Foss NIRSystems, Inc. v. Comptroller of the Treasury

JAMES R. EYLER, Judge. The Comptroller of the Treasury, appellee, assessed a use tax on certain equipment owned by Foss NIRSystems, Inc., appellant. Appellant appealed to the Maryland Tax Court, which affirmed the assessment. Appellant filed a petition for ⁴⁸ judicial review in the Circuit Court for Montgomery County, which affirmed the tax court.

The statutory provision at issue is Md.Code (1997 Repl. Vol.), Tax-General, section 11—101(i )(3)(ii), which provides that “use” does not include the exercise of a right or power over tangible personal property if the buyer intends to resell the property in the same form. The principal questions before us are (1) whether the tax court committed an error of law in affirming the Comptroller’s interpretation of the exclusion to mean that products held for sale and demonstrated for the purpose of selling the same or similar products must be held solely or primarily for resale to come within the exclusion, (2) whether the Comptroller’s interpretation constituted a change in policy requiring an administrative regulation, and (3) whether the tax court’s decision was supported by substantial evidence. We shall answer the first two questions in the negative and the last question in the affirmative and, thus, affirm the judgment of the circuit court.

Factual Background The basic underlying facts are not in dispute. Appellant is a Delaware corporation with its principal office located in Silver Spring. 1 Appellant designs, manufactures, and sells Near-Infrared (NIR) spectrographic analyzers, also known as spectrophotometers, which are used in the chemical, polymer, pharmaceutical, food, and agricultural products industries for quantitative and qualitative analyses of substances. Generally, each spectrophotometer is comprised of a monochromator, a sampling module, and associated software. The sale of the equipment includes training for two people in the use of. the equipment.

The training occurs at appellant’s Silver Spring offices. The equipment in question is manufactured in Maryland. Appellant has no warehouse facilities in Maryland, but its executive offices are in Maryland. ⁴⁹ The substance that is to be tested is placed in the sampling module, and the monochromator measures the spectral range of the substance and compares it with known data stored in the software. Appellant offers nine different monochromators and twenty two different sampling modules.

Appellant custom configures each spectrophotometer to suit a particular customer’s needs. The equipment in question is not sold off the shelf. Appellant offers demonstrations to potential customers, usually conducted at the customer’s place of business, or appellant obtains samples of the customer’s products and conducts a study at its Silver Spring offices. The latter procedure is called a “feasibility study.” Such a study is sometimes followed by a demonstration at the customer’s site.

The purpose of a demonstration is to establish suitability for a particular application and to assist a customer in selecting the most appropriate configuration. Appellant also demonstrates the equipment at trade shows and conventions, loans it to universities and other educational institutions, and uses it in its training laboratory. One of the purposes of taking the equipment to trade shows and conventions and loaning it to educational institutions is to create future markets. Appellant performs approximately 150 demonstrations per year at a potential customer’s site and approximately 70 feasibility studies per year at its headquarters.

The great bulk of demonstrations occurs outside of Maryland, and the great bulk of sales occurs to customers located outside of Maryland. The equipment in question is available for sale to potential customers at all times. Customers sometimes buy the demonstration model and sometimes buy a new piece of equipment configured to meet the customer’s needs. The parties differ in their interpretation of appellant’s accounting practices with respect to the equipment.

The equipment is in an account called “demonstration inventory,” which appellant states is a subcategory of sales inventory. While acknowledging that it depreciates the demonstration inventory internally, appellant states that it does not depreciate it for income tax purposes. Appellant also acknowledges that the ⁵⁰ movement of items in the demonstration inventory is tracked under appellant’s fixed asset tracking system but states that it is done only for the purpose of tracking and the inventory equipment is not accounted for as fixed assets. Appellee interprets appellant’s accounting as treating the demonstration equipment as fixed assets.

At the time of the audit that resulted in the assessment in dispute, the demonstration inventory list reflected approximately 365 items. Of that total, 275 had been in demonstration inventory for over one year. On April 15, 1998, appellee issued a Notice of Final Determination and assessed a use tax on appellant’s demonstration inventory in the amount of $155,865.77, including interest, for the period of time from May 1,1992, to January 31,1997. See Md.Code (1997 RepLVol), Tax-Gen. §§ 13-303, 13-402.

On April 17, 1998, appellant appealed to the Maryland Tax Court. The items in the demonstration inventory that were challenged involved approximately $72,000 in tax. In a memorandum and order dated March 15, 2001, the tax court affirmed the assessment. In part, the tax court found: We agree with the Comptroller that Foss’s demonstration inventory was used by Foss for demonstrations to prove that the product was capable of being adapted to the customer’s particular applications or use.

The primary purpose of the demonstration was not to sell a specific item of equipment being demonstrated. Often the inventory was used for training or for displays and demonstrations at trade shows and conventions. In addition, the inventory was provided to universities and colleges for a number of years in order to develop new markets for the sale of Foss’s equipment. Although the demonstration inventory may have been available for sale, the primary purpose of the demonstration inventory was for a purpose other than resale.

