Raytheon Company v. Commissioner of Revenue (July 17, 2008)

COMMONWEALTH OF MASSACHUSETTS
APPELLATE TAX BOARD

RAYTHEON COMPANY 	      v.        COMMISSIONER OF REVENUE

Docket No. C277684                   Promulgated:
		 					  July 17, 2008

This is an appeal filed under the formal procedure, pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the appellee to grant to appellant an abatement of sales and use taxes for the monthly periods beginning January 1, 2001 through December 31, 2002 ("tax periods at issue").  
Commissioner Scharaffa heard these appeals.  Chairman Hammond and Commissioners Egan, Rose, and Mulhern joined him in the decision for the appellee.
These findings of fact and report are made pursuant to requests by appellant and appellee under G.L. c. 58A,      § 13 and 831 CMR 1.32.   
Samuel B. Bruskin, Esq., Robert M. Buchanan, Jr., Esq., and Wendy S. Plotkin, Esq. for appellant.
 
Timothy R. Stille, Esq. and John DeLosa, Esq. for the appellee. 






FINDINGS OF FACT AND REPORT
On the basis of a Statement of Agreed Facts and testimony and exhibits submitted during the hearing of this appeal, the Appellate Tax Board ("Board") made the following findings of fact.  At all times relevant to this appeal, appellant, Raytheon Company ("Raytheon") was a corporation organized under Delaware law with its principal offices and operations in Massachusetts.  On February 20, 2004, Raytheon filed an abatement application with appellee, Commissioner of Revenue ("Commissioner") requesting abatement of sales and use taxes for the tax periods at issue included within calendar year 2001.  On May 20, 2004, Raytheon filed an abatement application with appellee requesting abatement of sales and use taxes for the tax periods at issue included within calendar year 2002.  On December 15, 2004, Raytheon filed a letter with the Commissioner revoking its consent to extend the time during which the Commissioner may act upon its abatement applications, with the effect that they were deemed denied as of that date pursuant to G.L c. 62C, § 39 and G.L.     c. 58A, § 6.  
On February 1, 2002, Raytheon obtained a direct pay permit from the Commissioner, which relieved its vendors from collecting sales tax.  For the tax periods after that date, appellant assumed liability for remitting sales or use taxes on its purchases.  Raytheon, therefore, also filed abatement applications at various dates between January 20, 2004 and June 15, 2004 on behalf of vendors from whom Raytheon had made purchases during the tax periods at issue ("vendor abatement applications").  These vendors had executed powers of attorney in favor of Raytheon.  On December 15, 2004, Raytheon filed a letter with the Commissioner revoking Raytheon's consent to extend the time during which the Commissioner may act upon the vendor abatement applications, with the effect that they were deemed denied as of that date pursuant to G.L. c. 62C, § 39 and G.L. c. 58A, § 6.  
On April 22, 2005, Raytheon seasonably filed its Petition with the Board.  On the basis of the foregoing, the Board found that it had jurisdiction over the instant appeal.
At all times relevant to this appeal, Raytheon was engaged in the business of producing specialized command, control, communication, telecommunication, intelligence and electronic warfare systems, primarily for sale to the United States Government ("federal government").  Raytheon entered into contracts with the federal government ("government contracts") to produce and sell these defense systems.  In connection with its performance of the government contracts, Raytheon purchased numerous items of tangible personal property.  Raytheon's purchases of "direct cost" items are not at issue in this appeal.  "Direct cost" items include semiconductor chips, sheets of metal, testing equipment, and other items used directly in the manufacturing of Raytheon's final products.  By contrast, the items at issue in this appeal, which are classified as "indirect cost items," are used at Raytheon's facilities in the performance of the government contracts and are not delivered to the federal government as final products.  They include, but are not limited to, the following: cell phones and accessories; food and catering services; janitorial supplies (including toilet paper and trash bags); office furnishings (including art work); salt and sand for snow removal; a jukebox; latex gloves; paper; printer toner; and promotional items like lapel pins, golf umbrellas, mugs, and key chains.  John Harris, vice president of contracts and supply chain for Raytheon, admitted on cross-examination that, aside from the occasion when a paper-copy of a report or memorandum was delivered to the federal government, the indirect cost items at issue were generally not delivered to the federal government in connection with the performance of the government contracts.  
Although possession of the indirect cost items did not pass to the federal government, Raytheon contended that title to the indirect cost items nonetheless passed to the federal government pursuant to the terms of the government contracts and the Federal Acquisition Regulations ("FARs"), set forth at 48 C.F.R., which govern these contracts.  FARs require that Raytheon allocate its indirect cost items to indirect cost pools, which are then allocated over Raytheon's contracts and are billed to each government contract in their allocable percentage.  Government contracts account for 81% of Raytheon's business, and therefore, 81% of Raytheon's purchases of indirect cost items are allocated to the federal government.  Raytheon demonstrated, and the Commissioner did not dispute, that the federal government paid for its share of the indirect cost items that were allocated to government contracts pursuant to indirect cost pools.  At the hearing, John Panetta, Raytheon's Director of Government Accounting, testified that each of Raytheon's purchases of indirect cost items is automatically assigned to a cost pool upon purchase, and the costs are tracked in detail so that they can be reported to the federal government.  Raytheon contended that, because title to the indirect cost items passes to the federal government pursuant to the FARs, then Raytheon's purchases of the indirect cost items qualify as "sale[s] . . . for resale in the regular course of business" pursuant to G.L. c. 64H, § 1, and thus are exempt from sales and use taxes.  
However, to the extent that it is a finding of fact, the Board found that Raytheon was primarily engaged in the business of producing and selling defense systems, and that its purchases of the indirect cost items at issue merely served to facilitate its completion of the government contracts.  Therefore, for the reasons explained more fully in the following Opinion, the Board found and ruled that Raytheon's purchases of the indirect cost items at issue did not qualify as "sale[s] . . . for resale in the regular course of business," and therefore were not exempt from sales and use taxes.  Accordingly, the Board issued a decision for the appellee in this appeal.

