KEOKUK NORTHERN REAL ESTATE CO. d/b/a KEOKUK JUNCTION RAILWAY AND RAIL SERVICES OF IOWA (1998) (CC) (O) (ST)

Topic Code: E108Enumerated Services(ST): I238Interstate Commerce (ST) R011Railroad and Equipment Repair           Document Reference: 98300107

IN THE IOWA DISTRICT COURT FOR POLK COUNTY

          KEOKUK JUNCTION RAILWAY CO.

          and RAIL SERVICES OF IOWA CO.,

          Petitioner,

          vs

THE IOWA STATE BOARD OF TAX REVIEW,

          Respondent.

          CASE NO. AA 2927

          RULING ON PETITION

          FOR JUDICIAL REVIEW

          

On November, 12, 1997, the above-captioned matter came on for hearing before the Court. Petitioners, Keokuk Junction Railway Co. and Rail Services of Iowa Co. (“KJ”) appeared through counsel, Richard Malm. Respondent Iowa State Board of Tax Review appeared through Special Assistant Attorney General Harry Griger. The Court, having reviewed the briefs and file, and after hearing arguments of counsel, now enters the following ruling:

I. FINDINGS OF FACT

1. Keokuk Real Estate Co. is an Iowa corporation doing business under the name “Keokuk Junction Railway” (“KJ”). Rail Services is a related entity in that its principal stock is owned by the principal shareholders of KJ. Rail Services was dormant at the time of the hearing. (Tr. 27.)

2. Prior to December 24, 1986, KJ was the smallest railroad in the world, operating 1.2 miles of switching track. As of December 24, 1986, KJ expanded to become an interstate carrier, acquiring 28.5 miles of rail line, connecting Keokuk, Iowa to LaHarpe, Illinois. KJ’s revenue operations include freight movement, switching and car repair. (Tr. 25.) KJ also owns a rebuilt vintage railroad passenger car, entitled the Chief Keokuk (“Chief”), which it leases for passenger service outside Iowa. (Tr. 133.)

3. The American Association of Railroads (AAR) requires rail cars to be in good repair to use in rail operations. The AAR regulates who is to repair railroad cars, the amount of the repair, and whom to charge for repairs. (Tr. 40.) The AAR requires carriers such as KJ to inspect interchange cars in its possession, and to bring cars up to necessary safety standards in order for the cars to continue in furtherance of interstate commerce. (Tr. 37-38.) This process is generally referred to as AAR car repair. (Tr. 37.) During the audit period, KJ did repair work on “bad order” cars “received in interchange” from other railroads. (Tr. 35.) When the party damaging the car is the car’s owner, the owner is billed for the repair work. The charges at issue in this audit were the car owner’s responsibility, and KJ was earning revenue from making the repairs. (Tr. 43-45.) The predominant service reflected in the AAR billing cards were rolling stock repairs. (Tr. 46.) Work incidental to rolling stock repairs includes pipe fitting, welding, painting, carpentry, part repair and return, part reconditioning, and inspection. (Tr. 47-49.) KJ bills car owners in accord with AAR standards by listing the job code performed and multiplying it by a specified rate. (Tr. 53-54.) Following completion of car repair, the cars are returned to interstate commerce. (Tr. 58.)

4. The Chief Keokuk was a badly deteriorated 1927 Pullman passenger observation car acquired by KJ from the Santa Fe Railroad in 1983 for $1,000.00. (Tr. 64-65.) From January 1986 until April 1987., KJ rebuilt the Chief for use as a private car in interstate passenger service. (Tr. 71.) In order to rebuild the Chief, the interior and exterior were stripped by sand or walnut blasting. (Tr. 68.) The KJ replaced major systems including the “trucks” (railcar wheel assemblies), couplers, brakes, air conditioning, and electrical and mechanical systems. The furnishing and windows were replaced or restored. (Tr. 67-71.) In April 1987, the finished car was placed in service for hire in interstate commerce. (Tr. 131.) In approximately 1993, the Chief was leased to an intrastate, tourist railroad in the Grand Canyon, Arizona area. (Tr. 133.)

5. The work on the Chief was performed by a number of craftsmen and contractors, who consisted of both employees of KJ and independent contractors. All of the people who work in the car repair shop are called “Carmen” and their craft is termed “Carmen’s Work.” The work performed on the Chief was separately invoiced. (Ex. R7.) The expenditures to rebuild and restore the Chief were equivalent to the creation of a new railroad car. (Tr. 134.)

6. In February 1987, KJ had problems with Locomotive 405, which was being used in interstate commerce in both Iowa and Illinois. (Tr. 122-23.) In order to be within federal standards, KJ’s locomotive had to be repaired. In February 1987, Greg Wolfersheim performed locomotive repair services, on Locomotive 405. (Tr. 124; R16-161.)

7. KJ also performed repair of Maintenance of Way (“MOW”) cars. MOW cars include flat cars, ballast cars, cabooses and “Hy-Rail” equipment. Hy-Rail equipment, which is used for track maintenance, is equipment with both rubber tires and railway-flanged wheels which can operate both on and off the rails. Following 1987, Hy-Rail track maintenance equipment was primarily used in Illinois. (Tr. 137.) Some of the invoices reflect repairs of equipment in Illinois with its predominant use in Illinois. (Tr. 137; R17.) Other invoices reflect repair of equipment in Iowa for use in Illinois. (Tr. 139; R17-5.)

8. The Iowa Department of Revenue and Finance (“Department”) audited KJ’s sales of tangible personal property, and services, for Iowa sales tax purposes, for tax periods July 1, 1985 through June 30, 1990. The Department audited KJ’s purchases of personal property and services for Iowa use tax, for tax periods July 1, 1985 through March 31, 1990. The Department audited Rail Services of Iowa Co.’s sales of tangible personal property and services, for Iowa sales tax purposes, for tax periods July 1, 1985 through March 31, 1990. (ALJ Decision p. 11, ¶26.)

9. A contested case hearing was held before Administrative Law Judge (“ALJ”) Elizabeth Duncan on March 14, 1995. A proposed decision was issued by ALJ Duncan on May 30, 1995. On December 18, 1995, Director of the Department of Revenue and Finance G.D. Bair, issued an order upon review of the ALJ’s decision, and affirmed portions of the ALJ’s decision. The Director reversed some of the ALJ’s decisions and these issues are no longer in dispute. KJ petitioned to the Iowa State Board of Tax Review. On April 15, 1997, Iowa State Board of Tax Review Chairperson Harold W. White, affirmed the Director’s order. On May 14, 1997, KJ petitioned this Court for Judicial Review.

          II. STANDARD FOR REVIEW

On judicial review of an agency action, the district court functions in an appellate capacity to apply the standards of Iowa Code section 17A.19(8) (1997). Baker v. Employment Appeal Bd., 551 N.W.2d 646, 648 (Iowa Ct. App. 1996); Iowa Planners Network v. Iowa State Commerce Commission, 373 N.W.2d 106, 108 (Iowa 1985). The court has no original authority to declare the rights of the parties. Office of Consumer Advocate v. Iowa State Commerce Commission, 432 N.W.2d 148, 156 (Iowa 1988). Nearly all disputes in the field of administrative law are won or lost at the agency level. Iowa-Illinois Gas and Elec. Co. v. Iowa State Commerce Commission, 412 N.W.2d 600, 604 (Iowa 1987). The district court may reverse, modify or grant other appropriate relief only if the agency decision is affected by error of law, is unsupported by substantial evidence in record or is characterized by an abuse of discretion. Burns v. Board of Nursing, 528 N.W.2d. 602, 604.

          Iowa Code section 17A.19(8)(f) (1997) provides that, in a contested case, the court shall grant relief from an agency decision which is unsupported by substantial evidence in the record made before the agency when the record is viewed as a whole. Neil v. John Deere Component Works, 490 N.W.2d 80, 82 (Iowa Ct. App. 1992). Review is not de novo. Hussein v. Tama Meat Packing Corp., 394 N.W. 2d 340, 341 (Iowa 1986). Evidence is substantial to support an agency’s decision when a reasonable person would find it adequate to reach a conclusion even though a reviewing court might reach a contrary inference. Mercy Health Ctr. v. State Health Facilities Council, 360 N.W. 2d 808, 811-12 (Iowa 1985); Langley v. Employment Appeal Bd., 490 N.W.2d 300, 302 (Iowa Ct. App. 1992). The question is not whether the evidence might support a different finding but whether the evidence supports the findings actually made. Neil, 490 N.W.2d at 82-83, Langley, 490 N.W.2d at 302. The mere possibility the record might support another conclusion does not permit the reviewing court to make a finding inconsistent with the agency finding so long as there is substantial evidence to support it. City of Davenport v. P.E.R.B., 264 N.W.2d 307, 311-12 (Iowa 1978).

In determining, whether substantial evidence exists, the court is to consider all the evidence together, including the body of evidence opposed to the agency’s review. Burns, 495 N.W.2d at 699. In considering all the evidence, including that offered in opposition to the agency’s finding, the court does not compromise the limitation on its scope of review. Id. When review is not denovo, the reviewing court must not usurp the fact finding function of the agency. The agency decision should be affirmed when there is no error of law and the decision is supported by substantial evidence. Heatherly v. Iowa Department of Job Services, 397 N.W.2d 670 (Iowa 1986).

          III. CONCLUSIONS OF LAW

Petitioners appeal from the Iowa State Board of Tax Review’s affirmation of the decision of the Director of the Department of Revenue and Finance. This Court determines there are five (5) issues to be resolved regarding the Director’s decision to sustain the tax assessments with respect to:

(1) AAR car repair;

(2) the assessment against KJ in respect to the repair and restoration of the vintage rail car, Chief Keokuk;

(3) he assessments against KJ and Rail Services for locomotive repair;

(4) he assessment against KJ for repairs to maintenance of way (MOW) cars; and

(5) assessments against KJ for out of state repairs to locomotives and MOW cars.

          A.          AAR CAR REPAIR

Taxpayers appeal from the decision of the Iowa Board of Tax Review concluding that services performed on railroad car repair were subject to Iowa sales tax. Taxpayers argue that services such as painting and welding are incidental to “rail car repair” and are not taxable services. Second, the definition of service under the Iowa statute specifically excludes services performed on tangible properties, such as the cars at issue, which are “delivered into interstate commerce.” The Department, on the other hand, asserts that machine repair, painting, pipe fitting, and welding are enumerated services subject to sales tax, and are not simply incidental to railroad car repair. Further, because the properties were used in Iowa after being serviced they were not immediately “delivered interstate commerce,” and are thus subject to tax.

          I.          Enumerated or Incidental Service

In construing a tax statute, doubts are resolved in favor of the taxpayer, and taxes should be imposed only if clearly intended by the language of the statute. Iowa Movers & Warehousemen’s Assn. v Briggs, 237 N.W.2d 759, 769 (Iowa 1976). “On the other hand, exemption statutes must be strictly construed and any doubts must be resolved against the exemption and in favor of taxation. The burden is on the one claiming the exemption to clearly show his right thereto.” Id. As Taxpayers are claiming an exemption, the statute will be strictly construed against them.

The Iowa Supreme Court recognizes that the legislature does not intend all activities to be taxable, merely because some activities are taxable. Iowa Movers, 237 N.W.2d at 770. Rather, taxes apply only to services enumerated in section 422.43(11). Id. The analysis for challenging a sales tax assessment involves a “two-step” test. “The first question is a legal one: what situations fall under the ambit of the service listed in the statute? The second question is a factual one: what services are involved in the challenged assessment?” Wakonda Club v. Iowa State Bd. of Tax Review, 444 N.W.2d 490, 492 (Iowa 1989) (citing Iowa Movers, 237 N.W. 2d at 770). The second question is resolved by determining the predominant service involved in the situation. Iowa Movers, 237 N.W.2d at 770.

The State concedes that railway repair is not an enumerated service subject to Iowa sales tax. Iowa Code § 422.43 (11) (1997). In re Unitrain Serv., Declaratory Ruling No. 80-144-6A-DR (Iowa Dept. of Rev., August 8, 1980); In re Sales Tax Assessment of Transco, Inc., Declaratory Ruling (Iowa Dept. of Rev., April 16, 1974). “In drafting section 422.43, the legislature was quite explicit in setting forth the type of repair it wished to tax. If the legislature intended to tax this particular service it presumably would have said so.” Unitrain, Dec. Ruling, at 4; Transco, Dec. Ruling at 4.

KJ argues that the services of painting and welding are incidental to railway repair and should not be subject to sales tax, while the Department insists that the predominant services performed are painting and welding which are enumerated services subject to taxation. Iowa Code §422.43(11) (1997); Iowa Administrative Code r. 701-26.34 (1997); Iowa Administrative Code r. 701-26.51 (1997). Whether painting and welding are incidental to railway repair or separate services subject to taxation depends on “the predominant service performed. Briggs, 237 N.W.2d at 770; In re Lithcote Co., Declaratory Ruling, Docket No. 79-88-6-DR (Iowa Department of Revenue, October 1, 1979). In addition, even if painting and welding are incidental to nontaxable railroad car repair, if a separate fee or charge is made for those services, those separate charges are subject to taxation. Lithcote, Dec. Ruling at 5. See Iowa Administrative Code r. 701-26.18(l)(a) (1997). As such, the services of painting and welding are subject to Iowa sales tax if they are (1) independent enumerated services, rather than services incidental to railway repair; or (2) a separate fee or charge is made for the services.

          In applying the Wakonda Club two step analysis, the gross receipts from welding and painting services are within the listed services enumerated in section 422.43(11). As for part two of the analysis, it is those services of painting and welding that are involved in the challenged tax assessment. Further, even if the services of painting and welding are merely incidental to railway car repair, separate fees were paid as consideration for the welding and painting services performed by KJ. The fact that the charges for welding were part of a larger fee schedule does not change the fact that welding was particularly listed and charged at a particular price. Therefore this Court concludes that substantial evidence exists in the record to affirm the Director’s decision that certain services performed for railway car repair are enumerated services subject to taxation.

          2.          Interstate Commerce

Taxpayers argue that AAR car repair services are specifically excluded from taxation because services were on tangible property delivered into interstate commerce. Taxpayers assert that the cars were delivered into interstate commerce as soon as the repairs were concluded. The Department and the Director take the position that because the rail cars were delivered to a person or entity in Iowa, the interstate exemption does not apply, even though the rail cars were thereafter placed in interstate commerce.

Iowa. Code section 422.42(6) states in relevant part:

          “Gross taxable services” means the total amount received in money, credits, property, or other consideration, valued in money, from services rendered, furnished, or performed in this state except where such service is performed on tangible personal property delivered into interstate commerce... (emphasis added.)

          Iowa Code §422.42(6) (1997). As section 422.42(6) is an exemption statute, rules of strict statutory construction apply. Any doubt will be resolved against the taxpayer and in favor of taxation. Iowa Movers, 237 N.W.2d at 769.