The demonstration inventory was in fact being used and that use was not incidental. Approximately three quarters of the demonstration inventory provided to the Auditor had been used as demonstration equipment for over one year. The 70 feasibility studies performed each year, as ⁵¹ well as the 150 on-site consumer customer demonstrations performed every year, together with the training sessions held 3 out of 4 weeks every month indicate an actual use of the demonstration inventory for business purposes and not for the sale of a particular piece of equipment. Appellant filed a petition for judicial review in circuit court.

In an opinion and order dated July 23, 2002, the court affirmed the tax court’s decision. Standard of Review This case comes to us from the Circuit Court for Montgomery County, as a result of a petition for judicial review filed in that court. See Md.Code. (1997 Repl.Vol.), Tax-Gen. § 13-532 (“A final order of the Tax Court is subject to judicial review”). “Despite its name, the Tax Court is not a court; instead, it is an adjudicatory administrative agency in the executive branch of state government.” Furnitureland S. v. Comptroller of the Treasury of State, 364 Md. 126, 138 , 771 A.2d 1061 (2001) (citing Kim v. Comptroller, 350 Md. 527, 534 , 714 A.2d 176 (1998); Shell Oil Co. v. Supervisor, 216 Md. 36, 43-47, 343 A.2d 521 (1975)).

Thus, the applicable standard of review is an administrative one. See Rossville Vending Mach. Corp. v. Comptroller of Treasury, 97 Md.App. 305, 310-12 , 629 A.2d 1283 (1993); Pinder v. Dean, 70 Md.App. 252, 255-58 , 520 A.2d 1119 (1987), aff'd, 312 Md. 154 , 538 A.2d 1184 (1988). “When reviewing a decision of an administrative agency, this Court’s role is ‘precisely the same as that of the circuit court.’ ” Stover v. Prince George’s County, 132 Md.App. 373, 380-81 , 752 A.2d 686 (2000) (citing Department of Health and Mental Hygiene v. Shrieves, 100 Md.App. 283, 303-304 , 641 A.2d 899 (1994)). We look only at “the decision of the agency, not that of the circuit court.” Lucas v. People’s Counsel for Baltimore County, 147 Md.App. 209, 225 , 807 A.2d 1176 (2002) (citing Carriage Hill Cabin John, Inc. v. Maryland Health Resources Planning Comm’n, 125 Md.App. 183, 211 , 724 A.2d 745 (1999)). ⁵² Administrative decisions, such as those by the tax court, receive considerable deference by reviewing courts.

See, e.g., Comptroller of Treas., Income Tax Div. v. Diebold, Inc., 279 Md. 401, 407 , 369 A.2d 77 (1977); accord State Dep’t of Assessment & Taxation v. North Baltimore Ctr., Inc., 361 Md. 612, 616 , 762 A.2d 564 (2000); Supervisor of Assmts. v. Southgate Harbor, 279 Md. 586, 595 , 369 A.2d 1053 (1977). This is because “a simple but fundamental rule of administrative law ... is ... that a reviewing court, in dealing with a determination or judgment which an administrative agency alone is authorized to make, must judge the propriety of such action solely by the grounds invoked by the agency.” Burlington Track Lines, Inc. v. United States, 371 U.S. 156, 167-69 , 83 S.Ct. 239 , 9 L.Ed.2d 207 (1962). Section 2-102(9) of the Tax-General Article in the Maryland Code (1997 Repl.Vol.) delegates to the Comptroller the task of enforcing Maryland’s sales and use tax laws. Therefore, we are constrained to accept the factual findings of the agency if reasonable minds could possibly have reached the same conclusions based upon substantial evidence found in the record.

Fairchild Hiller Corp. v. Supervisor of Assessments, 267 Md. 519, 521 , 298 A.2d 148 (1973) (citing Diebold, Inc., 279 Md. at 407, 369 A.2d 77 (“The application of this test need not and must not be either judicial fact finding or a substitution of judicial judgment for agency judgment.”)); accord Comptroller of Treas. v. Shell Oil Co., 65 Md.App. 252, 259 , 500 A.2d 315 (1985); Supervisor of Assmts. v. Fitzgerald, 49 Md.App. 411, 419 , 431 A.2d 1381 (1981); Comptroller of Treas. v. Machiz, 42 Md.App. 218, 225 , 399 A.2d 946 (1979). We may review legal conclusions de novo, however, to ensure that the tax court decision was not “premised solely upon an erroneous conclusion of law.” Ramsay, Scarlett & Co. v. Comptroller, 302 Md. 825, 834 , 490 A.2d 1296 (1985) (citing Comptroller of Treasury, Income Tax Div. v. Haskin, 298 Md. 681, 693 , 472 A.2d 70 (1984)); see also Director of Fin. v. Charles Towers Pshp., 104 Md.App. 710, 717 , 657 A.2d 808 (1995); Comptroller of Treas. v. World Book Childcraft ⁵³ Int'l, Inc., 61 Md.App. 424, 508 A.2d 148 , cert. denied, 307 Md. 260 , 513 A.2d 314 (1986). We have long recognized that the interpretation of tax law can be both legal and factual in nature: It is clear that the Comptroller’s findings of fact are final, and the court cannot properly substitute its own judgment. However, questions of fact, in this type of case, shade into mixed questions of law and fact, and courts may consider the facts at least for the purpose of ascertaining whether there is evidence to support a legal conclusion that necessarily involves the drawing of a line.

