Onex Communications Corp. v. Commissioner of Revenue (September 11, 2007)

COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD


ONEX COMMUNICATIONS CORP.     v.     COMMISIONER OF REVENUE


Docket No. C271834		 		  Promulgated:
							  September 11, 2007


	This is an appeal under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the appellee Commissioner of Revenue ("appellee" or "Commissioner") to grant an abatement of use tax assessed against appellant Onex Communications Corporation ("Onex") under G.L. c. 64I, § 2 for the taxable periods August 31, 1999 through September 21, 2001.
	Commissioner Gorton heard this appeal. With Commissioner Gorton materially participating in the deliberations of this appeal, Chairman Hammond and Commissioners Scharaffa, Egan, and Rose joined in the decision for the appellant.
	These findings of fact and report are made on the Appellate Tax Board's own motion under G.L. c. 58A, § 13 and 831 CMR 1.32 and are promulgated simultaneously with its decision.

	William E. Halmkin, Esq., Richard L. Jones, Esq., and Kristin M. Smrtic, Esq. for the appellant.

	Laura S. Kershner, Esq., and Timothy R. Stille, Esq., for the appellee.


FINDINGS OF FACT AND REPORT

	Appellant Onex was incorporated in Delaware in May, 1999 and maintained its principal place of business at 34 Crosby Drive, Bedford, Massachusetts 01730. Onex specialized in application specific integrated circuits that enable switching, routing, and transmission of multiple types of voice and data traffic. In September, 2001, Onex was acquired by TranSwitch Corp. ("TranSwitch") and subsequently carried on its business under the name Opal Acquisition Corporation.
	Onex made purchases totaling $2,886,662.91 during the taxable periods spanning August 1, 1999 through September 21, 2001 ("the audit period"), for which no sales/use tax was paid. Of this amount $163,153.00 pertained to non-exempt purchases made for marketing and administration. Onex later fully paid the sales/use tax due on non-exempt purchases through an amnesty program offered by the Department of Revenue. The remaining amount, $2,723,510.00, pertained to purchases reflected in Onex's records as made for research and development ("R & D") purposes, for which no sales/use tax was paid. The Department of Revenue auditor adopted the breakdown of Onex's purchases shown in its corporate records for purposes of the disputed assessment.
	Onex received notice by letter dated July 13, 2001 that its sales/use tax liabilities for the audit period would be examined. On or about July 27, 2001, the Commissioner issued a Notice of Failure to File ("NFF") to Onex for sales/use tax for the taxable periods August 1, 1999 through March 31, 2001. The Commissioner issued another NFF, dated May 17, 2002, for sales/use tax, adding the taxable periods April 1, 2001 through September 30, 2001.
	In the fall of 2002, Onex timely filed a request for Amnesty for the Periods at Issue for its non-R & D purchases. The Commissioner approved the request by letter dated May 16, 2003. The May 16, 2003 letter indicated that the Commissioner had waived penalties for those purchases that were covered by the Amnesty application. 
	On or about October 16, 2002, Onex filed Use Tax Returns on Forms ST-10 for the periods at issue, for the non-R & D purchases made for marketing and administrative purposes. Onex tendered payment in the tax amount of $8,158.00, plus interest. Onex did not pay use tax for the R & D purchases that are the subject of this appeal.
	The Commissioner issued a Notice of Intent to Assess dated December 18, 2002 for the periods at issue. A Notice of Assessment followed, bearing a date of July 2, 2003. On or about July 30, 2003, Onex filed an Application for Abatement for the periods at issue. The Commissioner's Notice of Abatement Determination denying Onex's abatement application was dated October 8, 2003. Onex filed a Petition Under Formal Procedure with the Appellate Tax Board ("Board") on December 5, 2003. On the basis of the foregoing facts, the Board found that it had jurisdiction over the instant appeal.
	Three witnesses testified for Onex at the trial of this matter: Mr. Daniel Curtis, its Vice President of Administration, Treasurer and Chief Financial Officer ("CFO"); Mr. Radu Iorgulescu, an engineer who was Onex's Systems Architect and later Director of Product Line Management, who headed software design for the OMNI chip, which was Onex's flagship product; and Mr. Scott Wiley, Vice President and Controller at TranSwitch, who testified as keeper of the records for Onex. The Commissioner called no witnesses. The hearing officer found the testimony of the witnesses to be credible, consistent, and probative. The Board adopted this determination based on the information supplied by the hearing officer in support of his observations. Synthesizing the recommendations of the hearing officer, the testimony, the exhibits, and the statement of agreed facts, the Board made the following findings.
Onex's Activities during the Audit Period
	Onex specialized in application specific integrated circuits ("ASIC's"). Onex was started in order to design, manufacture, and sell a then-revolutionary device for transmission of data over communications networks. Onex's flagship product was an ASIC chip-set called OMNI. The product consisted of two chips, one functioning as a "switch" and the other as a "network processor." The OMNI Switch Element (the "OSE chip") controlled the switching of electronic circuits, while the companion chip, the OMNI Transport Processor (the "TP chip"), processed data from the OSE chip. The two chips were sold as a package. The OMNI chip-set was cutting-edge technology for the telecommunications industry during the years at issue: nothing like it had existed before. The OMNI chip-set was capable of supporting 1,344 virtual circuits, with each of them supporting 32 voice channels. The product optimized telecommunications systems functionality, doing in one chip-set what would previously have required ten chips to accomplish. The innovation reduced power needs and system costs. Calling the product "iTAP" internally, Onex engineers authored and published a user-manual titled the iTap Service Processor Data Sheet.
	Onex's activities during the audit period centered on taking the OMNI chip from abstract concept to production.  Their work started from a blank piece of paper, according to Mr. Iorgulescu. Onex's engineers had to design both hardware and software elements to make the OMNI chip a viable product. They had to create, design, and refine hardware to house the functions of a complex telecommunications system on a single chip-set. The chip was made of silicon, a semi-conductor material. Tiny internal modules had to be interwoven, integrated, and laid out to enable the intended functionality. Hardware components included data ports, links, processors, forwarding engines, connectors, and memory. Software had to be developed to be embedded into the hardware. Mr. Iorgulescu referred to the detailed technical framework for the product as its "architecture."