          In 1967, the Iowa Legislature promulgated the exemption for services performed on tangible personal property delivered into interstate commerce. Prior to 1967, under the guise of the Commerce Clause, the law allowed states to tax services performed within the taxing state, even if delivered immediately into interstate commerce. Independent Warehouses, Inc. v. Scheele, 67 S. Ct. 1062, 1064-65 (1947). Prior to Iowa’s exemption for services delivered into interstate commerce, the Iowa Supreme Court determined that when tangible goods are delivered directly into interstate commerce, the goods are not subject to taxation. Dodgen Indus., Inc. v. Iowa State Tax Commission, 160 N.W.2d 289 (Iowa 1968). But, if the goods are delivered and transfer possession within the state of Iowa, and then delivered interstate, an intrastate transaction that is subject to taxation has occurred. Dodgen, 160 N.W.2d at 294. This Court is convinced that when current section 422.42(6) was promulgated in 1967, it was likely that the legislature intended to place the exemption for services performed on tangible personal property on the same footing as sales of personal property. As such, services performed on tangible personal property are exempt only if delivered directly into interstate commerce.

Prior to December 24, 1986, KJ was exclusively an intrastate carrier, (Tr. 11-12, 197), and the interstate exception was inapplicable. Following December 24, 1986, services were performed on AAR rolling stock in Iowa. Following repair, the cars were delivered to a destination in Iowa before any interstate travel occurred. (R. 197-201.) The fact that the property was then delivered into interstate commerce is separate and distinct from the local transaction which is the taxable event. Dodgen, 160 N.W.2d at 295 (quoting International Harvester Co. v. Department of Treasury, 322 U.S. 340, 345-46 (1944)). Since the services on the personal property in question were performed and delivered within the state of Iowa, taxation on the services is appropriate. Oklahoma Tax Commission v. Jefferson Lines, Inc., 115 S. Ct. 1331 (1995). As such the decision of the ALJ that the interstate exception is inapplicable is supported by substantial evidence.

          B.          CHIEF KEOKUK

          At issue is whether repairs made to the vintage antique railway car, The Chief Keokuk “Chief”), are subject to taxation. The Wakonda Club and Lithcote declaratory rulings remain relevant to the analysis of whether services performed on the Chief are taxable. Wakonda Club, 444 N.W.2d at 492; Lithcote, Dec. Ruling, at 5. Among other arguments, Taxpayers insist that services performed on the Chief are exempt from taxation as, “gross receipts from sales of tangible personal property, used or to be used as railroad rolling stock for transporting persons or property, or as materials or parts thereof.” Iowa Code §422.45(10) (1997). The Department, however, determined that the particular services performed on the Chief were enumerated services subject to taxation, and not exempt rolling stock. This Court concludes that services performed on the Chief are distinguishable from personal property used as “rolling stock” under section 422.45(10). Cedar Valley Leasing v. Iowa Department of Revenue 274 N.W.2d 357 (Iowa 1979). As such, the services are not encompassed by that exemption.

Taxpayers challenge the assessment of taxes on the services performed by Ewart’s Welding & Fabricating. The burden of proving entitlement to a tax exemption is on the taxpayer. Southern Sioux City. Rural Water Systems., Inc. v. Iowa Department of Revenue, 383 N.W.2d 585, 587 (Iowa 1986). Welding, not incidental to car repair, is a separately enumerated taxable service. Iowa Code §422.43(11) (1997). In deposition, Ralston Taylor, General Manager of KJ, stated that Ewart’s services included welding and other work, but did not know the exact apportionment for welding. (Taylor Department. 37-43.) However, at the contested case hearing, Taylor was able to apportion the amount of each invoice that constituted welding, labor, fabricating, or otherwise. (Tr. 98-101). It was the conclusion of the ALJ and the Director that KJ had not satisfied their burden of proving the Ewarts’ services were not for welding, an enumerated taxable service. This Court finds substantial record in the evidence to conclude likewise.

Taxpayers challenge the tax assessment of HELP Temporary Placement services. KJ asserts that temporary employee services are not an enumerated taxable service and it is immaterial that the temporary work performed was electric. The Department and Director take the position that the work. performed by HELP was primarily electrical, and Taxpayers failed to satisfy their burden that work performed was other than electric. Electrical and electronic repair are enumerated services subject to taxation. Iowa Code § 422.43(11) (1997); Iowa Administrative Code r. 701-26.16 (1997). Although the work performed by HELP was primarily electric, it was Taxpayers’ burden to demonstrate the amounts expended on work that was non-electric. (Tr. 83-85, 205; Ex. R16-6, 122, 129, 133, 135, 140, 149, 157, 164, 168, 172, 175, 177, 183.) To the extent some of HELP’s services were other than electrical this Court is convinced that KJ failed to specifically demonstrate that amount. As such, there is no basis to exclude any of HELP’s work from the tax assessment.

Mike Holmes was an independent contractor employed by KJ to do electrical work.

          Holmes billed for his time, rather than for his service. (R16-10, 11, 15, 18, 19, 21, 25, 26, 27, 29, 42, 45, 50, 51, 53, 55, 98., 125.) While Holmes performed electrical work, Ralston Taylor testified that Holmes primary service was ‘s, or car repair, work. (Tr. 93.) Electrical work is an enumerated service subject to taxation. Iowa Code §422.43(11) (1997); Iowa Administrative Code r. 701-26.16 (1997). John Pollitt was an independent contractor employed by KJ to do plumbing work. Pollitt’s work consisted primarily of plumbing services performed on car repair or restoration services. Pollitt did not bill specifically for plumbing, but for his time. (R16-8, 12, 16, 17, 20, 22, 23, 24, 28, 30: 32,33,43,46,49, 52.) Pipe-fitting and plumbing are specifically enumerated services the gross receipts of which are subject to taxation. Iowa Code § 422.43(11) (1997); Iowa Administrative Code r. 701-26.36 (1997). This Court concludes that to the extent Pollitt or Holmes performed work that was neither plumbing nor electrical, KJ failed to specifically demonstrate that amount.

Zeigler Painting and Sandblasting performed painting work on the Chief. (R16-7;Tr.87.) Taxpayers contend that Zeigler’s painting was a separate charge incidental to the overall service of car repair and restoration. (Tr. 88.) Mike Turner, doing business as Turner Sign Studios, performed decorative scrollwork, pattern work, and lettering on the Chief (R16-80, 93, 101, 121, 174.) Taylor testified that Turner’s work consisted of decorative work on railroad rolling stock. (Tr. 119.) Contrary to KJ’s assertions, this Court is convinced that painting performed by Zeigler and Turner are enumerated service subject to taxation. Iowa Code §422.43(11) (1997), Iowa Administrative Code r. 701-26.34 (1997),

Numerous invoices exist from Jim Lewiston, doing business as Pipe Works. (R16-77, 78, 94, 96, 102:, 109, 119, l37, 139, 143, 148.) Lewiston worked with John Harmon and Mark Whaley in general work that needed to be done. (Tr. 117.) Taylor testified at the contested case hearing that he considered Lewiston’s services to be general carmen’s work. (Tr. 117-18.) However, the invoices do not categorize whether the services Lewiston performed were anything other than enumerated services. Taxpayers did not present evidence to convince this Court the tax assessment for Pipe Works, Harmon, and Whaley were not correct. Donald Balentine, (R16-57), Harold Seltzer, (R16-59), Joe Collier, (R16-60), Dave Ewinger, (R. 61), John Applegate, (R16-69), and Andrew Wayson, (R16-84), were hired to sand off the bad exterior paint that the paint contractor had put on the Chief. The invoices were not detailed, but only set out the time spent on the job. As stated, painting is an enumerated service subject to taxation. Further included within the definition of painting is “... all necessary preparations thereto, including surface preparation.” Iowa Administrative Code r. 701-26.34 (1997). This Court is convinced the ALJ and the Director correctly determined that the work of these individuals was an integral part of painting the rail car, and properly upheld the tax assessment.

Richard’s Upholstery performed upholstery services on the Chief. (R16-87.) Taylor testified that upholstering required stripping the upholstery from the old seats, redoing the seats and woodwork, and reupholstering the seats with new material. (Tr. 121.) Persons engaged in repairing, restoring, renovating, or cleaning,. . . upholstery are performing a taxable service. Iowa Code § 422.43(11) (1997); Iowa Administrative Code r. 701-26.22 (1997). As Richard’s Upholstery were performing services in accord with the definition of the taxable service of upholstering, the tax assessment was correct.

Seither & Cherry Company are in the business of mechanical and electrical contracting. Taylor testified he did not know exactly the nature of the work performed by them on the Chief, but that some work was performed. (Tr. 122; R16-120.) The ALJ determined that the evidence concluded the work performed by Seither & Cherry Company was electrical, and therefore an enumerated service. KJ has presented no evidence to dispute the tax assessment.

Comet Industries repaired the Chief s brakes. (R16-85; Tr. 120.) The Director amended the ALJ’s ruling to exclude taxation on Comet Industries services because the Department conceded that repair of brakes was not taxable. This Court finds substantial evidence to support the Director’s findings.

          2.           Interstate Commerce

Taxpayers contend taxes cannot be assessed on the Chief because it was delivered into interstate commerce, and therefore specifically excluded under section 422.42(6). However, the work performed on the Chief occurred in Iowa, while the Chief was in the possession of KJ. (Tr 201.) The Director determined the Chief was not in interstate commerce prior to its restoration, and there was no assurance the Chief would be placed in interstate commerce after its restoration. This Court finds substantial evidence in the record to affirm the decision of the Director that the Chief was not immediately delivered into interstate commerce, and was therefore subject to taxation.

          C.          LOCOMOTIVE REPAIR

          At issue is whether KJ’s repair of locomotives is subject to taxation. The Director held and the Department urges that locomotives repair is included within the enumerated service “machine repair of all kinds” and therefore taxable. Taxpayers, on the other hand, argue that “locomotive repair” is not a specifically enumerated taxable service, and should not be subject to taxation. Taxpayers insist locomotive repair is not categorized as machine repair, but rather as “rolling stock repair,” which the legislature did not enumerate as a taxable service.

Service performed on locomotives is not specifically listed as a taxable service, however, “machine repair of all kinds” is a specifically enumerated service. Iowa Code §422.43(11) (1997). A machine is an “instrument composed of one or more of the mechanical powers, and capable, when set in motion, of producing by its own operation certain predetermined physical effects.” Transco, Dec. Ruling, at 5; Iowa Admin. Code r. 701-26.29 (1997). In Transco, the Director of the Department of Revenue concluded that a “...railroad car, (excluding locomotives), generally is not a machine.” Transco Dec. Ruling, at 5 (emphasis added.) The evidence presented allow this Court to conclude that services performed on locomotive repair are taxable as “machine repair of all kinds.”

Taxpayers point out that the tax exemption for sales of tangible personal property used as railroad rolling stock includes within that definition both locomotives and railcars. Iowa Code § 422.45(10) (1997); Iowa Admin. Code r. 701-17.13 (1997). Taxpayers contend the combining of locomotives and railcars as rolling stock for exemption demonstrates a legislative intent to give railcars and locomotives the same tax treatment. Their argument continues that just as the legislature exempted both items of personal property utilizing the term “rolling stock” if the legislature wanted to tax both services, it would have specifically enumerated “rolling stock repair” in section 422.43(11).

Taxpayers’ reasoning fails to consider that “the sales of personalty and the furnishing of services are consistently regarded as separate and distinct transactions.” Cedar Valley Leasing, 274 N.W.2d at 361. Railcars and locomotives can possess different definitions for the purpose of tax exemption for sales versus tax status for services. For the purpose of sales of tangible personal property, locomotives are rolling stock, but for the purpose of enumerated services locomotives are not railroad rolling stock and are not exempt from tax. Iowa Admin. Code r. 701-17.13 (1997). When taxing services, locomotives can be defined as “machines of all kinds” while excluding rail cars from that definition, and locomotives and railcars can together be defined as rolling stock for tax exemption of sales of personalty. Transco, Dec. Ruling, at 5. Simply stated, the general repair of a locomotive is “machine repair of all kinds,” while general repair of a railcar is not the repair of a machine.

2. Interstate Commerce

Taxpayers make an argument that locomotive repair is excluded from taxation as, “services on tangible personal property delivered into interstate commerce.” Iowa Code 422.42(6) (1997). The record indicates that the repairs were performed in Iowa, and when completed, the repaired locomotives were delivered to a destination in Iowa. As such, the interstate commerce exemption is inapplicable and the decision of the Director is affirmed.

D. MAINTENANCE OF WAY (MOW) EQUIPMENT

At issue is the tax assessment for repair services performed on Maintenance of Way (MOW) equipment. MOW equipment is used to haul railroad materials on a nonrevenue basis or to repair, maintain, or construct track, and is generally powered by a motor or engine. The AJL determined that repair work on MOW equipment is taxable as either an enumerated service on “machine repair of all kinds,” or as separate welding work.

          The ALJ acknowledged that many invoices on repair of MOW equipment, such as the Hy-Rail truck and Hy-Rail backhoe, were both serviced and predominantly used in Illinois, but had been used in Iowa. (R17-3, 7, 9, 10, 12, 14, 15, 16, 17, (R17-18, 19, 21 was service work performed on the Hy-Rail backhoe in Iowa with primary usage in Illinois); Tr. 136-44.)) The primary service involved on the Hy-Rail equipment was welding. Welding is a specifically enumerated taxable service. Iowa Code § 422.43(11) (1997). Further, the Director affirmed the ALJ’s determination that the MOW equipment is machinery, and encompassed within the taxable service of “machine repair of all kinds.” lowa Code §422.43(11) (1997). Although MOW equipment is encompassed within “rolling stock” for the purpose of sale of tangible personal property, taxes on sales of personalty versus furnishings of services are distinct and separate transactions. Iowa Code 422.45(10) (1997); Iowa Admin. Code r. 701-17.13 (1997). See Cedar Valley, 274 N.W.2d at 361. As such, this Court is in agreement with the Director that the repair of Hy-Rail equipment is a taxable service. Repair work was performed in Illinois on a MOW railroad ballast car. (Tr. 151.) The ALJ determined and the Director affirmed that work performed on the ballast car was welding, an enumerated taxable service. KJ has not demonstrated entitlement to a tax exemption for services performed on the railroad ballast car. Rural Water Systems., 393 N.W.2d at 587. As such, the tax assessment is affirmed.

Other MOW repairs included repair on a tamper, a device which forms a firm foundation for railroad track. Repair on the tamper was performed in Illinois and the tamper was used and maintained in Illinois. (R10-1; Tr. 156-57.) Work performed on a air-powered spike track, similar to a jackhammer, was also used predominantly in Illinois. (R10-5; Tr. 157-58.). The Department determined that these repairs were performed to “machines.” Iowa Admin. Code r. 701-26.29 (1997). This Court is convinced the Department is correct in its assessment.

Repair work was done by Dobson Welding in Illinois, without an exact indication of the work performed. (R10-18; Tr. 161-62.) The Department determined, and this Court has not been convinced otherwise, that Dobson performed the enumerated service of welding. As such, the determination by the Director that MOW services were taxable is affirmed.