Comptroller of the Treasury v. Smith, 205 Md. 408, 414 , 109 A.2d 47 (1954) (cited in Aerial Products, 210 Md. 627, 632 , 124 A.2d 805 (1956)). In cases of mixed questions of law and fact, we must insure that the tax court applied the law correctly to the facts as it found them. Ramsay, Scarlett & Co. v. Comptroller, 302 Md. at 834 , 490 A.2d 1296 . If the tax court decision was not erroneous as a matter of law, and its conclusion was supported by substantial evidence, we must affirm the decision.

CBS Inc. v. Comptroller of Treas., 319 Md. 687, 697-98 , 575 A.2d 324 (1990) (citations omitted); Diebold, Inc., 279 Md. at 407, 369 A.2d 77 . Contentions Appellant contends (1) the interpretation of the statutory provision in question is a legal question to which no deference is owed to the Comptroller or the tax court, (2) the language clearly does not require that equipment demonstrated for the purpose of selling the same or similar equipment be held solely or primarily for resale, (3) the statutory provision is an exclusion and thus should be strictly construed, (4) appellant’s interpretation is supported by case law, and (5) the Comptroller’s assessment of a use tax constituted a change in policy and required promulgation of a regulation as distinguished from an adjudicative determination. The Comptroller contends (1) the interpretation of the statutory definition of “use” is a mixed question of law and ⁵⁴ fact to which deference is owed, (2) the Comptroller’s interpretation is supported by legislative history and administrative and judicial interpretation, (3) the finding that the equipment was used for purposes other than resale was supported by substantial evidence, and (4) no regulation was required because the tax was imposed pursuant to a long standing policy that any tangible personal property acquired for use and not held solely for resale is subject to the use tax. Analysis Review of Tax Court’s Decision Maryland imposes a five per cent sales tax on retail sales and a five per cent use tax on the usé of tangible personal property or taxable services in the State.

Md.Code (1997 Repl.Vol.), Tax-Gen. § 11-102(a). The sales and use tax provisions are complementary. Comptroller of the Treasury v. Glenn L. Martin Co., 216 Md. 235, 242 , 140 A.2d 288 (1958). Generally, the use tax only applies to transactions subject to the sales tax but on which no tax has been paid.

Id. Section 11-101(0 of the Tax-General Article, Md.Code (1997 Repl.Vol.), defines “use” as: (Ɩ) Use.— (1) “Use” means an exercise of a right or power to use, consume, possess, or store that is acquired by a sale for use of: (i) tangible personal property; or (ii) a taxable service. (2) “Use” includes an exercise of a right or power to use, consume, possess, or store that is acquired by a sale for use of tangible personal property: (i) for use or resale in the form of real estate by a builder, contractor, or landowner; or (ii) except as provided in paragraph (3)(i) of this subsection, as facilities, tools, tooling, machinery, or equipment, including dies, molds, and patterns, even if the buyer ⁵⁵ intends to transfer title to the property before or after that use. (3) “Use” does not include: (i) a transfer of title to tangible personal property after its use as facilities, tools, tooling, machinery, or equipment, including dies, molds, and patterns, if: 1. at the time of purchase, the buyer is obligated, under the terms of a written contract, to make the transfer; and 2. the transfer is made for the same or greater consideration to the person for whom the buyer manufactures goods or performs work; (ii) an exercise of a right or power over tangible personal property acquired by a sale for use if the buyer intends to: 1. resell the tangible personal property in the form that the buyer receives or is to receive the property; 2. use or incorporate the tangible personal property in a production activity as a material or part of other tangible personal property to be produced for sale; 3. consume the tangible personal property directly and predominantly in a production activity by destroying, using up, or wearing out the property, other than through obsolescence, to the extent that the property cannot be rendered fit for further use in a production activity, if the consumption occurs within 1 year after the property is first used in a production activity; or 4. transfer the tangible personal property as part of a taxable service transaction; or (iii) an exercise of a right or power over a taxable service acquired by a sale for use if the buyer intends to resell the taxable service in the form that the buyer receives or is to receive the service.

Appellant contends that inventory does not have to be held solely or primarily for resale in order to be