	Next came the "blueprint", resulting from Onex's research and development activities, which was a computer-edited design that included technical specifications of the hardware and software components. The blueprint included detailed manufacturing instructions. The blueprint was stored on computer disks. Credible testimony established that the building of the architecture and blueprint was an essential step in manufacturing the OMNI chip. 
	Because Onex lacked the sophisticated equipment needed to make the chip internally, it outsourced production of the OMNI chip to IBM. Onex and IBM entered into a contract under which IBM would fabricate the product, commencing July 1, 2000 and running through December 31, 2005. IBM had no input into design and was required to follow the instructions of the blueprint with exactitude. The production was carried out under Onex's direction. The contract provided that the manufactured OMNI chips were Onex's property.
	Using the blueprint, IBM produced an initial run of 50-100 early production chip-sets in early 2001. These early stage chips were tested and analyzed at the Onex laboratory. Based on the findings of the analysis, the blueprint was refined. By mid-2001, Onex sent the refined blueprint to IBM. IBM proceeded to manufacture production quantities, then shipped the chips to Onex. 
	Just as it had outsourced production, Onex turned to a more established company to market the OMNI chip. On September 17, 1999 Onex entered into a barter contract with TranSwitch. As a "qualified vendor" with a considerable sales and marketing capability, TranSwitch could reach major telecommunications services providers more effectively than a start-up. The barter contract obviated any need for Onex to add an appreciable marketing and sales capacity to its operation. 
The barter contract called for TranSwitch to market the OMNI chip as part of its own product line. TranSwitch received a license to acquire the OMNI chip at a reduced price. The OMNI chip added a product to the TranSwitch line with enhanced functionality over any of their existing products. 
	In September, 2000, Onex secured its first customer, Polaris Networks of San Jose, California. Mr. Curtis described Polaris as a "beta customer," which meant that its use of the chip was considered the last step in testing the product before a formal commercial roll-out. Polaris received a preferential price of $1000 per chip; the list price was $1500. Onex sold Polaris 20-30 chips in 2001, 1000 in 2002, and 1400-1500 in 2003. 
Given the close ties between Onex and TranSwitch, the merger proceeded seamlessly in September of 2001. The Commissioner chose to end the audit period as of the date Onex was acquired by TranSwitch. The commercial roll-out of the product occurred subsequent to the audit period in 2002.
Onex Capitalization, Expenditures, and Income
Onex received its initial capital infusion in 1999, in two, nearly simultaneous rounds of investments, which Mr. Curtis referred to as the "A and B rounds." Its first rounds of investors included Saint Paul Venture Capital, Star Ventures, Signal Lake Ventures, and another smaller investor. TransSwitch was also an investor, contributing technology Onex utilized in its activities. The "A and B rounds" of investments occurred approximately in September of 1999 and yielded $8,000,000 to $9,000,000. The "C round," which occurred in 2000, resulted in another $20,000,000 of capital for the company. The "C round" included most of the existing investors in Onex and was led by a new investor named Ben Rock Associates. Progress in the development of the chip attracted the additional investment.
Onex leased 11,000 square feet of space at its Bedford facility, and later added another 7,000 square feet. At its peak, Onex had sixty-five employees. Approximately 90% of these employees were hardware and software engineers engaged in the development of the OMNI blueprint. At least 75% of Onex's floor space was dedicated to engineering activities, and approximately 20% was used for administrative and non-engineering, non-manufacturing purposes.
Onex's personal property consisted of computer equipment and software, lab equipment, and furniture and fixtures. Mr. Curtis testified that nearly all of the computer equipment and software was used in developing the blueprint, with the exception of about 5% used for administrative and marketing purposes. Furniture and fixtures were used in rough correspondence to the staffing ratios between engineering and administrative employees. 
Money not expended in pursuit of the company's activities was deposited in an interest-bearing bank account. Onex earned $113,996 in interest in 1999; $594,134 in 2000; and $485,657 for 2001.
	On the basis of the foregoing, the Board found that Onex was formed to take a new product from abstract concept to production and commercial sale. Onex used human skill in the form of software and hardware engineering expertise, assisted by sophisticated computer and laboratory equipment, to develop ex nihilo the architecture for a product with enhanced functionality for the telecommunications services industry. The product represented a significant advance in telecommunications technology at the time.
	Onex developed a blueprint with intricate manufacturing instructions through which silicon could be transformed into the OMNI chip with its complex software and hardware components. During the audit period, it entered into contracts for both the production and marketing of the OMNI chip and secured its first customer. Testing and refinement of the chip-set also occurred during the audit period. Production in commercial quantities followed seamlessly from Onex's ongoing activities begun in 1999 and was unaffected by the corporate reorganization which happened in September, 2001. Because the Commissioner chose to conclude the audit at the point TranSwitch acquired Onex, the audit period was not coextensive with the overall process intended from the outset to research, develop, and manufacture the OMNI chip for sale to telecommunications services providers.
	The Board concluded that Onex effectuated a significant transformation of raw ideas and engineering expertise into a technical blueprint capable of minutely directing the manufacture of the then-revolutionary OMNI chip from silicon. Initial production of the chip started during the audit period, followed by larger scale production in 2002 after the product had been further refined. 
The activities performed during the audit period constituted an essential and integral part of the overall process of manufacturing the OMNI chip. Because Onex, during the audit period, carried out essential and integral steps in the total manufacturing process which brought a new product to the marketplace, the company was "engaged in manufacturing" within the meaning of G.L. c. 63, § 42B. The purchases reflected on Onex's books and records as pertaining to "research and development" - accepted as such by the Commissioner's auditor in making the assessment -were for use "directly and exclusively … in research and development by a manufacturing corporation …." 
Accordingly, the purchased items were exempt from use tax under G.L. c. 64I, § 7(b) and c. 64H, § 6(r) and (s).
The disputed assessment was improper, and the Board accordingly ordered an abatement of tax in the amount of $136,175, plus statutory additions. 

