The Kentucky Board of Tax Appeals (the “Board”) has held that refractory shapes used at an aluminum processing plant are subject to sales and use tax, rejecting the taxpayer’s claim that the shapes are industrial supplies or, alternatively, machinery for new and expanded industry.[1]  The taxpayer, Novelis Corporation (“Novelis”), operates a plant in Berea, Kentucky, where it processes aluminum cans and aluminum scrap into ingots that are sent to a sister plant for further processing.  The majority of the refractory shapes are used as a protective lining for the room-sized furnaces or aluminum smelters that melt scrap aluminum during the hot metal stage. 

Novelis argued the refractory shapes are similar to “fire brick”, which is listed as an industrial supply exempt from sales and use tax pursuant to KRS § 139.470(10).  The statute exempts certain tangible personal property directly used in manufacturing or industrial processing, if the property has a useful life of less than one year.  Repair, replacement, and spare parts, however, are excluded from the exemption.  As opposed to industrial supplies, which are intended to be “used up” in the manufacturing process, repair and replacement parts are used to maintain or repair machinery and equipment.

The Board found the refractory shapes were an integral part of the large furnaces that melt the molten aluminum.  Any item that touches the molten aluminum must be lined with this refractory material, and the refractory items must be purchased each year because they wear and erode.  Testimony before the Board indicated the shapes are replaced during annual or semi-annual outages at the taxpayer’s plant.  Because the shapes wear and erode and are used to mend and repair the furnaces, the Board held these items are taxable repair and replacement parts.  The Board concluded the refractory shapes were distinguishable from fire brick, as the shapes are specially engineered slabs purchased by the taxpayer that are not consumed completely during the manufacturing process, unlike the standard fire brick included in the industrial supplies definition since the 1960s. 

The Board also held the refractory shapes do not qualify as exempt machinery for new and expanded industry because repair, replacement, and spare parts are excluded from the exemption.  Furthermore, the Board held the shapes are not exempt from sales and use tax pursuant to KRS § 139.480(23), which exempts certain machinery or equipment used primarily for recycling purposes.  The Board found that when the aluminum enters the hot metal stage of the taxpayer’s operation, the equipment, including the refractory shapes, is primarily being used for manufacturing purposes and not recycling purposes.  The Board noted the taxpayer can and does receive an income tax credit for some of its recycling equipment, which it uses to transform aluminum cans and scrap aluminum into the raw aluminum product used for its furnaces.  Finally, the Board rejected the taxpayer’s contemporaneous construction argument, holding the statute at issue was unambiguous.