200805111H



HEARING NO.  45,975

RE: **************
TAXPAYER NO.: **************
AUDIT OFFICE: **************
AUDIT PERIOD: October 1, 1999 THROUGH September 30, 2003

Direct Payment Permit Sales Tax/RDT

BEFORE THE COMPTROLLER 
OF PUBLIC ACCOUNTS 
OF THE STATE OF TEXAS

SUSAN COMBS
Texas Comptroller of Public Accounts

DEANNE Z. CUMMINGS-SCOTT
Representing Tax Division

**************
Representing Petitioner


COMPTROLLER’S DECISION

PRELIMINARY DISCUSSION:

An oral hearing convened in Austin, Texas, on September 19, 2006, before 
Administrative Law Judge (ALJ) Anne Perez.  Petitioner appeared and was 
represented by **************, State Tax Attorney for **************.  
************** presented the testimony of **************, Petitioner’s 
Divisional System Manager.  The Tax Division was represented by Assistant 
General Counsel DeAnne Cummings-Scott, who presented the testimony of Clyde 
Dickey, a Comptroller auditor.  At the conclusion of the hearing, Judge Perez 
set post-hearing submission deadlines and scheduled the record to close on 
February 22, 2007.

On January 3, 2007, the Comptroller and the State Office of Administrative 
Hearings (SOAH) executed a Memorandum of Understanding transferring the 
administrative hearing function to SOAH.  Under the agreement, hearings that 
were heard before January 1, 2007 by the Comptroller’s office, such as the 
above-captioned hearing, continue under the Comptroller’s Rules of Practice and 
Procedures in 34 TEX. ADMIN. CODE  1.1 et. seq., as it existed on December 31, 
2006.  Pursuant 34 TEX. ADMIN. CODE  1.21, the hearing was transferred to ALJ 
Eleanor Kim, who has reviewed the entire record, including listening to the 
oral hearing tapes, before issuing this decision.

On June 27, 2007, the State Office of Administrative Hearings (SOAH) issued a 
Proposal for Decision in the above referenced matter.  The parties were given 
fifteen days from the date of the Decision to file exceptions with SOAH.  No 
exceptions were filed, and the Comptroller has determined that the 
Administrative Law Judge’s Proposal for Decision in these cases should be 
adopted as written.  

Unless otherwise indicated, all Section references are to Title 2 of Texas Tax 
Code and all references to Rules are to sections of Title 34, Texas 
Administrative Code. 

AGREEMENT:

The Tax Division submitted Attachments A and B to its Closing Brief dated June 
25, 2008, as reflecting all proposed agreements for audit adjustments and tax 
credits, and representing that the attachments supersede any proposed schedules 
previously filed.  

PETITIONER’S CONTENTIONS:

1. Petitioner contends that the auditor erroneously scheduled items that were 
exempt under Section 151.318.

2. Petitioner contends that the Comptroller improperly assessed late-filed 
penalties.

3. Petitioner contends that a refund is due on tax erroneously paid on 
equipment and items used in manufacturing.

4. Petitioner contends that a refund is due on tax erroneously paid on items 
that were shipped out of state and used out of state for more than one year.

5. Petitioner contends that a refund is due on tax erroneously paid on 
non-taxable services; and

6. Petitioner contends that a refund is due on tax erroneously paid on wrapping 
and packaging supplies.

FINDINGS OF FACT:

1. Petitioner is a media company that publishes and sells ************** 
catalogs and other printed materials.  It provides other advertising services.  


2. Petitioner holds a direct pay sales and use tax permit and a regular sales 
and use tax permit.

Audit:

3. Petitioner was audited for use tax compliance for the above-captioned period 
and as a result, on October 4, 2004, the Comptroller issued a Texas 
Notification of Audit Results assessing Petitioner a tax deficiency, penalties 
on late-filed periods, and interest accrued as of the date of the notice.  
Petitioner’s request for redetermination resulted in the docketing of this 
hearing.

4. The examining auditor made adjustments to taxable purchases in the following 
three exams: (a) Exam 1: Purchases of Assets; (b) Exam 2: Purchases of 
Expenses; and (c) Exam 3: Purchases - Tax Reconciliation between accrued taxes 
and reported taxes.

5. The Tax Division’s proposed adjustments (see Agreement Section) will 
substantially reduce the taxable amount in Exam 2 and will zero out Exam 3.  
The Tax Division has agreed to delete or to give credit for tax paid on the 
computers, monitors, scanners, film, printers, cameras, some software used 
directly for the production of the catalog, printer cartridges, computer 
adapter, computer batteries, labor to repair certain computers, computer 
cables, copiers, and other items. 

6. Petitioner has its own in-house pre-press area where employees prepare files 
for print.  Workstations and scanners are used to scan images that are 
manipulated.  Each workstation is connected to the servers and employees at the 
workstations use the servers for production purposes.