OPINION
	The issue in this appeal is whether Onex's R & D purchases, the amount of which is agreed upon, qualify for exemption for use tax purposes. The use tax statute, G.L. c. 64I, adopts, by and large, the exemptions made applicable in the sales tax context. See G.L. c. 64I, § 7(b). In support of its claim for an abatement, Onex relied on two exemptions which appear at G.L. c. 64H, § 6 (r) and (s). 
As the Board summarized in Lawrence-Lynch Corp. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Report 1997-883, 897-98, "[t]he § 6(r) exemption addresses materials, tools, and fuel which become an ingredient of the manufactured product, or are consumed in the manufacturing process. The § 6 (s) exemption relates to the machinery and tools which are the instruments for changing raw materials into a manufactured product." It is well-settled that "[n]o 'special burden' is placed upon the
taxpayer invoking these exemptions." Lawrence-Lynch, Mass. ATB Findings of Fact and Report 1997 at 905. As the Supreme Judicial Court explained in DiStefano v. Commissioner of Revenue, 394 Mass. 315, 325 (1985), "'[t]he subsections are merely part of the statutory definition of the types of sales and uses of tangible personal property which are to be employed in measuring the excises and of those which are not so to be used.'" (Citations omitted.)  
The question which most often arises under the § 6(r) and (s) exemptions is whether "the machinery assessed was used (1) directly and exclusively; (2) in an industrial plant; (3) in the actual manufacture, conversion, or processing; (4) of tangible personal property; (5) to be sold." See Associated Testing Laboratories, Inc. v. Commissioner of Revenue, 429 Mass. 628, 630 (1999). See also Lawrence-Lynch, Mass. ATB Findings of Fact and Report 1997 at 899. However, the exemptions also reach items used "directly and exclusively … in research and development by a manufacturing corporation or a research and development corporation within the meaning of section thirty-eight C or forty-two B of chapter sixty-three."
See G.L. c. 64H, § 6(r) and (s).  See also Monsanto Co. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Report 1997-1154, 1159. As is clear upon a close reading of the statute, most of the elements of the § 6(r) and (s) exemptions addressed in Associated Testing Laboratories, 429 Mass. at 630, are inapplicable in determining whether research and development purchases are exempt. 
	Since the Commissioner did not controvert the "research and development" character of the purchases at trial, the exemption question turned on whether Onex could be classified as either a "manufacturing corporation" or "research and development corporation" within the meaning of G.L. c. 63, § 42B, which applies to foreign corporations. All that is required for exemption under the relevant prong of G.L. c. 64H, § 6(r) and (s) is direct and exclusive use of purchased articles in research and development by a qualifying corporation. Onex's claim to "research and development corporation" status rested on the version of § 42B in effect before the 2003 amendments:
A foreign research and development corporation for the purposes of this section is one whose principal activity herein is research and development and which derives more than two thirds of its receipts assignable to the commonwealth from such activity and derives more than one third of its receipts assignable to the commonwealth from the research and development of tangible personal property capable of being manufactured in this commonwealth.