          E. USE TAX

As this Court has determined that the tax assessment for the services involved in this appeal are correct, it must be determined whether Iowa use tax is applicable where the services were performed outside of Iowa. The Director affirmed the decision of the ALJ to assess use taxes on services used in Iowa. Taxpayers insist that use in Iowa was minimal and the use tax should not apply.

In Iowa, an excise tax is imposed on the use in this state of services enumerated in section 422.43 at the rate of five percent. This tax is applicable where services are rendered, furnished, or performed in this state or where the product or result of the service is used in this state.

          Iowa Code § 423.2 (1997). “Use” is the exercise by a person of any right or power over tangible personal property incident to the ownership of that property, excluding the sale in the regular course of business. Iowa Code §423.1 (1997). The purpose of the use tax is to supplement the sales tax. Chicago B. & Q R.R. Co. v. Iowa State Tax Commission, 142 N.W.2d 407, 410 (Iowa 1966). The tax is on the privilege of use after commerce is at an end. Inter-State Nurseries, Inc. v. Iowa Department of Revenue, 164 N.W.2d 858, 861 (Iowa 1969) (quoting Henneford v. Silas Mason Co., 57 S.Ct. 524, 526 (1937)). As such, when services are taxable if performed in Iowa, the service is likewise taxable when consummated outside of Iowa, but the product or result of such service is used in Iowa. Id.; Iowa Admin. Code r, 701-31.1 (1997), See In re Transco, Supp. Order (June 1, 1974).

With certain restrictions, interstate commerce can be required to pay its fair share of state taxes. D.H. Holmes Co., v. McNamara, 108 S.Ct. 1619, 1623 (1988); Kartridg Pak Co. v. Department of Rev., 362 N.W.2d 557 (Iowa 1985). A “taxable moment” exists at the end of interstate transportation, before being used or consumed in another interstate operation. Inter-State Nurseries, 164 N.W.2d at 865. The application of a use tax is not dependent on the length of time the property is stored or on its anticipated use. Chicago, B. & Q. R.R., 142 N.W.2d at 412. All services in this appeal were taxable as enumerated services under section 422.43(l 1).

          These services are taxable in Iowa when the product or result of out of state service is used in Iowa. Iowa Code §423.2 (1997). A reasonable inference from the record is that all rolling stock that was serviced outside of Iowa was subsequently used in Iowa. To the extent that KJ serviced rolling stock outside of Iowa that was not used in Iowa, this Court is convinced Taxpayers have not met their burden of establishing the service was not used in Iowa.

The Department argues that the challenged use tax assessment is constitutional under the Commerce Clause. To challenge a state tax under the Commerce Clause, the challenger must demonstrate that:

(1) the activity being taxed does not have a sufficient nexus with the taxing state to justify taxation by that state, or

(2) that the tax discriminates against interstate commerce, or

(3) that the tax is unfairly apportioned, or

(4) that the tax is unrelated to services provided by the state.

Jefferson Lines, 115 S.Ct. at 1337 (citing Complete Auto Transit v. Brady, 97 S. Ct. 1076 (1977)); Kartridg, 362 N.W.2d at 561. Although this Court is convinced the use tax assessment is constitutional under the Commerce Clause, this issue was not raised by Taxpayers on appeal. As such, this Court affirms the Director’s decision to assess a use tax on services performed outside of Iowa, when the product or result of that service is used in Iowa.

RULING

IT IS THEREFORE ADJUDGED, ORDERED, AND DECREED that the Decision of the Iowa State Board of Tax Review is AFFIRMED. Costs of appeal are assessed to Petitioner, Keokuk Junction Railway Co.

          DATED this 5th day of January, 1998.

          Ray Fenton

          Fifth Judicial District of Iowa

          COPIES TO:

          Richard A. Malm
DICKINSON, MACKAMAN, TYLER & HAGEN, P.C.
1600 Hub Tower
699 Walnut St.
Des Moines, IA 50309-3986
ATTORNEY FOR PETITIONER

          Harry M. Griger
Special Assistant Attorney General
1223 E. Court Ave. Executive Hills East
Des Moines, IA 50319
ATTORNEY FOR RESPONDENT

BEFORE THE IOWA STATE BOARD OF TAX REVIEW

HOOVER STATE OFFICE BUILDING

DES MOINES, IOWA

          IN THE MATTER OF          *

          

          KEOKUK NORTHERN REAL ESTATE CO.          *          FINDINGS OF FACT

          d/b/a KEOKUK JUNCTION RAILWAY                    CONCLUSIONS OF LAW

           AND RAIL SERVICES OF IOWA CO.          *          AND ORDER

          117 S. Water Street

          Keokuk, Iowa 52632          *

          

          SALES/USE TAX          *          DOCKET NO. 802

          ______________________________________________________________________________

          

          On January 27, 1997, the above captioned case came on for hearing pursuant to Notice of Time and Place of Hearing given both parties as provided by law on January 10, 1997. Present were Board members Harold White, chairperson, and Maria Waterman. Board member Richard Peebler was absent. A quorum being present, the Board found that it had jurisdiction of this appeal and ordered this matter to proceed to hearing. Appearing on behalf of the Taxpayers was Richard A. Malm of the law firm Dickinson, Mackaman, Tyler & Hagen, P.C., Des Moines, Iowa. Appearing on behalf of the Department was Harry M. Griger, special assistant attorney general.

The Board, having reviewed the file in this case and the Director’s order on review and having considered the briefs and argument of counsel for both parties, makes the following:

FINDINGS OF FACT

The Board adopts as its Findings of Fact the Findings of Fact in the administrative law judge’s proposed decision dated May 30, 1995, as modified by the Director’s order on review dated December 18, 1995.

On the basis of these Findings of Fact and having reviewed the entire record and the briefs and arguments of counsel for both parties, the Board reaches the following:

CONCLUSIONS OF LAW

The Taxpayers in this appeal from the decision of the Director dated December 18, 1995, and his order on re-hearing dated January 10, 1996, make five assignments of error that we are asked to resolve the Director’s sustaining the tax assessments in respect to:

(1) American Association of Railroad (AAR) car repair;

(2) the assessment against Keokuk Junction (KJ) in respect to the repair and restoration of the vintage rail car;

(3) the assessments against Keokuk Junction (KJ) and Rail Services (RS) for locomotive repair;

(4) the assessment against KJ for repairs to maintenance of way cars; and

(5) assessments against KJ for out of state repairs to locomotives and maintenance of way cars.

A short review of the background giving rise to this dispute is instructive. KJ owns and operates a “short line” railroad between Keokuk, Iowa and LaHarpe, Illinois. Rail Services, one of the Taxpayers in this case, is a related company which is owned by the principal shareholders of Keokuk Junction. It provided tract repair and construction and car repair for part of the audit periods. It is now dormant. KJ commenced operation on September 1, 1981, and initially was entirely intrastate with 1.5 miles of track in Keokuk, Iowa. On December 24, 1986, it expanded and became an interstate carrier by acquiring a 28.5 mile line to LaHarpe, Illinois. KJ is a class III interstate carrier, is subject to the Interstate Commerce Act, and is a signatory to the American Association of Railroad’s car interchange rules. The Taxpayers’ revenue operations include freight movement, switching and car repair. KJ also owns a vintage railroad passenger car which it leases for use outside Iowa. KJ does rail construction work on their rail lines. KJ switches cars in and out of a manufacturing plant in Keokuk and connects with larger railroads such as the Burlington Northern, Santa Fe and another short line railroad with connection to Peoria, Illinois.

The first item on appeal is the assessment for sales tax on the portion of the charges made by KJ to the rail car owners for repair. Rail cars travel freely along the nation’s railroads and AAR rules require a railroad to provide repairs to a damaged car that comes into its possession, regardless of who owns the car. The audit items in Docket No. 406 were attributable to a welding job. Repair items in docket no. 407 were for welding and painting. Each item of repair is assigned a job code by AAR and has a separate rate charge, which when added together constitutes the total bill owed by the car owner.

The Taxpayers argue that the services of welding and painting are not subject to Iowa tax because they are merely incidental to the total services performed. Such services include inspection, pipe fitting, painting, carpentry, parts installation or reconditioning and welding. The Taxpayers claim these repairs are excluded under Iowa Code §422.42(4) in that they were performed on tangible personal property delivered into interstate commerce, citing Iowa Department rule 701-26.2(3) IAC.

The Department argues that machine repair, painting, pipe fitting and welding are specifically enumerated in Iowa Code § 422.43(11) as being subject to tax and a separate itemized accounting of each of the repair activities was required by AAR rules and a separate charge is made for each item. Therefore, each repair item must be judged on its own merit alone and cannot be lumped together with non taxable services in an attempt to shield the specific enumerated items from tax. If the rail cars were delivered to a person or entity in Iowa, the interstate exemption does not apply, even though the rail cars were thereafter placed in interstate commerce. The Department cites the cases of Complete Auto Transit v. Brady, 430 U.S. 274, 51 L.Ed.2d 326, 97 S.Ct. 1075 (1977), and Oklahoma Tax Commission v. Jefferson Lines, Inc., 63 U.S.L.W. 4233 (1995), in support of its position that the services are taxable. The services are performed in Iowa and delivered to a person in Iowa. The Taxpayers rely on the order of the Director in the cases of In the Matter of the Sales Tax Assessment of Transco Inc. April 16, 1974, and June 1, 1974, and In Re Petition of Unitrain Services, August 8, 1980. These two cases are distinguished by the Department in that the assessments in the present case were for the specific enumerates services of welding and painting, which are specifically subject to tax.

The repaired cars were placed in service in Iowa immediately after being repaired. Any exemption from taxation must be strictly construed. Hearst Corporation v. Iowa Department of Revenue and Finance, 461 N.W.2d 295, 300 (Iowa 1990). We conclude that the Department must prevail on this issue.

The second issue to be resolved is the purchase and restoration of a vintage rail car. This car was a 1927 Pullman car purchased in 1983 in Baring, Missouri, for a nominal sum from the Santa Fe railroad and hauled to Keokuk for restoration. The car sat on a side track until 1986 when restoration began. In this case welding, electrical repair, and installation of wiring, switches, fixtures are specific services that are taxable under section 422.43(11) and 423.2. Painting and plumbing is also an enumerated taxable service under this Code section. The burden is on the Taxpayers to establish an exemption from the Iowa sales/use tax. These enumerated services were not merely incidental to general car repair.

Replying to the Department’s argument, the Taxpayers argue that the service performed is equivalent to the manufacturer of a new car, which is not taxable, or that it constitutes non-taxable general car repair. They also contend the repair was performed on tangible personal property delivered into interstate commerce. These arguments are not persuasive. The renovation completed by Taxpayers was not analogous to the manufacturer of a railroad car. After the restoration was completed, the car was delivered to persons in Iowa. The fact the car was later placed in interstate service does not make the work non taxable. These arguments of the Taxpayers are not persuasive. The assessment was for specific enumerated services and was performed in Iowa and delivered in Iowa. This constitutes sufficient Iowa nexus for the imposition of the Iowa tax.

For their third ground of appeal, the Taxpayers claim locomotive repair is not taxable because since 1986 the locomotives have been used in interstate service. The use of a locomotive is an integral part of its interstate operations. A locomotive is also a rail car and its repair is not an enumerated taxable service. To counter this argument, the Department claims a locomotive is a machine and machinery repair of any kind is an enumerated service under section 422.43(11) and 423.2 of the Code. The Department relies on Department rule 701-26.29 IAC which states in part:

           . . . machine shall include all devices having moving parts and operated by hand, powered by a motor, engine or other form of energy . . .

Locomotives are powered by an engine for self-propulsion purposes. Locomotives have moving parts. Courts have held that motor vehicles are machines under the ordinary meaning of the term. Northern New York Trust Co. v. Bano, 273 N.Y.S. 694 (1934); Haddad v. Commercial Motor Truck Co., 84 So. 197 (La. 1920). The record discloses no less than twenty-four separate invoices for machine repair to locomotives. As is the case of the other repairs in this appeal, the repairs were performed in Iowa and when completed, the repaired locomotive was delivered in Iowa to a person in Iowa. Under such circumstances, the interstate commerce exemption is not applicable and the locomotive repair is taxable.

In their fourth ground for appeal, the Taxpayers contend that the repair of maintenance of way (MOW) equipment is not taxable because it is rail car repair which is not enumerated taxable service and is tangible personal property delivered into interstate service.

The Department argues that MOW equipment is self-propelled, has moving parts, and as such constitutes a machine; and since machine repair of all kinds is enumerated taxable service, it is subject to tax just like a locomotive. Also a large part of the repair consisted of welding which is a taxable service. Since the work was performed out of state, it is subject to the Iowa use tax when delivered in Iowa to an Iowa person. We conclude the Department’s reasoning is persuasive and the repair to the maintenance of way equipment is taxable if the Taxpayers’ fifth ground on appeal is without merit.

In their fifth ground on appeal the Taxpayers contend that the repair service performed in Illinois on its maintenance of way equipment and locomotives is not taxable because they were used in Illinois and its exposure to Iowa was de minimus during the audit period. They argue the MOW equipment and locomotives do not have a permanent situs in Iowa.

The Department argues that there was sufficient nexus in Iowa for the imposition of the tax. Nexus can occur even if the property was in Iowa for a short period of time. Use does not depend on the length of time the property is stored or on its anticipated use. Chicago, Burlington & Quincy Railroad Company v. Iowa State Tax Commission, 259 Iowa 179, 142 N.W.2d 407 (1966); Interstate Nurseries, Inc. v. Iowa Department of Revenue, 164 N.W.2d 858 (Iowa 1969).

We conclude there was sufficient nexus in Iowa to tax the services performed on the maintenance of way equipment.

We conclude that the Director’s order on appeal should be affirmed.

IT IS THEREFORE ORDERED, ADJUDGED AND DECREED by the Iowa State Board of Tax Review, both members present concurring, that the Director’s order dated December 18, 1995, be and is hereby affirmed.

Dated at Des Moines, Iowa, the 15th day of April, 1997.

IOWA STATE BOARD OF TAX REVIEW

                                                             BY

Harold W. White

Chairperson

BEFORE THE IOWA DEPARTMENT OF REVENUE AND FINANCE

HOOVER STATE OFFICE BUILDING

DES MOINES, IOWA

          IN THE MATTER OF          *

          

          KEOKUK NORTHERN REAL ESTATE CO.          *          ORDER OF DIRECTOR

          dba KEOKUK JUNCTION RAILWAY                    UPON REVIEW OF

          and RAIL SERVICES OF IOWA CO.          *          DECISION

          117 S. Water Street

          Keokuk, Iowa 52632          *

          SALES/USE TAX ASSESSMENT          * DOCKET NOS.          91-30-1-0406

                                        91-30-1-0407

                    *                    91-30-1-0408

On June 26, 1995, the Department filed an appeal to the Director in this matter. On June 29, 1995, a cross-appeal was also filed with the Director. On August 8, 1995, the Director of the Iowa Department of Revenue and Finance reviewed the administrative law judge’s proposed decision. The time for issuance of the Director’s decision was extended. The Director, having examined the entire record developed by the parties, issues the following order.

