the packing of meats also presented in that statute.

Furthermore, the machinery and equipment listed in your refund claim is not combining any ingredients or manufacturing any products. Merchant’s employees are providing the service of adding the ingredients to the sandwiches according to the customer’s preference. To be eligible for the machinery and equipment exemption, the equipment itself must be performing the “manufacturing, refining, purifying, combining of different materials, or the packing of meats” as required in Iowa Code §428.20.

You also claim that the use of certain equipment included in the refund claim is necessary for maintaining product integrity and is, therefore, eligible for exemption under rule IAC 701—18.58(2). However, the relevant part of that rule states the following:

On and after July 1, 1997, sales or rentals of the following machinery, equipment, or computers (including replacement parts) are exempt from tax:

b. Machinery, equipment, and computers directly and primarily used to maintain a manufactured product’s integrity or to maintain any unique environmental conditions required for the product. (Emphasis added)

As stated previously, it is the Department’s position that Merchant does not meet the requirements to be classified as a manufacturer and, by definition, is not manufacturing any products. Therefore, rule IAC 701—18.58(2)“b” does not apply.

The final issue addressed in the protest is the denial of the refund on sales tax paid on nontaxable installation services. A review of the invoices included with the refund claim indicates that no sales tax was charged or paid on any installation fees. Therefore, the protest of this issue must be denied.

In summary, your protest is denied. Please respond in writing by December 23, 2013 whether you agree with the Review Unit’s position. If you agree, or choose not to pursue the protest, then your letter will serve as authority for the Review Unit to request the Director to close the protest.

If you disagree with the Review Unit’s position in this matter, then the Review Unit requests that you identify those areas of disagreement and provide documentation to support your position. If there is no such documentation and Protester chooses to pursue the protest, the Department, through counsel, will file an Answer, which will initiate the process for an administrative hearing on your protest.

If no response is received by December 23, 2013, then the Review Unit will construe this inaction as failure to pursue the protest and will request dismissal of the protest pursuant to departmental rule 701 IAC 7.11(2).