G.L. c. 63, § 42B (prior to being amended by St. 2003, c. 141, § 29.)

	There can be little doubt on the instant record that Onex's principal activity was research and development. However, "research and development corporation" classification also turned on a "receipts" test: more than two thirds of "receipts assignable to the commonwealth" must have derived from research and development activity, and more than one third of its "receipts assignable to the commonwealth" must have derived from the "research and development of tangible personal property capable of being manufactured in this commonwealth." 
The Commissioner opposed "research and development corporation" classification, arguing that "receipts" should be defined according to G.L. c. 64H, § 1 as "the total sales price received by a vendor as a consideration for retail sales." Onex countered that the term "receipts", not defined at G.L. c. 63, § 30, was broad enough to comprehend infusions of capital. Moreover, since its investors were motivated to support the design and manufacture of the OMNI chip, Onex argued that all the amounts it received from its investors qualified as receipts attributable to research and development activity. 
	The Board addressed the definition of "receipts" for purposes of § 42B in the recent case of Duracell, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Report 2007-903. The Board held that "a broad construction of the term ["receipts"] is consistent with the legislative intent of the statute and the construction of the language of the statute as established by case law." Id. at 914.  The Board observed that "receipts" may be broader in scope than the term "income." Id. The Board rejected a definition of "receipts" so narrow as to include only income realized from sales to unrelated parties.
However, Duracell did not present the question of whether the statutory term "receipts" was broad enough to encompass investments of capital. Nor did the Board need to decide that question in order to resolve the instant claim, in light of the conclusion that Onex constituted a "manufacturing corporation" within the meaning of G.L. c. 63, § 42B, such that its research and development purchases qualified for exemption under G.L. c. 64H, § 6(r) and (s). 
G.L. c. 63, §§ 38C and 42B confer manufacturing corporation status on domestic and foreign corporations, respectively, which are "engaged in manufacturing." Classification as a manufacturing corporation "'has a significant bearing on [the company's] tax liability to the Commonwealth….'" John S. Lane & Son, Inc. v. Commissioner of Revenue, 396 Mass. 137, 140 (1985)(Citation omitted.) G.L. c. 63, §§ 38C and 42B "provide[] no definition for a manufacturing corporation. Rather, that definition has been developed by decades of case law." Duracell, Mass. ATB Findings of Fact and Report 2007 at 917. "To merit the desired 'manufacturing' label … a corporation must engage in activities properly called 'manufacturing' and 'substantial' in relation to the whole of its operations." Noreast Fresh, Inc. v. Commissioner of Revenue, 50 Mass. App. Ct. 352, 354 (2000). Decisions of the Supreme Judicial Court "have embraced the basic concept of manufacturing articulated in Boston & Me. R.R. v. Billerica, 262 Mass. 439, 444-445 (1928): "'[C]hange wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use.'" William F. Sullivan & Co., Inc. v. Commissioner of Revenue, 413 Mass. 576, 579 (1992). 
The Court in William F. Sullivan & Co. stressed "that the phrase 'engaged in manufacturing' should not be given a narrow or restricted meaning." Id. Rather, application of the phrase should conform to the "broad purpose of the statute to be a promotion of the general welfare by inducing new industries to locate in Massachusetts and by fostering an expansion and development of our own industries." Joseph T. Rossi Corp. v. State Tax Commission, 369 Mass. 178, 181 (1975). Noreast Fresh, 50 Mass. App. Ct. at 355-57, illustrates the broad interpretation the courts have given to the phrase "engaged in manufacturing". In that case, the taxpayer's activities in making salads and coleslaw from raw vegetables were enough to support manufacturing corporation status. See id.