STATEMENT OF THE CASE

The Director adopts and incorporates into this order the Statement of the Case as set forth in the decision. The Director adds the following to the Statement of the Case: Deposition Exhibit 1-A was offered and admitted; Interrogatory #2 and its response except the last paragraph thereof were offered and admitted; Interrogatory #3 and the answer were admitted except the last paragraph of the answer; Interrogatory #5 and its answer were admitted in its entirety; Interrogatory #6 and its answer were admitted in its entirety; Interrogatory #7 and its answer were admitted in full; Interrogatory #8 and its answer were admitted in full; Interrogatory #9 and its answer were admitted in full; Interrogatory #11 and its answer were admitted; Interrogatory #13 and its answer were admitted; Interrogatory #14 and its answer were admitted; Interrogatory #18 and its answer were admitted; Interrogatory #19 and its answer were admitted; Interrogatory #21 and its answer were admitted; Interrogatory #22 and its answer were admitted; Interrogatory #23 and its answer were admitted; Deposition Exhibit #3 which is the responses to the Interrogatory was admitted in full; Deposition Exhibit #6 was admitted in full; Deposition Exhibit #7 was admitted except for the responses to nos. 9, 11, & 12; and Deposition Exhibit #13 was admitted in full.

FINDINGS OF FACT

The Director, having reviewed the entire file and the transcript, adopts and incorporates into this order the Findings of Fact as set forth in the decision, with the addition of the following: page 10, paragraph 24, the second full sentence is deleted and the following is inserted in lieu thereof: "The Protestor claims fusees are an integral part of locomotives in that locomotives are required by law (Federal Rule at 49 CFR 218.37) to carry fusees." The Director also deletes paragraph 25.

CONCLUSIONS OF LAW

                    I. Were the services performed on the railroad rolling stock properly assessed?

The Director reverses the finding of the administrative law judge on this issue. The decision of the administrative law judge’s proposed decision designated as Division I from page 15 through page 25 is deleted. The Director has reviewed the cases listed and the arguments and holds that in this protest the railroad was charging for specific enumerated services. The invoices in this case clearly specify that the charges made are for the services which are part of the enumerated services in Iowa Code §§422.43(11) and 423.2. The Director finds that the predominate services as set forth in the invoices were enumerated taxable services. The transactions can be distinguished from the Transco and Unitrain facts.

The Director is of the opinion that the decisions of the United States Supreme Court in Complete Auto Transit v. Brady, 430 U.S. 274, 51 L.Ed.2d 326, 97 S.Ct. 1076 (1977), and in Oklahoma Tax Commission v. Jefferson Lines, Inc., 63 U.S.L.W. 4233 (1995), clearly establish the right of the state of Iowa to tax the owners of railcars for "services" performed in Iowa. The Director notes that a truck used in interstate commerce which breaks down is subject to sales tax for the repair services performed in Iowa. Iowa has sufficient contacts to sustain the tax under the commerce clause of the United States Constitution.

The Director holds that the exemption language in §422.42(15), "other than services performed on tangible personal property delivered into interstate commerce," is not applicable to the services of railroad car repairs. Since it is exemption language, the rule of strict construction is applicable. This exemption would be available if the service was performed on personal property that was delivered into interstate commerce for use outside of the State of Iowa. If the property is delivered to a person in Iowa, even if that person is to transport the property outside Iowa, the exemption does not apply. The use of the railcars was immediately after the service in Iowa. It does not exempt from tax all services that have a connection to interstate commerce. The intent was to equalize instate sales and instate services on property delivered into interstate commerce. Therefore the Director finds that the welding and painting charges for AAR railcar repair were taxable.

          II. Were various contract services required in the course of reconstruction of an antique vintage railcar taxable?

The Keokuk Junction bought a used hulk of a railroad passenger car for $1,000.00. The car was moved in a special manner to Keokuk. The car was purchased in 1983 and the decision to restore the car was not made until 1986. The process was not completed until April of 1987. The antique passenger car is not the type of equipment regularly used today by modern railroads. There was no way to determine that this would be a car used in interstate commerce. It is the type of equipment that can be held for the special use of the owners. It was therefore not used in interstate commerce immediately prior to its restoration and there was no assurance of its use after restoration. The director therefore affirms the administrative law judge on her determinations that the enumerated services were taxable. The Director finds that services performed in other states after the "Chief" entered interstate service are not taxable by Iowa. The plumbing, upholstery repair and other enumerated services done in Iowa are taxable. Since the Iowa Code is clear on its exclusion of materials and parts of railroad rolling stock, the Director deletes the administrative law judge’s reference to "materials and parts" on page 26. The order of the administrative law judge is amended to exclude the first full paragraph on page 34 because the department conceded that the Comet Industries repair of the brakes was not taxable. The remainder of Division II is adopted.

                    III. Are repairs of Protestor’s locomotives taxable?

The Director revises the heading by deleting the word "rolling stock" and substituting ”locomotives“. The Director amends the decision for the correction of the quotation on page 35 to add the word "car." With these changes the Director affirms and adopts the administrative law judge’s decision in Division III.

                    IV. (p.35). Is Maintenance of the Way Equipment Repair Taxable?

The Director affirms and adopts the administrative law judge’s decision in Division IV. If the protester paid sales tax on the services performed in Illinois, it is entitled to credit for the taxes paid.

          IV. (P. 36) Are Services Performed Outside of Iowa Subject to Use Tax If The Product or Result Was Used In Iowa?

The Director affirms and adopts the administrative law judge’s decision in Division IV because of the use tax credit for sales taxes paid to Illinois.

          V. Is KJ’s Acquisition of Track           Materials into Inventory Taxable?

The Director affirms and adopts the decision of the administrative law judge on this issue. On appeal the Department asserts that there was no showing to demonstrate that the Protester acquired track material for construction for others and therefore there is no showing that made the Protester a construction contractor and entitled to purchase track and materials tax free under Iowa Code §422.42(12). The witness testified regarding sales of track materials to at least two other industrial customers. This is confirmed by Exhibit 24-W.

The Protester further testified to collecting the tax for the materials sold to the industrial customers. The analogy of the Protester’s business is sufficiently close to qualify the Protester as being a contractor for purposes of that Code section involving sales tax. The Director finds that, pursuant to the recognized accounting systems, once the track materials are affixed they become part of the real estate. This is mandated by interstate commerce commission accounting. Therefore the Director adopts and affirms the administrative law judge’s decision in Division V.

          VI. Are KJ’s Grade Crossing Flashers Purchased For Use, And Installed, In Illinois Taxable?

           The Director finds that the flasher was not purchased for use in Iowa and the Protester did not exercise a taxable use of the property within the State of Iowa sufficient to cause the flasher unit to be subject to Iowa use tax. It was in Iowa only briefly while it was still in transit to storage and use in Illinois. The Director affirms and adopts the administrative law judge’s decision in Division VI.

VII. (p. 46) Is KJ’s Track Switch Rebuilding Taxable?

The Director affirms and adopts the administrative law judge’s holding with regard to this issue. The Director further notes that the rebuilding of the switch points "in track" as testified to by the witness would be a service to the real property owned by the railroad. This is in addition to the finding by the administrative law judge that the services were specifically enumerated as welding.

VII. (p. 47) Are the Red Fusees Exempt from Tax?

The Director adopts and affirms the administrative law judge’s decision on this issue.

          VIII. Is Protestor Entitled to a Tax Credit Upon the Inventory Items?

The Director deletes the administrative law judge’s decision in Division VIII. The Protester has demonstrated substantial compliance with Iowa sales tax procedures and Iowa Code §422.42(12) in filing Iowa and Illinois sales and use tax returns for the materials taken out of inventory and added to the value of the real estate. For the purposes of the facts presented in this case, the Director finds it would not be proper for the Department to require the tax on all inventory items when the taxpayer made a reasonable attempt to properly account for inventory items as they were withdrawn for outside retail sale, or to improve the real estate of the Protester in Iowa, or to improve the real estate in Illinois. The Director therefore holds that because of the facts in this case, the Protester is entitled to credit for the taxes paid on items removed from inventory and for which tax had been paid.

IX. Should Penalties Be Waived?

The Director adopts and affirms the administrative law judge’s findings on this issue.

          X. Does the Exemption for Services Performed on Tangible Personal Property Delivered Into

          Interstate Commerce Apply in this Case?

The Director deletes the decision of the administrative law judge in Division X. The Director holds that the language of §422.43(11) and of §422.42(4) is not applicable in this case. The Director believes that the State of Iowa has sufficient nexus to the providing of services in Iowa to sustain the taxation of those services. The fact that the services are for owners of railroad cars is not sufficient to disallow taxation. The Director holds that the language is exemption language which applies to services when they are performed in Iowa on tangible personal property which is then delivered directly into interstate commerce to a point outside of the State of Iowa. If the recipient of the service is in Iowa, the exemption doesn’t apply even if that recipient then transports the property into interstate commerce. The exemption was to place instate sales and instate services on equal footing with respect to tangible personal property delivered into interstate commerce.

DECISION

The Director therefore deletes the decision section of the proposed decision and substitutes the following.

The Director sustains the taxation of the enumerated services performed on railroad cars including the antique car. The Director sustains the taxation of services on locomotives as machine repair. The tax is sustained on repairs done for an Iowa owner on equipment used in Iowa, even if used also in Illinois.

If the taxpayer can prove sales tax paid to another state, then the Taxpayer is entitled to credit on the Iowa use tax. The Taxpayer in this protest did its accounting in the manner of a contractor making improvement to real estate and making retail sales; therefore it is entitled to credit for the taxes paid in its accounting. The grade crossing flasher was not used in Iowa and therefore no tax is due for it. The rebuilding of the track switches is taxable as an enumerated service of welding. There is no legal ground for waiving penalties and the exemption language in §§422.43(11) and 422.42(4)is not applicable.

The Director’s decision is the final order of the Iowa Department of Revenue and Finance.

Dated at Des Moines, Iowa, this 18th day of December, 1995.

IOWA DEPARTMENT OF REVENUE AND FINANCE

           BY___________________________

G. D. Bair, Director

BEFORE THE IOWA DEPARTMENT OF REVENUE AND FINANCE

HOOVER STATE OFFICE BUILDING

DES MOINES, IOWA

          IN THE MATTER OF          *

          

          KEOKUK NORTHERN REAL ESTATE CO.          *          DECISION

          d/b/a KEOKUK JUNCTION RAILWAY

          AND RAIL SERVICES OF IOWA CO.          *

          117 S. Water Street

          Keokuk, Iowa 5263          *

          

          SALES/USE TAX ASSESSMENT          *          DOCKET NOS.           91-30-1-0406

                                        91-30-1-0407

                                        91-30-1-0408

          STATEMENT OF THE CASE

Protests were received by the Iowa Department of Revenue and Finance ("Department") in the three (3) above-referenced cases on August 26, 1991. On September 21, 1993, the Department filed answers to said protests; and on September 29, 1993, a notice was issued in each case scheduling an evidentiary hearing for June 8, 1994. All three (3) hearings were subsequently continued and rescheduled for March 14, 1995.

On September 29, 1993, an order was issued to consolidate the three (3) protests for consideration at a single hearing; and on February 13, 1995, the parties stipulated that the total tax liability (tax, penalty and interest) in all three (3) protests totals $19,076.32.

Appearing on behalf of the Department was Harry M. Griger, Special Assistant Attorney General, along with Charles Flickinger, Revenue Examiner IV. Attorney and authorized representative for Protestors, Richard A. Malm, appeared along with R.L. Taylor, General Manager for Keokuk Junction Railway.

Prior to the evidentiary portion of the hearing, the parties filed a written stipulation: They agreed that, after giving effect to concessions and alterations, the total tax liability then assessed and claimed in all three (3) protests was $16,768.66; and that Protestors are entitled to a refund of $2,307.66 plus interest.

During the course of the hearing, Ralston L. (“Rich”) Taylor testified. Attached to the written stipulation and received as part of this record are Exhibits 1-A through 24-W. Introduced during the hearing and received as evidence were Protestors Exhibits I through 8, 13, 14 through 25 and 27; along with the Department’s Exhibit A, Deposition of Mr. Taylor taken on February 15, 1995 with the exception of specified portions. The parties presented initial briefs and reply briefs setting forth legal and factual arguments; and these matters were deemed submitted for a decision on May 12, 1995. Now, having fully considered the entire record and the arguments of both parties, I make the following:

          FINDINGS OF FACT

R.L. Taylor testified under oath and was subject to direct and cross-examination. He is a knowledgeable railroad man with many years of experience, working since 1954 with both large and small railroads. He was a credible witness and the Department did not present any rebuttal witnesses or evidence other than the elicited during cross examination and in Taylor’s deposition testimony and interrogatories subscribed by him. I find as facts those set forth by Taylor during the hearing and in his deposition and responses to discovery requests.

1. Keokuk Real Estate Co. is an Iowa corporation which did business under the name “Keokuk Junction Railway” (hereinafter “KJ”). Rail Services is a related entity in that its principal stock is owned by the principal shareholders of KJ. Rail Services formerly provided track repair and construction and railcar repair and did so for a part of the audit period under consideration.

2. KJ is a locally-owned and managed Iowa corporation which owns and operates a “short line” railroad between Keokuk, Iowa, and LaHarpe, Illinois. KJ began operation on September 1, 1981, with track purchased from the bankrupt Rock Island road. For a brief part of the audit period, prior to December 24, 1986, KJ was an intrastate carrier. It was then the smallest railroad in the world, operating just 1.2 miles of switching track for a major customer in the city of Keokuk.

3. As of December 24, 1986, KJ expanded to become an interstate carrier with the acquisition of a 28.5 mile rail line, connecting Keokuk with LaHarpe, Illinois.

4. KJ is currently a Class III interstate carrier subject to the Interstate Commerce Act as a common carrier. It is a signatory to the American Association of Railroads Car Interchange Rules.

5. KJ has eighteen (18) employees.

6. The track which KJ acquired in 1986 was badly deteriorated and under-maintained. KJ thereafter instituted a program to upgrade its Illinois track facilities. There was a significant upgrading and rehabilitation of KJ’s Illinois track system during the audit period under consideration.

7. KJ operates 1.2 miles of track in Iowa and 28.5 miles in Illinois. Before December 24, 1986, KJ operated 1.2 miles of track in the city of Keokuk.

8. KJ provides switching of cars from a major customer in Keokuk, a wet corn processing plant owned by Roquette Co. (formerly Hubinger). Roquette/Hubinger has a fleet of 400 tank cars. KJ “switches” these cars in and out of the Roquette/Hubinger plant. KJ also connects with the Burlington Northern, the Santa Fe, and with various roads serving Peoria, through another shortline the Toledo, Peoria & Western.

9. KJ’s revenue operations include freight movement, switching and car repair. It also maintains an inventory of rail materials, such as ties and spikes, from which it makes sales at retail. It owns a rebuilt vintage railroad passenger car which it leases for passenger service outside Iowa. The KJ also does rail construction work.

