January 9, 2016

The Long and Narrow Road to a Sales Tax Exemption – Machinery for New and Expanded Industry

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In a recent article, we discussed the exemption from sales and use tax for supplies and industrial tools. In this article, we address a similar exemption for machinery for new and expanded industry.  Both exemptions were enacted with the goal of encouraging manufacturing in the Commonwealth.  In recognition of the significant capital investments manufacturers often must make, the legislature enacted the exemption for machinery for new and expanded industry allowing manufacturers to purchase certain machinery without paying sales or use tax.

The Exemption for Machinery for New and Expanded Industry

Under KRS § 139.480(10), businesses engaged in manufacturing or processing production[1] can purchase machinery exempt from sales or use tax if the machinery meets certain requirements, set forth in KRS § 139.010(15).  These requirements are further defined by regulation; 103 KAR 30:120 contains four criteria that must be met for machinery to qualify for the exemption: (1) it must be machinery; (2) it must be used directly in the manufacturing process; (3) it must be incorporated for the first time into plant facilities established in Kentucky; and (4) it must not replace other machinery.  Each of these requirements is discussed in greater detail in the paragraphs that follow.

The first and most obvious requirement is that only “machinery” qualifies for the exemption. “Machinery” includes not only machines, but also the working parts of a machine, provided those parts are not repair or replacement parts.  Thus, the “machinery” need not perform a function in and of itself.  The regulation uses the working parts of a watch as an example.

The Second requirement – that the machinery must be used directly in the manufacturing process – has been the most contentious. This requirement raises two questions that have precipitated litigation over the years.  First, what constitutes, “manufacturing”?  And, Second, what does it mean to be “used directly” in the manufacturing process; specifically, when does manufacturing begin and end?

Early court decisions defining “manufacturing” reached various, and inconsistent, results. For example, Kentucky courts held the pasteurizing of milk, water filtration, and sizing and washing of coal were not manufacturing, but the crushing of coal and bottling of whiskey were manufacturing.  Today, all of these activities are considered manufacturing.  In 1978, the Kentucky Supreme Court set forth the current definition of manufacturing in the case of Revenue Dep’t ex rel Luckett v. Allied Drum Service, Inc.[2]  The Court defined “manufacturing” as any process by which material having little or no commercial value for its intended use before processing has appreciable commercial value for its intended use after processing by the machinery.  This definition is now contained in KRS § 139.010(16). 

In order to qualify for the exemption, the machinery also must be “used directly” in the manufacturing process. The definition of “used directly” developed over the years as a result of several court decisions, and eventually was codified in KRS § 139.010(16).  To understand “used directly”, the beginning and end of the manufacturing process has to be defined.  Under the statute, the manufacturing process begins with the movement of raw materials from storage into a continuous, unbroken, integrated process, and ends when the product being manufactured is packaged and ready for sale.  The machinery need not come into direct contact with the product being manufactured to qualify for the exemption if the machinery is used as part of a continuous, unbroken, and integrated process. 

To satisfy the 3rd requirement, the machinery must be installed in Kentucky for the first time and must be incorporated into plant facilities in the Commonwealth. This requirement can be satisfied by purchasing a “new” machine or by purchasing a “used” machine that has never been installed in a plant facility in Kentucky.  Machinery that is purchased and delivered in Kentucky but not acquired for installation in Kentucky is subject to tax. 

A “plant facility” is defined by KRS § 139.010(21) as a single location exclusively dedicated to manufacturing or processing production activities. A location qualifies as a plant facility even if retail sales are made at the location, so long as the retail sales are incidental to the location’s manufacturing activities.  Restaurants, grocery stores, shopping centers, and other “retail” establishments do not qualify as plant facilities. 

Finally, the machinery must not replace other machinery unless the new machinery (1) increases the consumption of recycled materials at the plant facility by not less than 10%; (2) performs different functions; (3) is used to manufacture a different product; or (4) has a greater productive capacity, as measured in units of production, than the machinery being replaced.  Modification of existing machinery to perform a different function or manufacture a different product is not considered replacement machinery and may qualify for the exemption.  However, the Department of Revenue has taken the position that modifications that only increase production are taxable. 

Repair, Replacement, and Spare Parts

Repair, replacement, and spare parts do not qualify for the exemption. This portion of the statute was enacted in response to the Kentucky Court of Appeals’ decision in Revenue Cabinet v. Armco[3].  In Armco, the court held “first spares” necessary to the operation of a bloom caster were exempt from sales and use tax because while the spares were not used until after other parts had worn out, they were necessary for the caster to operate in the first instance.  The vendor of the bloom caster required customers to purchase the first spares as a condition of the warranty.  The court found the first spares were an integral part of the purchase of the bloom caster and, therefore, were exempt from sales and use tax.

In response to the court’s decision in Armco, the Kentucky legislature enacted what is now KRS § 139.010(15)(b), providing that repair, replacement, or spare parts of any kind do not qualify for the exemption, regardless of whether the purchase of repair, replacement, or spare parts is required by the manufacturer or vendor as a condition of sale or as a condition of warranty. 


The exemption for machinery for new and expanded industry has developed over the past several decades as result of various court decisions and multiple amendments to the relevant statutes.  The exemption, however, remains an important one for manufacturers looking to locate or expand their operations in Kentucky.  Large and expensive pieces of machinery are essential to many manufacturing businesses and the sales or use tax on such machinery can be substantial.  Manufacturers capitalizing on the new and expanded industry exemption can recognize significant cost savings.

[1] KRS § 139.010(15) clarifies that machinery also qualifies for the exemption if the machinery is used directly in the “processing production” process, including the processing and packaging of raw materials, in-process materials, and finished products; the processing and packaging of farm and dairy products for sale; and the extraction of minerals, ores, coal, clay, stone, and natural gas.

[2] 561 S.W.2d 323 (Ky. 1978).

[3] 838 S.W.2d 396 (Ky. App. 1992).