OPINION

General Laws c. 64H, § 2 imposes a sales tax of five percent upon a vendor's sales at retail in the Commonwealth of tangible personal property that are not otherwise exempt.  General Laws c. 64I, § 2 imposes a corresponding use tax "upon the storage, use or other consumption in the commonwealth of tangible personal property purchased from any vendor for storage, use or consumption within the commonwealth . . . ."  "Sale" is defined as including "any transfer of title or possession, or both . . . of tangible personal property . . . for a consideration."  G.L. c. 64H, § 1.  It is undisputed that Raytheon obtained possession of the indirect cost items at issue, in exchange for consideration that it paid to its vendors.  Therefore, Raytheon made purchases of the indirect cost items at issue in this appeal.  
The principal issue before the Board was whether Raytheon's purchase of indirect cost items, which Raytheon allocated to government contracts, qualified as "sale[s] . . . for resale in the regular course of business," thereby entitling Raytheon to an abatement of the sales or use taxes paid on those items.  G.L. c. 64H, § 1; G.L. c. 64I, § 1.  
In support of its position that the subject sales were for resale in the regular course of its business, Raytheon contended that, pursuant to applicable FAR provisions, title to the indirect cost items vested in the federal government immediately, since the indirect cost items were automatically assigned to a cost pool upon purchase by Raytheon.  However, Raytheon's argument is counter-intuitive and does not support its overall sale-for-resale position.  The logical conclusion of Raytheon's contention is that title never vested in Raytheon; thus, a transfer of title from Raytheon to the federal government could not have occurred under these facts.  Moreover, possession of the indirect cost items remained with Raytheon; thus, a transfer of possession from Raytheon to the federal government also could not occur under these facts.  The definition of "sale . . . for resale" envisions two transactions, i.e., a sale followed by a resale.  Acceptance of Raytheon's premise that title to the indirect cost items vested immediately in the federal government would lead to the conclusion that only one transaction occurred for each indirect cost item.  Therefore, no resale occurred under the facts of this appeal. 
Even if the sales could be construed as sales for resale to the federal government, then the critical issue to be resolved in this appeal is whether the indirect cost items were sold "in the regular course of business."  G.L. c. 64H, § 1.  According to the seminal cases in this area, particularly Clark Franklin Press Corp. v. State Tax Commission, 364 Mass. 598 (1974), Prince v. State Tax Commission, 366 Mass. 470 (1974), and Jan Co. Central, Inc. v. Commissioner of Revenue, 405 Mass. 686 (1989), the Board must determine whether the indirect cost items were integral components of Raytheon's transactions with the federal government, or whether they were incidental items that facilitated the main purposes of the government contracts.  A careful review of the above cases establishes that the indirect cost items were incidentals that facilitated the transactions in question, not items with any independent consumer value that were "resold" to the federal government.
Clark Franklin Press addressed the taxability of travel brochures, which advertised and promoted the travel services provided by AITS, a travel tour operator.  Clark Franklin Press Corp. v. State Tax Commission, 364 Mass. 598, 600 (1974).  These brochures were sold by the taxpayer, a lithograph business, to AITS, its parent, which then distributed the brochures to its customers, the purchasers of travel tour packages.  Id.  "Though AITS did not charge its customers separately for the brochures, their cost was included in the ultimate selling price of the 'service package,' and thus AITS in fact received consideration."  Id. at 601-02.  Based on this fact, the appellant there contended that the sales of the brochures by the taxpayer to AITS constituted sales for "resale in the regular course of business," pursuant to the plain language of G.L. c. 64H, § 1.  Id. at 602.  
However, the Supreme Judicial Court "reject[ed] this rather simplistic approach," finding that "[the 'regular course of business'] language must find its meaning in the inherent nature of the business in question."  Id.  The Supreme Judicial Court ruled that: 
AITS is in the business of selling travel services, not brochures.  The transfer of brochures constituted only an insignificant part of AITS's transactions with its customers, and it is obvious that the services provided by AITS were the predominant factor in the charges made to its customers. . . .  These brochures, provided by AITS to its customers for promotional and advertising purposes, in and of themselves had no consumer value. 