10. While Rail Services formerly provided track repair and construction and railcar repair for a part of the audit period, it has now become dormant.

11. Both KJ and Rail Services hold Iowa retail sales tax permits.

12. During the audit period, KJ did repair work on “bad order” cars “received in interchange from other railroads” These freight cars were either cars owned by other railroads or were private cars. Rail cars are required to be in good repair to be used in rail operations; and a “bad order” car is a car that is not in good repair.

13. A badly deteriorated hulk of a 1927 Pullman passenger observation car was acquired by KJ from the Santa Fe Railroad in 1983 for $1,000.00. It was named the “Chief Keokuck” At the time it was acquired, the car was located at Baring, Missouri, and it was not up to minimum standards for movement. It was then moved by a “hospital train” to a KJ siding in Keokuk, Iowa.

14. The hulk remained on a KJ siding for two years. Initially the hulk was sandblasted and painted for preservation purposes. In January 1986, KJ decided to rebuild it for use as a private car in interstate passenger service. over the course of 1986 to April 1987, the car which became the Chief Keokuck was completely rebuilt.

The car was first stripped to a shell. The entire structure was sand or walnut shell blasted, inside and out. Parts and materials from a 1950’s modernization of the car were removed and discarded. The KJ replaced major systems, including the "trucks," couplers, brakes, air conditioning, electrical systems, and mechanical systems. Furnishings, fixtures and systems were restored or replaced in part from another car acquired for salvage. The windows were removed and rebuilt. A kitchen was installed. A sleeping berth was installed. The rear platform, which was badly corroded, was restored. The entire car was painted. All of the work was done in Iowa, while in the KJ’s possession.

15. The finished car, the Chief Keokuck ("Chief"), was delivered to Burlington Northern in April, 1967. Burlington Northern hauled the car in freight services to West Quincy, Missouri. The Chief was then moved by Amtrak in passenger service to Chicago and then on to St. Louis, MO.

16. The general course of the rebuilding of the Chief took place between January, 1986 and April, 1987. After April, 1987, the Chief was placed in service for hire in interstate commerce. From April, 1987 until before the hearing, the Chief was leased to an intrastate, tourist railroad in the Grand Canyon, Arizona area.

17. The work on the Chief Keokuck was like a construction project which proceeded in stages, which were inter-related to each other, and which were performed by a number of craftsmen and contractors, who were both KJ employees and independent contractors. In the railroad industry, repair and rebuilding of railcars requires application of a number of skills including woodworking, welding and sandblasting. All of the persons who work in a car repair shop are called "carmen" and their craft is called "carmen’s work." Other crafts in the railroad industry include engineers, conductors, brakemen, switchmen, dispatchers, and yard workers.

18. The KJ’s expenditures were the equivalent of the creation of a new car and were capitalized on the KJ’s books of account.

19. The most significant contractors who performed work on the Chief Keokuck include Ewart’s Welding and Fabricating of Iowa and Norm Ewart’s Welding of Iowa; John Pollitt and Mike Holmes (a pipefitter and electrician, respectively); Lewiston Pipe Works; HELP Temporary Placement Service; Mark Whaley and John Harmon (general labor and carmen’s work on the Chief); Ziegler Painting and Sandblasting; Turner Sign Studio; and miscellaneous persons that did various carmen’s work, upholstering, air conditioning, rolling stock part repairs and mechanical contract work.

20. KJ acquired track materials including spikes, ties, plates, couple bars, anchors and boots; and during the audit period KJ maintained an inventory of such materials from which it made sales to the public to customers with private track. KJ also used such materials in the construction of its own lines and in construction for other parties. Most of the materials were purchased for use in Illinois in connection with KJ’s program for upgrading Illinois track.

21. KJ maintained a system of accounting for its inventory of track materials whereby it accounted for items as they were withdrawn for sale for KJ’s use. As items were withdrawn, sales/use tax returns were filed initially in Iowa, and later in both Iowa and Illinois. Because its inventory of track materials is of fungible items, KJ is unable to show an item by item connection between the audit items (as purchased) and the track materials (as withdrawn) listed in its tax returns.

(Taylor testified that all of the KJ material was ultimately accounted for, either when sold or used or by reporting what was left in inventory when KJ ceased using the inventory system; and this testimony is unrebutted.)

22. KJ purchased flasher materials to upgrade its Illinois grade crossings (i.e. rail/highway intersections). KJ has no Iowa grade crossings equipped with flashers, but has eight (8) such installations in Illinois. In addition to new flashers the upgrading included installation of new masks, crossbucks, and other associated appurtenances.

Various items were specifically ordered for installation in Illinois. These items were initially delivered by common carrier, to the KJ’s engine house in Keokuk, Iowa; and in turn these items were hauled by KJ to a Hamilton, Illinois storage shed where they were stored until actually put to use. The time spent in Iowa, before the items were transferred to Illinois, was limited. The possession in Iowa by KJ was as brief as KJ could make it consistent with its normal operating practice.

23. KJ purchased a number of items for repair of switch points "in track," i.e. work done in place at the site of the track. The work was performed to restore switches which had been worn down from their original profile. The restoration is accomplished by a series of metal laminations created by repetitive welding of a metal head on the switch point followed by grinding to shape the profile. Said work includes an implicit travel charge.

24. KJ also purchased a number of items for "fuses;" i.e. red signal flares. Fuses are an integral part of locomotives in that locomotives are required by law (Federal Rule at 49CFR 218.37) to carry fuses. When used, fuses are usually placed in the appropriate hole in the coupler knuckle, or alternatively placed on the running board of cars or locomotives, or held in the hand of a trainmen. Sometimes they are placed on the ground.

25. KJ’s inventory or purchases included items that were for purchase or fabrication of parts, either for cars such as the Chief Keokuck or for locomotives, or which were parts or materials for car repair. (Protestor contends these items are sales tax exempt as "parts and materials of rolling stock."

26. The Iowa Department of Revenue and Finance (Department) audited Keokuk Junction Railway’s sales of tangible personal property and services, for Iowa sales tax purposes, for tax periods July 1, 1985 through June 30, 1990. It is this audit and assessment which are in issue in Docket No. 91-30-1-0406.

The Department audited Keokuk Junction Railway’s purchases of tangible personal property and services, for Iowa use tax purposes, for tax periods July 1, 1985 through March 31, 1990. It is this audit and assessment which are in issue in Docket No. 91-30-1-0407.

The Department audited Rail Services of Iowa Co.’s sales of tangible personal property and services, for Iowa sales tax purposes, for tax periods July 1, 1985 through March 31, 1990. It is this audit and assessment which are in issue in Docket No. 91-30-1-0408.

          CONCLUSIONS OF LAW

The Iowa Department of Revenue and Finance has jurisdiction of this matter under the authority of Iowa Code §422.70 made applicable by §§ 422.59, 423.23. This is a contested case arising out of the consolidated protests of three sales/use tax assessments for audit periods from July 1, 1985 to June 30, 1990. Two of the protests (Docket Nos. 91-30-1-0406 and 91-30-1-0407) were filed by Keokuk Northern Real Estate Co., d/b/a Keokuk Junction Railway Co. (”KJ“). The other protest was filed by Rail Services of Iowa (”Rail Services“) a related company. The protests present a variety of issues concerning the application of Iowa sales and use tax on various kinds of goods and services in interstate commerce.

The three audits involved seek to impose Iowa sales or use tax liability on KJ and Rail Services for KJ’s sales of services to others (Docket 91-30-1-0406); KJ’s purchases of goods and services (Docket 91-30-1-0407); and Rail Services sales of goods and services (Docket 91-30-1-0408). The disputed items assessed, for the most part, arise from the conduct of an interstate railroad business, and concern KJ. KJ operates a railroad primarily in Illinois, both with track and general offices in Iowa, and simultaneously offers various related goods and services at retail.

The instant case involves assessments. Protestor has the burden to show that an assessment is erroneous. Richards v. Iowa Department of Revenue, 360 N.W.2d 830, 831 (Iowa 1985). If Protestor has failed to present evidence to clearly substantiate a particular claim, Protestor cannot prevail on such claim.

Some of the Protestor’s contentions are based upon exemption statutes. The Iowa Supreme Court has repeatedly held that tax exemption statutes, including sales and use tax exemption statutes, must be strictly, not broadly, construed with all doubts as to entitlement to exemption resolved in favor of taxation and against exemption. Hearst Corporation v. Iowa Department of Revenue and Finance, 461 N.W.2d 295, 300 (Iowa 1990); Hope Evangelical Lutheran Church v. Iowa Department of Revenue and Finance, 463 N.W.2d 76, 84 (Iowa 1990), cert. denied, 111 S.Ct. 1585 (1991); Iowa Auto Dealers Association v. Iowa Department of Revenue, 301 N.W.2d 760, 762-3 (Iowa 1981); Peoples Gas & Electric Co. v. Iowa State Tax Commission, 238 Iowa 1369, 1374, 28 N.W.2d 799, 803 (1947). ”Taxation is the rule and exemption therefrom the exception; and the claimant of such an exemption must show his right thereto by evidence which leaves the question free from doubt.“ Jones v. Iowa State Tax Commission, 247 Iowa 530, 534, 74 N.W.2d 563, 565 (1956). ”The party seeking the exemption has the burden of proving its entitlement.“ Heartland Lysine, Inc. v. Department of Revenue and Finance, 503 N.W.2d 587, 588-9 (Iowa 1993). ”The claimant for exemption must show that his demand is within the letter as well as the spirit of the law.“ Jones, 247 Iowa at 534-5, 74 N.W.2d at 565. The burden to show clear entitlement to a statutory exemption is heavy. If the matter is debatable, the exemption claimant cannot prevail.

Protestors acknowledge that the burden of proof rests with them. However, it is true as they point out that they have presented substantial evidence and that Mr. Taylor’s testimony, at the hearing and by deposition, is the record in these matters and that the Department has essentially offered no rebuttal evidence. The Department limited its case to an offer of the deposition of KJ manager, Rich Taylor, and KJ interrogatory answers. In effect, the Department relies on the facts as Mr. Taylor relates them and the benefit of a presumption that the portion of its assessment not previously conceded is correct.

The issues to be considered are those set forth in the statement of issues in the notice of hearing issued on September 27, 1993.

I. Were The Services Performed On Railroad Rolling Stock Properly Assessed?

During the audit period, KJ did repair work on “bad order” cars “received in interchange” from other railroads. See FOF #12. The entire assessment in Docket No. 91-30-1-0406 relates to the assessment of sales tax by Iowa on portions of the charges by KJ to car owners for bad order car repair. The Department contends parts of these invoices were for separate enumerated service of “welding.” The invoices indicated that the charges were for “AAR” car repair on interchange cars, or they generally relate to AAR car repair. The overall repairs were performed by the KJ on “bad order” cars which came into its hands as a part of interstate railroad operations. The use, maintenance, and repair of railcars is governed, pursuant to mandate of federal law, under AAR Car Interchange Rules. The AAR rules include specific rules for the repair of cars as a part of a system that provides for the efficient use of railcars in the nation’s integrated rail system. The AAR rules include a standardized method for computing the charges for repairs and for billing such charges.

The KJ is a signatory of the AAR Interchange Rules and participates in this system. The audit items in Docket 91-30-1-0406 include portions of some 67 invoices for car repair services rendered by the KJ from the period March 12, 1986 through May 30, 1990 (Ex. 3-C; Ex. 11-J). The audit items in Docket 91-30-1-0407 include four such invoices (Ex. 12-K, R16-184 to R16-187). These services were for repairs made to cars at Keokuk, Iowa, "Per AAR Interchange Rules." Docket 91-30-1-0406 audit entries reflect the auditor’s singling out of entries on these AAR car repair billings for services that relate to "welding" as a part of the overall repair. See Ex. 3-C. The four invoices in Docket 91-30-1-0407 relating to this issue include welding and painting items.

Each of the invoices, from which audit items were extracted, reflects an overall car repair service. These services were performed, and were billed to the car owners, in strict accordance with AAR Interchange Rules.

Protestor contends that repair services performed on locomotives, railcars, and maintenance of way equipment are not subject to Iowa sales tax or use tax because Protestor contends that rolling stock repairs are not an enumerated service taxed under Iowa Code sections 422.43 (11) and 423.2. In this regard, Protestor relies upon an Order of the Director of Revenue and Finance (Director) in In The Matter of the Sales Tax Assessment of Transco, Inc., April 16, 1974 and June 1, 1974, and upon Declaratory Rulings in In Re: Petition of Lithcote Company, October 1, 1979, and in In Re: The Petition of Unitrain Services, August 8, 1980.

The Department contends that the instant case involves services enumerated under sections 422.43 (11) and 423.2 for which a fee or charge was made and, therefore, such services are subject to Iowa sales or use tax. Specifically, section 422.43 (11) imposes the Iowa sales tax on the enumerated service of "welding." Department rule 701 IAC 26.51 provides that "[p]ersons engaged in the business of welding materials whether for the purpose of mending existing articles, adding to them or creating new articles are rendering, furnishing or performing a service, the gross receipts from which are subject to tax.”

To be subject to sales tax, taxpayer is required to come clearly within terms of the statute. Associated General Contractors of Iowa v. State Tax Commission, 255 Iowa 673, 123 N.W.2d 922 (1963). As applied to services, “the tax applies only to. . . enumerated services.” Moreover, the question of whether a particular item is within specifically enumerated service turns on the predominant service involved in-the situation. Iowa Movers and Warehousemen’s Association v. Briggs, 237 N.W.2d 759, 769-770 (Iowa 1976). In case of doubt the issue goes to the taxpayer.

In the rulings, supra, the Director of Revenue has applied these basic concepts to find rail car repair not taxable. The Transco case involved the operation of a shop for the “repair and renovation of worn or damaged railroad rolling stock.” The work considered in Transco was AAR car Repair. As stated in Transco:

Rates charged for repairs and billing procedures are regulated and set under rules of the American Association of Railroads (AAR). The standards set by the AAR are based upon the “Car Interchange Rules” of the Interstate Commerce Commission. 49 U.S.C. §3 (4), et seq. Among the AAR rules is one prohibiting the collection of local sales taxes on the gross charge for repair services rendered on the rolling stock of member railroads. The taxpayer testified to the strict rigidity with which these rules are enforced. It is said that no railroad will, under any circumstances, pay local sales tax on repair.

The Director ruled that the services performed were not taxable based on the following rationale:

The taxpayer simply contends that repair of railroad rolling stock is not an enumerated service under §422,43 Code of Iowa (1973) and therefore is not subject to sales tax in the first place. A careful examination of the foregoing section leads the Director to the conclusion that the taxpayer is correct. in drafting §422.43, the legislature was quite explicit in setting forth the types of repair services it wished to tax. It struck out at automobiles, boats, farm implements, motorcycles, scooters, bicycles, office machines, appliances and others. It is fairly apparent that attention was given to many of the smaller things in life, and it is difficult to imagine that railroad stock repairs was overlooked accidentally. But whether the exclusion of railroad car repairs was deliberate of not, the Director believes the application of the rule of inclusion unius est exclusio alterius is appropriate in this case. If the legislature intended to tax this particular service it presumably would have said so.