"At bottom, the proper mode of analysis is of the 'case-by-case analogical' variety." Noreast Fresh, 50 Mass. App. Ct. at 355, quoting William F. Sullivan & Co., 413 Mass. at 581. Two decisions of the Supreme Judicial Court have particular bearing on whether Onex qualified as a manufacturing corporation under G.L. c. 63, § 42B and therefore, G.L. c. 64H, § 6(r) and (s). First, a book publisher was accorded manufacturing corporation status in Commissioner of Revenue v. Houghton Mifflin Co., 423 Mass. 42 (1996). The taxpayer's activities consisted of researching and developing ideas for books to be published, leading to the write-up and editing of a manuscript by various writers and editors. Thumbnail sketches were also generated, and with the manuscript underwent "further processing and refinement." 423 Mass. at 43. Templates were then created, and art and photographs were developed for inclusion in the ultimate product. These items were "assembled into layouts." Id. at 44. Proofs were produced and marked up for changes and corrections to "further refine the product." Id. The second proofs were converted into color proofs. Houghton then produced "CD ROM tapes which [were] then sent to independent contractors for final packaging in compact disks, or [Houghton] sen[t] the proofs (usually on computer diskettes) to independent contractors for printing and binding into conventional books." Id. As the Court explained, "[t]hroughout this process, [Houghton] uses, among other things, human skill and knowledge as well as various implements, materials, and machines or machinery such as computers, digital modems, printers, photocopiers, writing utensils, lighting machines, drawing equipment and materials, graphic art tools, electronic graphic equipment, electronic color collection equipment, photo-retrieval equipment, sophisticated software, and scanners." Id. 
The Court held that in the course of these activities, "Houghton transforms ideas, art, information, and photographs, by application of human knowledge, intelligence, and skill, into computer disks, ready for use by independent printers, containing an immense amount of information in a highly organized form. We have never required that source materials be tangible." Id. at 48. 
The Court rejected the Commissioner of Revenue's argument that "Houghton's activities to some extent resemble those of a furniture designer who produces designs used by others to build furniture, or an author who writes and sells a manuscript to a publisher." Id. at 49. The Court found a "reasonable basis for distinguishing Houghton's activities." Id. In contrast to documents generated by designers and authors, Houghton's completed computer disks and CD ROM tapes, "although having intellectual content, are valuable principally because they are physically useful in making the finished product." Id. The Court analogized Houghton's computer disks and CD ROM tapes to "'composition proofs'" and linotype held to be exempt in earlier cases. Id., citing Houghton Mifflin Co. v. State Tax Comm'n, 373 Mass. 772, 773, 776 (1977) and Courier Citizen Co. v. Commissioner of Corps. and Taxation, 358 Mass. 563, 572-573 (1971.) 
In William F. Sullivan & Co., 413 Mass. at 579-80, the Court applied the doctrine that "'processes which themselves do not produce a finished product for the ultimate consumer should still be deemed 'manufacturing' for purposes of this tax exemption so long as they constitute an essential and integral part of a total manufacturing process.'" Citing Joseph T. Rossi Corp., 369 Mass. at 181-82. The taxpayer was a scrap-metal processor, which purchased approximately 50,000 tons of scrap metal from roughly 1000 businesses and individuals per year. Metals were separated for processing, then "sent to either an hydraulic shear, which cuts the scrap to specified lengths, or to a baler, which compresses the scraps into cubes." William F. Sullivan & Co., 413 Mass. at 578. Once processing was concluded, the scrap metal was sold to steel mills and foundries according to customer specifications.	
The Court held "that Sullivan's scrap processing operation qualifies for exemption. In our view, Sullivan's operation produces a similar degree of change and refinement to the source materials as did the processes at issue in the wool scouring case and in Rossi." Id. at 581. The Court went on to elaborate on when activities which stop short of producing an end product can be considered "essential and integral" to an overall manufacturing operation:
This is not to say … that every process comprising the first step, or a step, in the transformation of some source material into a finished product qualifies as a process which is an essential and integral part of the total manufacturing process…. To constitute an essential and integral part of the total manufacturing process and to qualify for the exemption, the process under study must effect the kind of change and cause a correlative degree of refinement to the source material as exemplified by the taxpayers' operations in the wool scouring case, Rossi, and now, Sullivan's scrap processing operation.