Id. (emphasis added).  Accordingly, the Supreme Judicial Court ruled that "AITS was not engaged in the resale of the travel brochures in the regular course of its business" and, therefore, the sales of the brochures by Franklin Press to AITS did not qualify for exemption from the sales tax as sales for resale.  Id. 
Prince addressed the taxability of prizes distributed by an amusement park operator to customers who won them by being successful at "games of skill."  Prince v. State Tax Commission, 366 Mass. 470 (1974).  In that case, the Supreme Judicial Court ruled that the prize was not the central purpose of the park operator's transactions with its customers; rather, the purpose of the transaction was to engage the customers in playing the game, and "[t]he prize awarded [was] an inducement to play the game and [was] not a sale at retail."  Id. at 473.  Moreover, "[t]hat the inducement results in the transfer of the personal property to the successful contestant is not crucial."  Id.  Accordingly, the amusement park operator owed a use tax on its purchases of the prizes.  Id.
Jan Co. addressed the taxability of paper and plastic products, including napkins, utensils, sandwich cartons and wrappers, and French fry sleeves, which the taxpayer, a Burger King restaurant franchisee, purchased from its suppliers and then transferred to its customers in conjunction with purchases of meals.  Jan Co. Central, Inc. v. Commissioner of Revenue, 405 Mass. 686, 686-87 (1989).  "In determining whether Jan Co. purchased the paper and plastic products for resale in its regular course of business, we look to the inherent nature of Jan Co.'s business."  Id. at 688 (citing Clark Franklin Press, 364 Mass. at 602, and Coca Cola Bottling Co. of Northampton v. Commissioner of Revenue, 393 Mass. 726, 729 (1985)).  Pursuant to a review of its earlier cases, the Supreme Judicial Court found that: 
[C]ertain transfers of tangible personal property (brochures and prizes) are not resales in the regular course of the transferor's business but are incidental to the transferor's business, serving to facilitate the consummation of the principal transactions. . . .  Clearly, neither the travel company nor the game operator purchased the property in question for the resale value of the property.  Rather, the value of the property was connected to its use in facilitating the main goal of the business and not its resale in the regular course of business.