          One of the enumerated services subject to sales and use taxes under Iowa Code §§422.43 (11) and 423.2 is “machine repair of all kinds.” Implementing this provision is Department Rule 701 IAC 26.29 as follows:

          Persons engaged in the business of repairing machines of all kinds are rendering, furnishing or performing a service, the gross receipts from which are subject to tax. . . .

          The Department argues that locomotives are powered by an engine for self-propulsion purposes; they have moving parts; and they are clearly “machines” within the scope of the statutes and rule 26.29. This precise issue was also addressed in the Transco case, with the Director holding as follows:

Consideration has been given to the question of whether railroad car repair services could fall within the class of “machine repair of all kinds” which is taxable under §422.43. The Code does not define “machine.” Rule 5,28 of the Department of Revenue sales tax rules [now rule 701 IAC 26.29] defines “machine” as follows:

          “Machine” shall include devices having moving parts and operated by hand, powered by a motor engine, or other form of energy. It is a mechanical device or a combination of mechanical powers and devices used to perform some function and produce a certain effect or result.

In view of our own rule and the many judicial interpretations that have come down relative to the meaning of “machine”, the Director is persuaded that a railroad car, (excluding locomotives), generally is not a machine. A machine is more properly an instrument composed of one or more of the mechanical powers, and capable, when set in motion, of producing by its own operation certain predetermined physical effects. Stearns & Co. v. Russell, 29 C.C.A. 121, 85 F.218 (1898). See also, 26 Words & Phrases, Machine at Pp. 5-12 (1953). (Emphasis added)

Locomotive repair is taxable as the enumerated service of “machine repair”.

The rule in Transco was reaffirmed in In Re: Petition Lithcote Company (October 1, 1979) Docket 79-88-6-DR. Lithcote involved not only a generalized car repair shop like Transco, but also a further specialized service. Lithcote was “in the business of lining the interior of new and use railroad tank and hopper cars”. The general services of repair offered Lithcote were varied. “The functions performed in the line of repair include brake, bearing and truck repair, hydrostatic tank testing, valve and heater system inspection, welding, x-ray examination, steaming and interior cleaning, blasting, and exterior painting.”

The Director held that rail car lining “is not an enumerated service”. He also went on to apply and amplify the Transco rule as to general rail car repairs as follows:

Petitioner in furnishing its railroad car repair service, performs repairs including brake, bearing and truck repair, hydrostatic tank testing, valve and heater systems inspection, welding, x-ray examination, steaming and interior cleaning, blasting, and exterior painting.

          * * *

In providing its repair service, Petitioner does perform painting and welding, both of which are services enumerated in section 422.43, Code of Iowa. Petitioner agrees in its Brief that “[t]he question of taxability of the welding and painting performed by Petitioner turns upon the predominate service performed. . . ”, citing to Iowa Movers & Warehousemen’s Association v. Briggs, 237 N.W.2d 759 (Iowa 1976), and that the predominate service performed by Petitioner is rail-car repair.

Rule 730-26.18(422,423) IAC deals, in part, with the situation where a taxpayer is involved in renting equipment (an enumerated service) and in furnishing a nontaxable service. The relevant portion of the rule provides as follows:

“When the possession and use of equipment by the recipient is merely incidental as compared to the nontaxable service performed, all the gross receipts are derived from the furnishing of such nontaxable service and unless a separate fee or charge is made for the possession and use of equipment, no gross receipts are derived from the service of equipment rental. When the nontaxable service is merely incidental to the possession and use of the equipment by the recipient, all the gross receipts are derived from the furnishing of equipment rental and unless a separate fee or charge is made for the nontaxable service, no gross receipts are derived from the nontaxable service.”

The above described situation is analogous to the situation of Petitioner. The Department therefore rules that insofar as any welding or painting that Petitioner performs is incidental to its railroad car repair service and where no separate fee or charge is made for welding or painting, all the gross receipts are derived from the furnishing of Petitioner’s railroad car repair service and thus, are not subject to the tax.

          See also, In re: The Petition of Unitrain Services (August 8, 1980) involving a firm which provided various services related to utility coal unit trains. Unitrain followed the same analysis as applied in Transco and Lithcote.

The Department argues that the form of the AAR billing includes a separate enumeration of amounts attributable to welding and therefore this case comes within the exception of the general Transco rule set forth in the Lithcote Declaratory Ruling in which the Director observed at p. 5 that insofar as the welding is incidental to its railroad car repair service and where no generate fee or charge is made for the welding, all the gross receipts are derived from the furnishing of railroad car repair service and thus, are not subject to tax. The Department points out that in the instant case, rolling stock repairs involve enumerated services for which a fee or charge was made and that such enumerated service was therefore taxable.

          The facts in this case indicate that the form of the billing is mandated under AAR rules which are intended to have a national scope and a uniform effect throughout the nation. There was no intent on the part of KJ to separately charge for welding. It was simply a matter of complying with mandatory billing rules.

          Regardless of how the total fee is computed, the real basis for including or not including a subsidiary service is whether the service is incidental. As stated in Iowa Movers and Warehousemen’s Association v. Briggs, 237 N.W.2d 759 (Iowa 1976), the question of taxability “turns on the predominant service performed. . . ” Here there can be no serious questions that the predominant service was car repair. The welding which was done simply was a step in the overall service of car repair.

Although the total bill is computed by reference to a system which enumerates and calculates the total fee by job codes which include welding, no separate charge for welding is made in the sense that welding would be separately offered at that price. Rather, the scheduling of an amount for welding is simply a step in the process of computing the overall charge for car repair. Thus, the charge is not within the intent of the separate charge concept.

AAR welding items come within the audit of a service performed on tangible personal property delivered into interstate commerce. Iowa Code § 422.42 (4) specifically excludes from the scope of the Iowa sales tax this kind of service, providing as follows:

“Gross taxable services” means the total amount received in money, credits, property, or other consideration, valued in money, from services rendered, furnished, or performed in the state except where such service is Performed on tangible personal property delivered into interstate comm. . .“ (emphasis added)

          Implementing this statute, Rule 701 IAC 26.2(3) provides in relevant part:

           701—26.2 (422) Enumerated services exempt. Tax shall not apply on any of the following services.. .

          26.2 (3) A service which is performed on tangible personal property delivered into interstate commerce or when such service is performed in interstate commerce in such-a manner that imposition of tax would violate the commerce clause of the United States Constitution.

The cars that were repaired were tangible personal property; and the record establishes that the cars were delivered from interstate commerce, repaired and then delivered back into interstate commerce as soon as the repairs were concluded. The cars, which were switched onto the KJ line from other interstate rail carriers, were repaired under a federal mandate because they were deemed to be in need of repairs at the time of switching; and the safety and interchange of railcars within a nationwide transportation system constitutes a function and concern of interstate commerce.

          II. Were Various Contract Services Required In the Course of Reconstruction Of An Antique Vintage Railcar Taxable?

The bulk of the disputed items in Docket No. 91-30-1-0407 concern services on items rendered with respect to reconstruction of an antique Pullman parlor car now known as the “Chief Keokuck.” The car was acquired by KJ in 1983 in an inoperable condition. It was completely rebuilt mechanically and restored inside and out to modern standards with its original 1927 vintage character restored. The car was rebuilt and refurbished by KJ by KJ personnel and, in other instances, skilled independent contractors. To the extent that there were specific charges for services that the Department viewed as taxable services, the Department assessed those charges. The audit items in this protest (91-30-1-0407) includes a large number of items and invoices for services, materials and parts provided by contractors in the rebuilding process. The taxability of the various contract services provided by the most significant contractors and the work they performed follows.

          A. Ewart’s Welding and Fabricating of Iowa And Norm Ewart’s Welding of Missouri.

The Ewarts are brothers who have separate operations and each worked on the Chief. Ewarts of Iowa is a fabricating shop which does welding, forming, bending, and cutting work in steel. Norm Ewart did metal work and welding. The Ewart’s work would have included both welding, general restoration and part fabrication. For example, the Ewarts (Iowa) fabricated new steel doors for the car. Ewarts (Missouri) worked on removal of massive steel brake cylinders and steel ice bunkers which were not going to be part of the rebuilt car. The Ewarts fabricated and attached a water tank shell, Ewarts (Missouri) fabricated custom fittings to attach the new "trucks" to the railcar.

None of Ewarts’ work was separately billed between welding or non-welding service or part fabrication. It was all considered non-taxable carmen’s work by the KJ.

Welding, not incidental to car repair is taxable as an enumerated service under Iowa Code §422.43 (11) and 423.2. Protestor contends that while some of the Ewarts’ work involved welding, the Ewarts also did general restoration and fabrication work; and that the work other than welding was nontaxable in that it was not an enumerated service under § 422.43 (11). On deposition, Mr. Taylor testified that all Ewarts, work involved welding and other work but that he could not break down the welding from other work. In his testimony during the hearing, he testified that the total of invoices of Ewarts (Missouri) is $12,800 approximately, and of that, approximately $300 was for fabricating; $8,700 for labor, approximately; $2,900 for welding, approximately; and approximately $950 for locomotive work. All of the estimates were approximate and the actual breakdown between "welding" and "fabricating", "labor" and "locomotive work" was questionable.

Protestor has not satisfied its burden of proving that Ewarts’ services were not for "welding," an enumerated taxable service; and the Department properly assessed all Ewarts’ charges as the taxable enumerated service of "welding."

          B. John Pollitt and Mike Holmes.

John Pollitt, a pipe fitter, and Mike Holmes, an electrician, were skilled craftsmen engaged by KJ as independent contractors to work on the Chief. They were on strike from their regular work at the time. Pollitt did work on the "plumbing" of the car, and he also worked on air brakes, the air conditioning system and the hot water system of the car. He did not bill by type of service, but for his time generally. Holmes was a skilled electrician and did electrical work on the car, as well as assisting with other various aspects of the project as the progress of the work and time dictated.

Pollitt and Holmes, like the Ewarts, supra, were not tradesmen or businesses engaged in the business of repairing railroad cars. Unlike KJ whose business involved the repair and renovation of worn or damaged railroad stock, Pollitt, Holmes and the Ewarts were tradesmen engaged in the business of plumbing, electrical work and welding, respectively. All such work performed by tradesmen engaged in an enumerated trade (and not in the business per se of repairing railroad rolling stock) is subject to sales/use tax under §§ 422.43 (11) and 423.2. These sections impose Iowa sales tax and use tax on the enumerated services of "electrical repair and installation," "pipe fitting and plumbing," and "installation of air conditioning."

          There are a number of invoices for work performed by Pollitt, whose work was mostly plumbing. There is no breakdown on the invoices between Pollitt’s plumbing work and other work. Pollitt also helped Holmes with electrical work. ”Pipe fitting and plumbing“ is defined in Rule 701 IAC 26.36 as ”the trade of fitting, threading, installing and repairing of pipes, fixtures or apparatus used for heating, refrigerating, air conditioning or concerned with the introduction, distribution and disposal of a natural or artificial substance.“

          The Pollitt invoices mostly represent charges for plumbing services or electrical work as contemplated by statute and the Department’s rules. To the extent that a minor portion of the Pollitt services may not be plumbing or electrical work, it was Protestor’s responsibility to show specifically what that amount was. Since Protestor made no such showing and since most of the Pollitt services were for plumbing work or electrical work, there is no basis to exclude any of the Pollitt charges from the assessment.

There were a number of invoices involving Mike Holmes. Holmes’ work on the Chief Keokuck was primarily electrical work. Also, Holmes helped Pollitt and did other work. The electrical and plumbing work of Holmes constituted enumerated taxable services for which charges were made to Protestor. To the extent a minor portion of the Holmes’ services may not have been plumbing or electrical work, it was Protestor’s responsibility to show specifically what that amount was. Since Protestor made no such showing and since most of the Holmes’ services were for electrical work or plumbing work, there is no basis to exclude any of the Holmes, charges from the assessment.

          C. Miscellaneous invoices involving the Chief.

A number of invoices were specific charges by HELP Temporary Placement Service for Terry Hamilton, “Electrician,” who did electrical work and other work on the Chief. The invoices did not break down that portion of Hamilton’s work which was electrical and that portion which was not.

Sections 422.43 (11) and 423.2 impose Iowa sales tax and use tax on the enumerated service of “electrical repair and installation.” Department rule 701 IAC 26.16 provides in relevant part that “[p]ersons engaged in the business of repairing or installing electrical wiring, fixtures, switches in or on real property or repairing or installing any article of personal property powered by electric current are rendering, furnishing or performing a service, the gross receipts from which are subject to tax.”

          The HELP electrical services are clearly taxable under the statute and regulation. To the extent that a minor portion of such services may not have been electrical, it was Protestor’s burden to show specifically what that amount was. Since Protestor made no such showing and since most of the HELP services that were assessed were for electrical services, there is no basis to exclude any of the HELP Terry Hamilton charges from the assessment.

There are a number of invoices from Jim Lewiston, doing business as Pipe Works. Lewiston did electrical work, plumbing work, and general car work. The invoices do not break down the type of work performed and Protestor made no showing whether Lewiston’s work for any invoice was electrical, plumbing, or something else. It cannot be assumed that Lewiston’s electrical and plumbing work was a nontaxable service. Protestor had the burden of proof that any particular invoice would represent general car repair work that was not electrical or plumbing or another taxable service. Since the assessment is presumed to be correct, Protestor’s proof failure offers no basis to exclude the pipe works charges from the assessment.

Mark Whaley assisted with electrical and plumbing work on the Chief. He also did painting. ”Painting“ like electrical and plumbing work is an enumerated service subject to tax under §§422.43 (11) and 423.2. Protestor failed to establish that any of Whaley’s work was not an enumerated service; and for that reason there is no basis to exclude his charges from the assessment.

Invoices from John Harmon are for the same type of work as Whaley’s, and, as was the case with Whaley, the work was properly a taxable service, because Protestor failed to establish that Harmon’s work was not an enumerated service.

Kelly Electric repaired electric fans. Such work is either electric repair or installation or is machine repair since an electric fan has moving parts and is powered by electrical energy. The charges on the Kelly Electric invoices were taxable as an enumerated service in §422.43 (11), and rules 26.16 and 26.29.

Donald Balentine, Harold Seltzer, Joe Collier, Dave Ewinger, John Applegate and Andrew Wayson were hired to remove exterior paint from the Chief so it could be repainted. "Painting" is an enumerated service under §422.43(11). Rule 701 IAC 26.34 defines "painting" as meaning "covering of both interior and exterior surfaces of tangible personal or real property with a coloring matter or a pigment or sealant, with some suitable liquid to form a solid adherent when spread on in thin coats for decoration, protection or preservation purposes and all necessary preparation thereto. including surface preparation. . . " (emphasis added). Because the work of all these individuals was an integral part of painting the rail car, these charges would be a taxable enumerated service. Turner Sign Studio painted signs on the Chief and Ziegler Painting and Sandblasting did painting work on the Chief. Such painting is an enumerated service subject to tax under §422.43 (11) and Rule 26.34.