Id.
	Analogizing to the facts of Houghton Mifflin Co. and William F. Sullivan & Co., the Board concluded that Onex caused a sufficient degree of refinement to both intangible and tangible source materials so that its activities could be considered "an essential and integral part of the total manufacturing process" which yielded the OMNI chip. Cf. William F. Sullivan & Co., 413 Mass. at 581. As in Houghton Mifflin Co., Onex's engineers carried out "extensive research and development" aimed at organizing and enhancing a vast amount of sophisticated technical data. Cf. Houghton Mifflin Co., 423 Mass. at 43-44. Various engineering equations, scientific data, and numeric specifications had to undergo at least as much processing and refinement as did the ideas which went into the production of the CD ROM tapes and diskettes in Houghton Mifflin Co., in order to create the blueprint for manufacturing the chip. As in Houghton Mifflin Co., the blueprint was stored on computer disks. The blueprint was refined and perfected in laborious operations to ensure the architecture was suitable for producing ONMI chips which performed fully as intended. A further analogy to Houghton Mifflin Co. lay in the fact that the blueprints were provided to an independent contractor, who, following the intricate details, fabricated the finished product, ready for sale to telecommunications industry customers. "The work [Onex did] approache[d], to the extent humanly possible, creation ex nihlo; it [was] quite different from the mere manipulation of information and electric currents" which have been held not to constitute manufacturing.  Houghton Mifflin Co., 423 Mass. at 49. 
	Moreover, the blueprint was not an abstract academic treatise or work of art. It was painstakingly developed because the architecture for the OMNI chip was an essential first step to fabricating the end product which had been envisioned from the very outset. The blueprint was "physically useful in making the finished product." Id. See also Commissioner of Revenue v. Fashion Affiliates, Inc., 387 Mass. 543, 546 (1982) (Process used to create markers for use in dress-making held to be within the scope of manufacturing: "The machinery is used to guide and measure a direct and immediate physical change in the material, a function that is an integral and necessary role in producing properly cut portions of the dresses being manufactured.") The development of the blueprint and the fabrication of the OMNI chip according to its intricate specifications represented a process of transformative change "'wrought through the application of forces directed by the human mind'", out of which came a new commodity with capabilities that had never existed before. Houghton Mifflin Co., 423 Mass. at 46. 
	Given the big picture view of the manufacturing process taken in the decisions of the Supreme Judicial and Appeals Courts, the Commissioner was unconvincing in his attempt to truncate the overall operations leading up to the production of the OMNI chip. The Commissioner chose to end the audit period based on a circumstance that bore no relationship to the organic process of inventing, manufacturing, and marketing the OMNI chip. The acquisition of Onex by TranSwitch did nothing to interrupt the ongoing activity which began with raw ideas and flowed continuously according to plan to the point that the OMNI chip was commercially available. Thus, only by sub-dividing the overall manufacturing process on the basis of the extrinsic circumstance of corporate ownership was the Commissioner able to argue that Onex was not "engaged in manufacturing". Case law rejects such a balkanized analysis of the complex, multi-step processes entailed in designing and manufacturing the finished product. See generally Courier Citizen Co. v. Commissioner of Corps. and Taxation, 358 Mass. 563, 571-72 (1971)(Statutory language "'should not be construed to require the division into theoretically distinct stages of what is in fact continuous and indivisible.'")(Emphasis in opinion)(Citations omitted.)
	Finally, the Supreme Judicial Court has held that "the Legislature did not intend to confer a windfall tax exemption on nonmanufacturing corporations that engage in manufacturing 'which is merely trivial or only incidental to its principal business.'" Fernandes Super Markets, Inc. v. State Tax Comm'n, 371 Mass. 318, 322 (1976) (Citation omitted.) "[T]he degree of manufacturing must be 'substantial' … or 'important and material' … when measured against the entire operations of the corporation." Id. (Citations omitted.) The research, development, design, and manufacture of the OMNI chip was the "principal business" of Onex, if not its only activity. Cf. id. Where the OMNI chip was "not a mere sideline, but the heart of the corporate business", the degree of manufacturing is considered to be "substantial" for purposes of the statute. See Noreast Fresh, 50 Mass. App. Ct. at 358. 
	The Board found and ruled that the activities of Onex constituted "an essential and integral part of the total manufacturing process…" under William F. Sullivan & Co., 413 Mass. at 581, and were substantial. See Noreast Fresh, 50 Mass. App. Ct. at 357-58. Given this finding, it follows that Onex was "engaged in manufacturing" for purposes of G.L. c. 63, § 42B. 
The purchases to which the use tax assessment applied were reflected in corporate records as relating to research and development, and their character as such was accepted by the Commissioner's auditor in his review of corporate books and records. Use tax was separately paid on those purchases deemed to be "administrative" or otherwise not "research and development"-related. Accordingly, the evidence warranted the conclusion that the disputed assessment pertained to items "used directly and exclusively in … research and development by a manufacturing corporation…" G.L. c. 64H, § 6(r) and (s). 
Because the use tax assessment at issue applied to purchases which are exempted by the sales and use tax statutes, it was improper. The Board issued a decision for the appellant, and ordered an abatement of $136,175 tax, plus statutory additions. 

