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Tennessee Court Determines Creation of New Product Not Required for Manufacturing Exemption

Tax Development Sep 27, 2023

Tennessee Court Determines Creation of New Product Not Required for Manufacturing Exemption

A Nevada company that rented hygienically clean textiles to customers in Tennessee challenged the revocation of industrial machinery tax exemption certificates previously issued to them. In Alsco, Inc. v. Tennessee Department of Revenue,1 the dispute on appeal from the Chancery Court for Davidson County centered on whether the business operations of Alsco, Inc. (“Alsco”) constituted “manufacturing,” which is not defined in Tennessee statutes.

To qualify for the Tennessee industrial machinery exemption, the taxpayer’s manufacturing operations must include three elements:

  1. The machinery or equipment used “is necessary to, and primarily for, the fabrication or processing of tangible personal property.”
  2. The tangible personal property is sold for “consumption off the premises.”
  3. The operation or activity is the manufacturer’s “principal business.”2

The only point of contention in this case is the first requirement—the Department of Revenue (“the Department”) contended that the sanitation operations did not constitute “processing” under that statute.

Alsco contends that its sanitization operations constitute “processing” under the definition adopted in Beare Co. v. Tennessee Department of Revenue3 because the administrative record contains evidence showing that Alsco’s sanitization operations alter the textiles’ state or form. Alsco points to evidence showing that, in the sanitization process, soiled, unabsorbent textiles undergo a physical change because highly customized processing formulas are applied to break the chemical bonds between the soils interwoven with the fabric, transforming the textiles into sanitized and absorbent textiles.

The Department agrees that Alsco subjects its textiles to a rigorous and highly specialized cleaning process that makes them marketable, but the Department argues that this process does not constitute “processing” because bar towels and uniforms are the same bar towels and uniforms before and after going through Alsco’s sanitization process. Ultimately, the Department’s argument is that Alsco’s operations do not constitute “processing” because the resulting product is neither a new nor substantively different product—the sanitization process “merely return[s] the items to the hygienic condition in which they were originally rented to its customers.”

Beginning with the definition adopted in Beare, the court noted that it contains the phrase, “a different state or form from that in which they originally existed.” Immediately after that phrase is the following language: “the actual operation incident to changing [the articles or materials] into marketable products.” This phrase means that the change the material undergoes must be the result of the taxpayer’s operations and that the change must result in a marketable product.

Following the logic in Beare, the court found that all that is required is that each time the articles or materials are submitted to a taxpayer’s operations, they must be in a state or form different than the state or form they were in prior to undergoing the process. The court determined that the taxpayer’s sanitation process changed the state of the textiles by removing contaminants and transforming the textiles into hygienically clean textiles fit for consumption. The court concluded that the taxpayer qualified for the industrial machinery exemption and that the creation of an entirely new product is not required.

Interested in more information on this issue or how it could impact your business? Please contact our Ryan tax professionals below.

1 No. M2022-01019-COA-R3-CV.

2 Tenn. Code Ann. § 67-6- 102(46)(A)(i).

3 Beare Co. v. Tennessee Department of Revenue, 858 S.W.2d 906 (Tenn. 1993).


Brian Stromen

Bob Andre

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