“Upholstery repair” on the Chief by Richard’s Upholstery is an enumerated service subject to tax under §422.43(11) and Rule 26.22.

Work performed by Seiller & Cherry Co. appears from the evidence available to have been electrical work. Accordingly, this work is subject to sales tax as an enumerated service §422.43(11).

Comet Industries repaired the Chief’s brakes. As previously indicated “machine repair of all kinds” is taxable under §422.43. Under Rule 26.29 “machine" is defined as including "all devices having moving parts and operated by hand, powered by a motor engine, or other form of energy. It is a mechanical device or combination of mechanical-powers and devices used to perform some function and produce a certain effect or result . . . ." In view of the rule, it is clear that the Chief’s brakes were mechanical devices used to perform a particular function, braking. Cleaning the air brakes comes within the scope of “machine repair of all kinds;” and was therefore taxable under 422.43(11) as an enumerated service.

          III. Are Repairs Of Protestor’s Rolling Stock Taxable?

As previously indicated ”machine repair of all kinds“ is an enumerated § 422.43(11) taxable service. Locomotives are powered by an engine for self propulsion purposes; and are clearly machines within the scope of the statute and rule 26.29. (This issue was discussed previously at pages 19-23.)

The Lithnote, Transco, and Unitrain cases lend support to this conclusion. The Transco order dealt with repair of rolling stock and the Director in his Order specifically provided that "a railroad, (excluding locomotives), generally is not a machine." Inherent in this statement is a conclusion that a locomotive is a machine and therefore, subject to tax as the enumerated service under §422.43(11) of “machine repair of all kinds.” This same conclusion is reiterated in Lithcote and Unitrain.

          IV. Is MOW Equipment Repair Taxable?

The Department’s assessment includes repair services performed on maintenance of way (MOW) equipment. This is equipment used to haul railroad materials on a nonrevenue basis or to repair, maintain, or construct tract. Most of this equipment is powered by a motor or engine.

At issue are invoices which have charges for repair work on MOW equipment. MOW equipment are machines or instrumentalities that are for the most part “composed of one or more of the mechanical powers, and capable, when set in motion, of producing by their own operation certain predetermined physical effects,” and such equipment is therefore, a machine, the repair of which is taxable under § 422.43 and Rule 26.29. Self-propelled MOW equipment, in this respect, is similar to a “locomotive."

Many invoices on repair of MOW equipment (including a Hy-Rail truck, Hy-Rail backhoe, way ballast car) involve welding services. Most of the repair work was done outside of Iowa. The Hy-Rail equipment was predominantly used in Illinois, but was also used in Iowa. The charges for welding are taxable as an enumerated service under §422.43(ii) and rule 26.51.

Repair work was performed in Illinois on a nonself-propelled ballast car. The invoices suggest that these repairs consisted of welding work, taxable as an enumerated service.

Other invoices are for repairs to a nontrack machine used to stamp track, an air powered spike track, and a tie inserter track machine. All of these repairs were to ”machines“ within the definition of Rule 26.29, and taxable as the enumerated service ”machine repair of all kinds“ under § 422.43.

Repair work was performed by Dobson Welding in Illinois on a rail car; inasmuch as there is nothing in the record to indicate that the service was not welding, the Department correctly assessed tax on the basis that the work involved the enumerated taxable service of welding.

          IV. Are Services Performed Outside of Iowa Subject to Use Tax If The Product Or Result Was Used In Iowa?

Much of the MOW equipment (including the Hy-Rail truck, Hy-Rail backhoe, tamp track and tie inserter track machine) was repaired outside of Iowa for use both in and out of Iowa. The rail car repaired by Dobson Weldon in Illinois was for interstate use, as was the case with other rail cars. Protestor contends that these services were not properly subject to Iowa tax.

As previously indicated, all of thses services were taxable as enumerated services under §422.43(11) and 423.2. Such services are taxable for Iowa state tax purposes where the services are performed outside of Iowa becuase the product or result of the service was used in Iowa. Iowa Code § 423.2 specifcally provides in relevant part:

An excise tax is imposed on the use in this state of services enumerated in section 422.43 at the rate of five           percent. This tax is applicable where services are rendered, furnished, or performed in this state or where the product or result of the service is used in this state. This tax is imposed on every person using the services or the product of the services in this state until the user has paid the tax either to an Iowa use tax permit holder or to the department. (Emphasis supplied).

See also, Rule 701 IAC 31.1 and Supplemental Order for Tnansco dated June 1, 1974.

Protestor has not established that the rolling stock serviced outside of Iowa, was not used in Iowa, and the record as a whole indicates that the rolling stock was used in Iowa after it was repaired. Accordingly, the Department correctly assessed Iowa use tax on all services performed outside of Iowa on the rolling stock and MOW equipment because the result of such services (the repaired rolling stock or MOW equipment) was used in Iowa.

V. Is KJ’s Acquisition of Track Materials Into Inventory Taxable?

The audit items posted in Docket 91-30-1-0407 include numerous items relating to KJ’s acquisition of track materials into inventory. During the audit period KJ was a consumer of such materials, a contractor using such materials and a retailer of such materials. It held a retail sales tax permit and filed quarterly returns reflecting tax on withdrawals of its inventory. KJ’s system of accounting provided for payment of tax, either to Iowa or to Illinois, upon the withdrawal of inventory for use by KJ or on sale to a consumer. Protestor contends that this method of accounting is specifically contemplated by Iowa Code §422.42 (12); that its methods comply with the concepts of §422.42 (12); and that the inventory assessment items are improper.

          Iowa Code §422.42(12) provides in relevant part:

Sales of building materials, supplies, and equipment to owners, contractors, subcontractors or builders, for the erection of buildings or the alteration, repair, or improvement of real property, are retail sales in whatever quantity sold. Where the owner, contractor, subcontractor, or builder is also a retailer holding a retail sales tax permit and transacting retail sales of building materials, supplies, and equipment, the person shall purchase such items of tangible personal property without liability for the tax if such property will be subject to the tax at the time of resale or at the time it is withdrawn from inventory for construction purposes. The sales tax shall be due in the reporting period when the material, supplies, and equipment are withdrawn from inventory for construction purposes or when sold at retail. The tax shall not be due when materials are withdrawn from inventory for use in construction outside of Iowa and the tax shall not apply to tangible personal property purchased and consumed by the manufacturer as building materials in the performance by the manufacturer or its subcontractor of construction outside of Iowa. (Emphasis added.)

Clearly, the method of accounting available in §422.42 (12) is applicable to contractors for the improvement of real estate. Acquisition of track materials by KJ would qualify for this type of accounting method; and KJ’s method complies with these concepts. Accordingly, the inventory assessment of track materials acquired by KJ for the improvement or repair of its real estate is improper.

VI. Are KJ’s Trade Crossing Purchased For Use, And Installed In, Illinois Taxable?

Docket 91-30-1-0407 includes numerous invoices totaling $15,301.70 for the acquisition of grade crossing flashers which the KJ purchased for use, and did use, in Illinois. Protestor contends that it is unreasonable to attempt to tax KJ for those items simply because they were delivered to KJ at its office in Iowa, when such delivery was not truly the end of the interstate transportation of those items.

All of these items were specifically ordered for installation in Illinois. The items were initially delivered by the common carrier, to KJ’s engine house in Keokuk, Iowa, and from this point the items were hauled by the KJ to a Hamilton, Illinois storage shed where they were stored until actually put into use. The time spent in Iowa, before the items were transferred to Illinois, was limited; and the possession, in all cases, was brief as KJ could make it consisting with normal operating practice. KJ intended the flashers to be used in Illinois from the outset and never had the intention to use or to store them in Iowa.

The Department argues that even though the inventory was functionally used in Illinois, Protestor’s possession of the inventory in Iowa was a taxable ”use“; and that since Protestor purchased the inventory with the intent to possess it in Iowa, the inventory was purchased for use in Iowa. Relied upon by the Department as authority for its position are the following cases:

Inter-State Nurseries, 164 N.W.2d at 861-863; Chicago, Burlington & Quincy Railroad , 142 N.W.2d at 412; Bandag, Inc., Docket No. 82-147-6B-A, Director’s Order, January 13, 1994, aff’d, Bandag, Inc., Docket No. 480, State Board of Tax Review, December 20, 1984.

In the Inter-State Nurseries case, personal property was purchased by Inter-State Nurseries outside Iowa, delivered by common carrier to Hamburg and there removed from the carrier. At this point movement within the channels of interstate commerce ended. Actually, the interstate flow ceased at that time, and the product came to rest in Iowa for use in Iowa. The record in that case established that catalogues, fliers, and envelopes were held by Inter-State Nurseries for one to three days after arrival during which time the firm packaged the material and then delivered the package materials to postal authorities for mailing. The court held that the materials had actually been put to use by Inter-State Nurseries.

KJ did not “use” the flashers in Iowa other than to transfer them as soon as consistent with normal practice, from common carrier to a KJ carrier for completion of the intended interstate transportation from outside of Iowa, through Iowa, and terminating at Hamilton, Illinois for storage. In this respect, the instant case differs from the fact situation in Inter-State Nurseries.

In Chicago, Burlington to Quincy Railroad (a 1966 case), the plaintiff railroad purchased fuel oil outside of Iowa, brought it Docket No. 480, State Board of Tax Review, December 20, 1984.

In the Inter-State Nurseries case, personal property was purchased by Inter-State Nurseries outside Iowa, delivered by common carrier to Hamburg and there removed from the carrier. At this point movement within the channels of interstate commerce ended. Actually, the interstate flow ceased at that time, and the product came to rest in Iowa for use in Iowa. The record in that case established that catalogues, fliers, and envelopes were held by Inter-State Nurseries for one to three days after arrival during which time the firm packaged the material and then delivered the package materials to postal authorities for mailing. The court held that the materials had actually been put to use by Inter-State Nurseries.

KJ did not “use” the flashers in Iowa other than to transfer them as soon as consistent with normal practice, from common carrier to a KJ carrier for completion of the intended interstate transportation from outside of Iowa, through Iowa, and terminating at Hamilton, Illinois for storage. In this respect, the instant case differs from the fact situation in Inter-State Nurseries.

In Chicago, Burlington to Quincy Railroad (a 1966 case), the plaintiff railroad purchased fuel oil outside of Iowa, brought it into Iowa in its own tank cars, pumped the oil into a storage facility and at a later time the oil was pumped from the storage facility into locomotives to run trains. In this case the Court held that the interstate transportation of the fuel had ended, and that the fuel had been stored in Iowa. Such actual storage, according to the Court, is the exercise of a right or power over it, and therefore, a taxable use; and this taxable use does not depend upon the length of time the property is stored or on its anticipated use.

The instant case differs from Chicago, B. & 0. R. Co., in that the evidence indicates that the flashers were not "stored" in Iowa. While the flashers came to rest in Iowa in transit to Illinois, they were stored in Illinois. In this respect, the flashers were analogous to the use of motor vehicles in Bruce Motor Freight, Inc. v. Lauterbach, 247 Iowa 956, 77 N.W.2d 613. The vehicles in Bruce stopped in Iowa for the purpose of adding safety equipment. The Court held that the temporary stop at the plaintiff’s repair shop for this purpose, was not a taxable use because the vehicles in Bruce were not stored for later use but the use was continual in interstate commerce. The interstate trip had not ended in either the Bruce case or in the instant case involving KJ’s flashers.

In the Bandag case molds were purchased from an Indiana firm, delivered to a Bandag facility in Muscatine, Iowa where they were inspected by Bandag’s quality assurance personnel and then transported by Bandag trucks to manufacturing facilities outside Iowa. The Court in the Bandag affirmed an Iowa State Board of Tax Review Order holding that taxable use within Iowa included, inter alia, review and testing and storage for later shipping. Unlike the KJ flashers, the Bandag molds were brought into Iowa for a distinct purpose - inspection as to their suitability and proper function prior to being shipped to Bandag’s other plants; and clearly the interstate transportation scheduled by Bandag to allow the molds to be inspected, terminated at Muscatine, Iowa where the molds were acted upon by Bandag prior to shipping the molds out of state.

Protestor cites a 1990 case, Grudle v. Dept. of Revenue, and Finance, 450 N.W.2d 845 (Iowa 1990) in support of its argument. In this case, the taxpayer appealed from the assessment of consumer use tax by the Department on truck tractors and trailers, for periods of time that the vehicles were stored and maintained in Iowa between interstate trips. The Supreme Court held that a ”taxable moment“ for purpose of the use tax was not triggered by the temporary cessation of interstate commerce because of required repairs, maintenance or temporary idleness.

Based on the facts of the Grudle case and the facts in the instant protest involving KJ, there was more of a factual basis to justify imposition of a use tax in the Grudle case than there is in this matter involving KJ. In Grudle the taxpayer was an interstate trucker who hauled products to and from Iowa. Occasionally, between trips, the vehicles were serviced or stood idle on the taxpayer’s farm in Iowa where he conducted his business. These intervals were for periods of time up to months. Compare this with KJ’s practice wherein the flashers were temporarily in Iowa and at rest for periods more accurately measured in hours.

In Grudle the Court held that there was no interruption of interstate use when the vehicles were at rest either awaiting another trip or being repaired to keep them in condition for interstate use. The fact that the trucks were standing still and inactive did not constitute a withdrawal of that instrument from interstate commerce.

The Protestor in this case has presented substantial credible evidence to establish that KJ’s grade crossing flashers were not “Purchased. . . for use” in Iowa and were not “used” in Iowa within provisions of Iowa Code §§ 423.2, 423.1. (These sections impose use tax but require that the property in question be not only in “use” in Iowa but also "purchased for use" in Iowa.)

          B. Was There Sufficient Nexus To Impose Iowa Use Tax?

          Iowa did not have sufficient nexus with that portion of the inventory consumed in Illinois, for the purpose of imposing a use tax. In Grudle, the Court held a state tax withstands scrutiny under the commerce clause, article I, section 8, clause 3 of the United States Constitution, if there is a “taxable moment” or it meets the four-pronged test of Complete Auto Transit, Inc., v. Brady, 430 U.S. 274 97 S.Ct. 1076, 51 L.Ed.2d 526 (1977). The Grudle Court declined to rule on this issue because the legislature was then about to enact an exception to use tax for property used in interstate commerce. See Iowa Code § 423.10 (1985 Code). Nevertheless, the Grudle Court appears to have resolved that issue holding at 450 N.W.2d at 849:

The fact that an instrument of interstate commerce is brought into a state and for a short period of time is not actively engaged in, or being used or consumed in, interstate commerce because temporarily standing still and inactive, does not constitute a withdrawal of that instrument from interstate commerce.

The grade crossing flashers, though delivered by common carrier to KJ in Iowa, never came to rest in Iowa. KJ is itself a carrier and it moved the items promptly from Iowa to Illinois for storage prior to their use. This hiatus was not enough to tax goods, goods temporarily out of the flow of interstate commerce.