Id. at 689.  Likewise, the Supreme Judicial Court in     Jan Co. ruled that the paper and plastic products had no independent value apart from their facilitation of the taxpayer's business, the provision of meals, and were therefore "incidental to the basic purpose of the transaction, the sale of food and drink."  Id. at 689.  Accordingly, the taxpayer's provision of those products did not qualify as sales for resale in the regular course of its restaurant business.  Id. at 689-90.  See also, Hanover Mall Cinema, Inc. et al. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1997-959, 966 (finding that transfers of containers for popcorn and drink "merely facilitated the sale of food and drinks, which was the ultimate object of the transaction" and thus did not qualify as "retail sale[s]" as defined in G.L. c. 64H,     § 1). 
In McDonald's Restaurants of Massachusetts, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Report 2005-189, the Board addressed the taxability of Happy Meal toys transferred by the taxpayer to its customers in conjunction with the sale of a complete Happy Meal.  In that appeal, the Board held that the interpretation of "regular course of business" "does not simply 'end[] with a determination of the seller's primary line of business,' but instead must focus on the 'dominant purpose' of the particular transaction involved."  Id. at 2005-207 (quoting International Business Machines Corp. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Report 1997-1028, 1045).  The Board found that the dominant purpose of the transactions at issue there was "the sale of Happy Meals," and that the Happy Meal Toys "were a significant part of the Happy Meals which [the taxpayer] sold in the regular course of its business."  Id. at 2005-208.  
Key to the Board's finding was "the evidence concerning the planning and marketing of the Happy Meal Toys, including the commercials which showcased those toys," which "established that the Happy Meal Toys were intended to be, and were, a popular commodity with intrinsic value to the customers of McDonald's and its franchisees."  Id. at 2005-207-08.  It was undisputed that "[t]he Happy Meal Toys were heavily advertised and available contemporaneously with many trends in children's pop culture, including movies and popular toy fads" and became collectibles with McDonald's patrons, in stark contrast with the paper and plastic products at issue in Jan Co., the brochures at issue in Clark Franklin Press, and the prizes at issue in Prince.  Id. at 2005-209.  
In the instant appeal, the items at issue were indirect cost items, including janitorial supplies (such as toilet paper), food and catering services, office furnishings (including artwork and a jukebox), lapel pins, and salt for snow removal, which were allocated to government contracts.  The Board does not dispute Raytheon's contention that the items were necessary to Raytheon's ability to complete its government contracts.  However, the proper inquiry is "whether the transfer of the disputed items was part of the 'inherent nature' of the taxpayer's business [or transaction] and not [] whether the transfer of the disputed items was 'critical' to the sale or 'integrated' with the sale."  Hanover Mall Cinema, Mass. ATB Findings of Fact and Reports at 1997-968.  The Board here found that the indirect cost items, while they facilitated the completion of the transactions, were nonetheless incidental to the transactions at issue, which were the completion and delivery of defense programs like the Patriot surface-to-air missile.  The Board thus found and ruled that the indirect cost items were more akin to the brochures, paper and plastic items, and prizes at issue in Clark Franklin Press, Jan Co. and Prince, respectively, and not like the heavily-advertised Happy Meal toys at issue in McDonald's, and therefore, the transfer of their title did not qualify as "sale[s] . . . for resale in the regular course of business."  
Raytheon urged the Board to follow the reasoning applied by the Texas Court of Appeals, Third District, Austin, in Strayhorn v. Raytheon E-Systems, 101 S.W.3d 558 (Tex. App. 2003).  The court there found that "Raytheon's normal course of business in this context is performing contracts to provide intelligence systems, aircraft navigation systems, and other defense-related products to the federal government," and because Raytheon allocated its indirect cost items to the federal government in completion of the contracts, "it sold the items to the federal government in the normal course of business."  Id. at 567.  However, the Board finds this reasoning to be akin to the "rather simplistic approach" criticized by the Supreme Judicial Court in Clark Franklin Press, because it fails to account for the lack of consumer value of the indirect cost items to the federal government.  The provision of title to the federal government of the indirect cost items was not the dominant purpose of Raytheon's government contracts.  Instead, the dominant purpose was the completion of defense programs like the Patriot surface-to-air missile; the indirect cost items merely facilitated the completion of those programs.  Moreover, the Strayhorn Court specifically acknowledged that "[w]hether Raytheon is entitled to the sale for resale exemption is a question of state law."   Id. at 565.  The Board was thus not persuaded by this foreign case interpreting Texas tax law.
Raytheon also contended that key to this appeal was the fact that title to the indirect cost items at issue was transferred to the federal government pursuant to the terms of the government contracts and the applicable FARs.  However, under the governing statute, there is no distinction between the passage of title and the transfer of possession: G.L. c. 64H, § 1 defines "sale" as "any transfer of title or possession, or both."  (emphasis added).  In each of the cases where the Supreme Judicial Court ruled that a "sale . . . for resale" had not occurred - Clark Franklin Press, Prince and Jan Co. - a transfer of possession had occurred with respect to the disputed items.  However, the Supreme Judicial Court, and the Board, have made clear that the central inquiry is whether a transfer is "in the regular course of [appellant's] business," as opposed to a transfer of an  incidental item which merely serves to complete the transaction.  See Jan Co., 405 Mass. at 689 (finding that paper and plastic items transferred to customers in conjunction with restaurant meals were "incidental" to, and "facilitate[d] the consummation of the principal transaction").  Raytheon did not purchase toilet paper and lapel pins "for the resale value of the property."  Id.  Instead, the Board found that the value of the indirect cost items was connected to their use in facilitating Raytheon's completion of the government contracts.  
Moreover, whether a party specifically pays for its share of enumerated indirect cost items pursuant to a detailed contract, or whether their cost is simply passed along to the consumer pursuant to the seller's internal accounting procedures, is irrelevant, because tax consequences do not turn on a party's internal accounting procedures.  See National Amusements, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2001-594, 602 ("There is 'no basis, however, for assuming that the Legislature intended to import accounting practice into its statutory language" in all instances.") (citing First Federal Sav. & Loan Ass'n of Boston v. State Tax Commission, 372 Mass. 478, 483 (1977), aff'd, 437 U.S. 255 (1978) and Xtra, Inc. v. State Tax Commission, Mass. ATB Findings of Fact and Reports 1979, aff'd, 380 Mass. 277 (1980)).  The Board thus did not find persuasive Raytheon's contention that the facts of this appeal differed in a significant manner from those of Jan Co., Clark Franklin Press and Prince. 