     APPELLATE TAX BOARD

			By: _________________________________
			 Thomas W. Hammond, Jr., Chairman
 
				
A true copy,

Attest: ____________________________
       Clerk of the Board

   On September 11, 2006, Commissioner Gorton was sworn as a temporary member of the Appellate Tax Board pursuant to G.L. c. 58A, § 1, his status as a member of the Board having terminated on that date with the appointment and qualification of his successor.  See G.L. c. 30, § 8.  That appointment was extended for an additional one-year term, commencing September 11, 2007. Commissioner Gorton's material participation in the deliberations of this appeal included, inter alia, drafting proposed findings of fact supplying a report on the evidence and his observations as to witness credibility. He also made oral presentations of his recommendations to the Board members. 

   G.L. c. 64H, § 6(r) and (s), in relevant part, exempt from sales and use tax:
	
	§ 6(r). Sales of materials, tools and fuel, or any substitute therefor … which are consumed and used directly and exclusively in … research and development by a manufacturing corporation or a research and development corporation within the meaning of section thirty-eight C or forty-two B of chapter sixty-three.

	§ 6(s). Sales of machinery or replacement parts thereof, used directly and exclusively in … research and development by a manufacturing corporation or a research and development corporation within the meaning of section thirty-eight C or forty-two B of chapter sixty-three.

 The Commissioner's argument that Onex was not engaged in "actual manufacture" was not relevant to the determination of manufacturing corporation status under G.L. c. 63, §§ 38C and 42B. See generally, William F. Sullivan & Co., Inc. v. Commissioner of Revenue, 413 Mass. 576, 579-80 (1992).
 In its present form, G.L. c. 63, § 42B grants "research and development corporation" status where 2/3 of expenditures are "allocable" to research and development activity.
  The Commissioner argued, for the first time in his reply brief, that Onex had failed to show that the items purchased were used "directly and exclusively … in research and development…." Given the auditor's meticulous review of Onex's records and his sorting out of research and development-related purchases, the Commissioner's eleventh-hour assertion was unpersuasive. Onex was formed specifically for the research, development, and manufacturing of the OMNI chip, so it is unclear what disqualifying uses of the purchased items the Commissioner could be referring to. Moreover, uses of purchased items which are "de minimis" will not undermine their exempt character. See Lawrence-Lynch, ATB Findings of Fact and Report 1997 at 906, n.11.

ATB 2007-976