          VII.          Is KJ’s Track Switch Rebuilding Taxable?

Six disputed invoices were included in Docket 91-30-1-0407 which the Department deemed to be for welding (Ex. 16-0). As explained by Mr. Taylor, this work was ”in track“ switch repair performed in the field, wherein switch points were rebuilt to proper size and shape by a repetitive process of-laying a weld bead on the switch and grinding it to a specific profile.

This work was performed by skilled welders who appear to have considered their work to be welding or a necessary adjunct to, and a part of, the welding process. The invoices were issued by Garrison Metal Weld Process Corp.

Protestor also contends that each of the six invoices (in Exhibit 16-0) should have $300 deducted from any taxable amount as nontaxable travel expense. The Department has exempted the $300 travel separately listed on one of the invoices (R3/4-6 in Exhibit 16-0). Any other travel expense is included in the lump sum billings for the welding services.

Iowa Code sections 422.45(2) and 423.4(3) exempt transportation services from tax. This exemption is implemented in Department rule 701 IAC 15.13 which provides in relevant part that “[w]hen freight and other transportation charges are not separately stated in the sale agreement or are not separately sold, the gross receipts from the freight or transportation charges become a part of the gross receipts from the sale of tangible personal property or a taxable service and are subject to tax.” In the instant case, there is no evidence of a separate sale or separate statement in an invoice (other than R3/4-6) of any transportation charges.

Protestor’s attempt to exempt $300 travel charges for each lump sum invoice is inconsistent with Schemmer v. Iowa State Tax Commission, 254 Iowa 315, 117 N.W.2d 420 (1962). In Schemmer, the Court disallowed any exemption for transportation charges because such charges were not separately sold, but were merely included in a lump sum billing of the purchase price.

Protestor is not entitled to an exemption for any transportation charges in the lump sum charges for the welding services for Iowa use tax purposes.

          VII. Are The Red Fusees Exempt From Tax?

          Iowa Code §§ 422.45(10) and 423.4(4) exempt from use tax “tangible personal property used or to be used as railroad rolling stock for transporting persons or property, or as materials or parts there for.” See also rule 701 IAC 17.13.

Based upon the record in the instant case, these red fusees do not constitute a material or part of the rolling stock. They may or may not be consumed within the rolling stock. They are not affixed to rolling stock. They are used for safety purposes. They do not cause any operations by the rolling stock. They simply are not a material or part of the rolling stock. The fact that they are required by federal regulation to be. kept aboard a locomotive does not make them a material or part of the rolling stock any more than would clothes of a trainman kept aboard rolling stock be a material or part of rolling stock.

Since the rule of strict construction of exemption statutes is applied here and since the red fusees are not clearly materials or parts of rolling stock, they are not within the statutory exemption.

VIII. Is Protestor Entitled to a Tax Credit Upon the Inventory Items?

The audit items in Docket 91-30-1-0407 include items for the KJ’s acquisition of track material. Other audit items includes invoices for acquisition track materials including spikes, tie, plates, couple bars, anchors and boots.

During the audit period the KJ maintained an inventory of such materials from which it made sales to the public to customers with private track such as Hubinger and J.I. Case Company. The KJ also used such materials in the construction of its own lines and in construction for other parties.

The KJ maintained a system of accounting for its inventory of track materials whereby it accounted for items as they were withdrawn for sale or for KJ’s use. As items were withdrawn, sales/use tax returns were filed initially in Iowa, and later in both Iowa and Illinois.

Because its inventory of track materials is of fungible items, the KJ is unable to show an item by item connection between the audit items (as purchased) and the track materials (as withdrawn) listed in its tax returns. However, Mr. Taylor testified that all of the KJ material was ultimately accounted for, either when sold or used or by reporting what was left in inventory when the KJ ceased using the inventory system.

Most of the materials were purchased for use in Illinois in connection with the KJ’s program for upgrading the Illinois track. In 1988, for example, the KJ’s track materials purchases went up to $391,500 from $63,280 in 187 in anticipation of the upgrading program. The purchases subsided again in 1989 to $126,650.

          A. Taxes Paid to Illinois

Iowa Code section 423.25 provides for a credit against Iowa use tax “[ i ]f any person who causes tangible personal property to be brought into this state has already paid a tax in another state in respect to the sale or use of the property, or an occupation tax in respect to the property. . . .” Department rule 701 IAC 30.7 provides in relevant part:

When a person has already paid to any other state of the United States a state sales, use, or occupational tax on specifically identified tangible personal property or taxable services on its sale or use, prior to bringing the property into Iowa, and the tax is equal to or greater than the current rate of tax imposed by the Iowa use tax law, no additional use tax shall be due the state of Iowa by such person.

In the instant case, the inventory came into Protestor’s possession in Iowa, a taxable “use” under the Iowa use tax law, before any inventory was consumed in Illinois.

The Iowa use tax was imposed before any Illinois tax was imposed. Since the § 423.25 credit provisions do not apply to Protestor’s situation involving payment of Illinois tax after imposition of Iowa tax, no credit against Iowa tax is available. Protestor’s recourse is to apply to Illinois for a tax credit.

          B. Taxes Paid Iowa On Inventory Items.

Protestor contends that it should not have to pay any of the assessment attributed to tax on materials withdrawn from inventory for its own use in Iowa because Protestor paid the Iowa sales tax when the inventory withdrawals for use in Iowa occurred. Protestor admits that it cannot trace any tax payments to specific items that were included in the assessment because inventory is fungible, but that it had to have paid the tax because it was its custom to pay Iowa sales tax when inventory was withdrawn by Protestor for use in Iowa.

The Department did authorize tax credit in this matter where the evidence produced by Protestor established that such taxes had been paid. other than these items, the evidence does not sufficiently establish that Iowa sales tax was paid on the assessed inventory. There is no showing of Iowa sales tax paid upon specific items.

Protestor did not present any evidence of inventory control system. There is no beginning or ending inventory or purchases from a specified period to compare to Iowa tax returns that Protestor presented. While Mr. Taylor speculated that Iowa tax had been paid, there is no evidence in the record to support his opinion that the Department has already received Iowa tax on the assessed inventory.

When a person claims a tax credit on the grounds that the tax has already been paid with respect to any item assessed for sales/use tax, the burden of proof is on that person to establish by documents that the tax has been paid. No such evidence was presented; and, for this reason, there is no basis on which to grant credit for tax paid on such inventory.

          C. Double Taxation In Docket 91-30-1-0408

Protestor contends that while the retail sale of the inventory items in Exhibit 24-W would be subject to Iowa sales tax, those inventory items were already assessed to Keokuk Junction Railway in Docket No. 91-30-1-0407. Protestor did not present any evidence of such duplication. If Protestor had demonstrated an adequate inventory control system, it could then be determined whether any such duplication occurred. No such system was shown; and there is insufficient evidence in the record to establish that there was double taxation.

          IX. Should Penalties Re Waived?

Protestor requests that penalties be abated or waived to the extent allowed by law for the applicable periods for the following reasons: Protestor made a substantial and good faith effort at sales/use tax compliance; and Protestor relied on Department advice with respect to rolling stock repair items.

Unfortunately, there was no statutory authority in effect during the assessment period from 1985 through 1990 to waive penalties for reasonable cause. Iowa Code §§ 422.58 and 423.18 (1985) (1987) (1989) expressly provided that ”[t]he penalty imposed upon this subsection is not subject to waiver.“

In 1986 Iowa Acts, ch. 1007, § 20, effective January 1, 1987, Iowa Code section 421.27 provided for penalty for failure to pay at least ninety percent of various taxes, including sales and use taxes, except under the following conditions:

1. The taxpayer voluntarily files an amended return and pays all tax town to be due on the return prior to any contact by the department.

2. The taxpayer provides written notification to the department of a federal audit while it is in progress and voluntarily files an amended return within sixty days of the final disposition of the federal government’s audit.

3. The return is timely, but erroneously, mailed with adequate postage to the internal revenue service or another state agency and the taxpayer provides proof of timely mailing with adequate postage.

4. The return is timely mailed with adequate postage to the department of revenue and the taxpayer provides proof of timely mailing with adequate postage.

5. The taxpayer presents proof that the taxpayer relied upon documented written erroneous advice from the department, county treasurer, or federal internal revenue. service, whichever is appropriate.

Section 421.27 was in effect until January 1, 1991. 1990 Iowa Acts, ch. 1172, §§ 7, 16. Accordingly, current Iowa Code section 421.27(3), providing for penalties for audit deficiencies, was not in effect during the audit periods. In summary, from July 1, 1985 through December 31, 1986, there was a lack of statutory authority to waive or not assess penalties.

From January 1, 1987 through June 30, 1990, the end of the latest audit period in the instant case, the only statutory authority for nonassessment of penalties was the foregoing conditions set forth in S 421.27.

Protestor contends that it relied on the Transco, Lithcote and Unitrain rulings provided by the Department with respect to the rolling stock repair items. Those rulings indicate that rolling stock repairs, excluding locomotives are not an enumerated taxable service; and consistent with those rulings, legal conclusions have been made in this decision that rolling stock repairs, excluding locomotives, are not subject to sales/use tax. These rulings did not deal with the inventory items on track repairs.

For the foregoing reasons, the Department’s assessment of penalty was proper.

X. Does the Exemption For Services Performed on Tangible Personal Property Delivered Into Interstate Commerce Apply In This Case?

Iowa Code section 422.42(15) defines "Services," for purposes of taxation of section 422.43 (11) enumerated services, in part as "all acts or services rendered, furnished, or performed, other than services performed on tangible personal property delivered into interstate commerce. for a valuable consideration by any person engaged in any business or occupation specifically enumerated in this division." This language which excepts services performed on tangible personal property delivered into interstate commerce from the tax is exemption language. Peoples Gas & Electric Co. v. Iowa State Tax Commission, 238 Iowa 1369, 28 N.W.2d 799, 803 (1947). Therefore, the rule of strict construction of tax exemption statutes is applicable to Protestor’s claim for exemption under this statute.

Department rule 701 IAC 26.2 (3) recognizes this exemption by providing in part that tax does not apply to “[a) service which is performed on tangible personal property delivered into interstate commerce.”

At the time the Chief was acquired in 1983, it was located in Missouri. It was moved by a “hospital train” to a KJ sidinq in Keokuk, Iowa where it remained for two years. In 1986, KJ decided to rebuild the Chief; and over the course of 1986 to April 1987, the car which became the Chief Keokuck was sandblasted, painted, refurbished, repaired, rewired, replumbed, and otherwise restored and rebuilt. The work was done by KJ employees and independent contractors in phases over a period of “at least two years” with “very extensive repair work from January of ‘86 until April of ‘87.” All of the work was performed while the car was in possession of KJ and while the car was in Iowa. Deposition, p. 39.

In April, 1987, when the last of the work on the car was finished, the Chief was delivered to the Burlington Northern Railroad and this line then transported the Chief from Keokuk to Missouri, and from there the Chief was transported by Amtrak to Chicago.

The work was not performed by a single contractor and then delivered into interstate commerce. The work was performed by various employees or independent contractors in stages and the Chief remained in Iowa throughout this restoration project. The Chief was not delivered into interstate commerce following the completion of each of the jobs covered by the invoices. Following the work of the Ewarts Welding and Fabrication, John Pollitt and Mike Holmes, Lewiston Pipe Works, HELP, Whaley and Harmon, Ziegler Painting and Sandblasting, Turner Sign Co. and all the other miscellaneous firms and persons who did work on the Chief, the Chief remained in Keokuk, Iowa. The Chief was not delivered into Interstate Commerce following their work. Again, following all of the work covered in the audit, the Chief remained in Keokuk, Iowa subject to the continued use and possession of KJ - and it was not engaged in interstate commerce during any of this time.

It was not until April, 1987, that the Keokuck Chief was placed in service for hire in interstate commerce. The facts in this case simply do not indicate that the Chief was placed in interstate commerce following the service and provision of materials provided by the various contractors and employees in the rebuilding process. The f act that eventually the Keokuck Chief was placed in interstate commerce does not satisfy the exemption requirements. The exemption is limited to those services performed upon tangible personal property - which property is then delivered into interstate commerce. See, Dodgen Industries, Inc. v. Iowa State Tax Commission, 160 N.W.2d 289, 291 (Iowa 1968); Department of Treasury v. Wood Preserving Corp., 313 U.S. 62, 85 L.Ed. 1188, 61 S.Ct. 885 (1941); Exel v. Clayton, 269 N.C. 127, 152 S.E.2d 171 (1967).

As indicated by the Court in Dodgen, 160 N.W.2d at 298, “To rule that where a sale is made in Iowa it is not subject to a sales tax merely because the item purchased is to be taken to another state, would open an avenue to easy avoidance of the tax by the customer simply declaring his intention to take the purchase elsewhere . . . . ”

The exemption for “services performed on tangible personal property delivered into interstate commerce” does not apply to the services performed on the Chief Keokuck.

However, the cars subject to AAR repair are a different matter. These cars were received from service in interstate commerce, and when the repairs were completed, the cars were immediately returned into service in interstate commerce. It is this type of situation that is specifically excluded from the definition of “gross taxable services" under §422.42(4) and "services" under §422.42(15).

          DECISION

The Department’s assessment is AFFIRMED in part and REVERSED in part as provided in the foregoing conclusions of law. In summation: The services performed on railcars was not an enumerated service taxed under Iowa Code §§422.43(11) and 423.2 and therefore were not subject to tax; welding services incidental to car repair is not taxable; Protestor’s AAR car repair is excluded from the definition of taxable service; contract and KJ services performed on the Chief Keokuck are enumerated services subject to sales/use tax and inasmuch as the Chief was not immediately delivered into use in interstate commerce upon completion of these services, the services were not excluded from taxation under Iowa Code §§ 422.42(4), 422.42(15; repair of locomotives is subject to sales/use tax as an enumerated service under § 422.43(11); MOW equipment repair is taxable under §422.43(11); KJ’s acquisition of track materials is subject to tax in the reporting period when the materials are withdrawn from inventory for construction purposes; KJ’s grade crossing flashers are not subject to Iowa sales/use tax; KJ’s track switch repairs are taxable and, Protestor is not entitled to an exemption for transportation charges in lump sum charges for the welding services; the red fusees are subject to sales/use tax; Protestor is not entitled to a tax credit upon inventory items for taxes paid to Illinois or Iowa; penalties should not be waived.

No affidavit has been filed under 701 Iowa Admin. Code §7.9 seeking the deletion of identifying details, if any.

Pursuant to Iowa Code §17A.15 (3), this proposed decision becomes the final order of the Iowa Department of Revenue and Finance without further proceedings unless there is an appeal to, or review on motion of, the Director of the Department within 30 days of the date of this proposed decision.

Issued at Des Moines, Iowa, this 30th day of May, 1995.

IOWA DEPARTMENT OF REVENUE AND FINANCE

          BY

          Elizabeth Duncan

          Administrative Law Judge