Conclusion
The Board thus found and ruled that the indirect cost items at issue in this appeal were incidental to the government contracts at issue and merely served to facilitate the completion of those contracts.  Accordingly, the Board found and ruled that Raytheon's purchases of the indirect cost items were not "sale[s] . . . for resale in the regular course of business" pursuant to G.L. c. 64H,   § 1 and G.L. c. 64I, § 1 and therefore did not qualify for exemption from sales or use tax.  

                    			APPELLATE TAX BOARD



				 By:___________________________________	      			  		 Thomas W. Hammond, Jr., Chairman






	      

  On May 17, 2005, Raytheon filed a corrected Petition, to which the Commissioner assented, to correct a typographical error in the original Petition. 
  The sales and use taxes are described as "complementary components of a unitary taxing program . . . ."  Towle v. Commissioner of Revenue, 397 Mass. 599, 604 (1986).  Certain transactions may be subject to either a sales tax or a use tax, while other transactions may be subject to both taxes.  However, a taxpayer will not be liable for a use tax if the transaction has already been subjected to a sales tax.  G.L. c. 64I, § 7(a).
  Raytheon specifically waived its contention that it was acting as a purchasing agent of the federal government.
  Raytheon also cited the following cases from other jurisdictions in support of its contention: Northrop Grumman Corp. v. County of Los Angeles, 134 Cal. App. 4th 424 (2005); Motorola, Inc. v. Arizona Dep't of Revenue, 993 P.2d 1101 (Ariz. Ct. App. 1999); McDonnell Douglas Corp. v. Dir. of Revenue, 945 S.W.2d 437 (Mo. 1997);  United Techs. Corp. v. Groppo, 238 Conn. 761 (1996); and Aerospace Corp. v. State Bd. of Equalization, 218 Cal. App. 3d 1300 (1990).  However, these cases did not make specific findings as to whether the disputed purchases were sales for resale in the purchaser's "regular course of business."  Therefore, these appeals were not relevant to the instant appeal.  

ATB 2008-906