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Railroad “Supplies” Not Exempt from Sales Tax

by Erica Horn & Jordan Green

In CSX Corporation, Inc. v. Department of Revenue, Ky. Bd. Tax App. File No. K12-R­33 (Oct. 9, 2014), the Kentucky Board of Tax Appeals (the “Board”) held that certain track, signal and communication items used by a railroad company were not supplies used for the direct operation of a locomotive or train, and therefore, were not exempt from sales and use tax. KRS 139.480(1) provides a sales and use tax exemption for “supplies for the direct operation of locomotives and trains … used or to be used in interstate commerce.” Therefore, in order for CSX’s items to fall within this exemption, the items must qualify as “supplies” and must be used in the “direct operation” of a train.

As to the first requirement, the Board held that CSX did not meet its burden of showing that most of the items were in fact “supplies.” CSX witnesses testified that most of the signal and communications items have very long life cycles (all lasting several years and some lasting up to thirty years), unless they were damaged and needed to be replaced sooner. The Board concluded that the plain meaning of the term “supplies” included items used up or consumed in a process, but excluded items that were merely worn out or broken down. Since the Board found that most of the items in question were either repair parts used when a defective or damaged part had to be replaced or were replacement parts used in a periodic capital improvement program, such items did not qualify as exempt supplies.

The Board then addressed one remaining item at issue, weed chemicals, which did in fact constitute supplies for purposes of the exemption. However, the weed chemicals were not exempt because they were not used in the “direct operation” of a locomotive or train. The Board concluded that the plain meaning of the words “direct operation” means that the supplies have to actually be used on or in the locomotive or train itself, so that the locomotive and train will function and be operable. Since the weed chemicals were merely sprayed on and near the train track and in the surrounding brush, they were not used in the direct operation of a locomotive or train.