7. In general, there are different types of servers.  A server can be one of 
the following types: (a) an application server; (b) a database server; (c) a 
networked file server; or (d) a combined server that has two or more of the 
previously stated servers in one.  

8. An application server, once software applications are loaded onto it, 
enables the use of software for an entire computer network and avoids the need 
for software to be loaded individually on each user’s personal computer. 

9. A database server processes the files of a database or software application 
and manages the various files required for a software application to function.  
It helps to organize data, and distributes data to storage where the data 
resides in, and expedites and simplifies production. 

10. A networked file server is attached to the network and serves up disk 
storage and files. 

11. During the audit period, Petitioner purchased three servers that were 
scheduled in the audit.  The three contested servers are identified as SUN 
SparcCenter 2000e, Auspex NS700/800, and SUN 6500E.

12. SUN SparcCenter 2000e was a server that was a combined application-database 
server and was called the CEPS-Ingress Database Server by Petitioner.  CEPS is 
the acronym for the Catalog Electronic Publishing System, which was the 
application itself.  Ingress was the database server.  The CEPS-Ingress 
Database Server was an integrated unit where the application and database 
servers were intertwined and resided in a single functional unit that drew from 
the same memory and processor capacity.  Petitioner cannot segregate the cost 
of the hardware associated with the application server from the database 
server. 

13. The SUN SparcCenter 2000e server allowed Petitioner’s employees to create 
images, text, and logos (“assets”) and provided all the pointers or roadmap to 
the image and text files created by the users via the application software. 

14. Petitioner did not have enough capacity on the SUN SparcCenter 2000e 
server, so it purchased Auspex NS700/800, a disk file or array storage unit 
that was connected to the workstations and through the SUN SparcCenter 2000e to 
expand the application capacity.  The SUN SparcCenter 2000e server and the 
Auspex NS700/800 server operated jointly to perform functions similar to a 
personal computer, but allowed multiple networked computers to share software 
applications and data.  The SUN SparcCenter 2000e server was used to create, 
and Auspex NS700/800 stored data in the same way that the hard disk drivers of 
a personal computer would store data. 

15. The images, text, or logos, as they were being worked on, were placed in 
directories on Auspex NS700/800, in ready mode for use in production.  When 
artists and copy writers created a catalog page, they drew the information from 
the server, worked on the page, made changes, and then sent the page back to 
the server.  Depending what was done on the page or file, it went through 
several check points or work flow status where the page or file moves down the 
production line, so that the person assigned to review the page at any 
particular stage could access and view it.  It is similar to an assembly line 
production that goes from one work point to another point in the flow of the 
printing process.  Until the media was sent to the printer, the assets would 
continue to reside on the server because several users were accessing and using 
it. 

16. In the latter part of the audit period, Petitioner purchased a new server, 
SUN 6500E, that had the application server, database server, and disk array 
capacity in one unit.  SUN6500E server was purchased from Germany and was known 
as the Lago-Oracle server.  SUN6500E eventually replaced both the SUN 
SparcCenter 2000e and Auspex NS 700/800 servers.  However, there was a time 
period when Petitioner had the two systems (CEPS and Lago) running 
concurrently.  

17. The SUN6500E server performed functions similar to a computer. 

18. An average print job for Petitioner takes about 73 days.  Petitioner 
produces three major catalogs a year for ************** as well as many other 
smaller printed media.  Annually, Petitioner produces an average of 10,000 
print pages, so there are continuous cycles of production throughout the year. 

19. When the servers fail, Petitioner’s production ceases until the servers are 
back on line.

20. The contested servers were used exclusively in the production area.  
Routine office work and other administrative functions were performed on a 
corporate server that is outside the production area.

21. Petitioner purchased tape libraries that were physically connected to the 
Auspex NS700/800 server and to the SUN6500E server, but were located in a 
secured area outside the production area.  A tape library is peripheral 
equipment that connects to any or all of the servers and is used to back up and 
restore digital assets.  It contains 1 to 20 tape drives and holds tape 
cartridges.  The robotic device moves tapes from the tape slots and places them 
into tape drives.  An application runs on top of it and controls the back ups 
by scheduling the job of backing up files if files need to be restored.  The 
contents of the library enable the recovery of data that is lost as a result of 
a system failure.  The library provides disaster recovery ability for six weeks 
to two months, but it is not permanent archive. 

22. The Tax Division disallowed the manufacturing exemption claim on servers 
and items related to the servers such as software, tape library, and chassis 
switch.

23. Other items adjusted in the audit were computer switches, and a media 
converter that are connected to the SUN6500 server.  Switches are a network 
switch that allows communication between networks, between servers, and between 
the network and the workstations connected to the network.  A media converter 
is used to convert and transport electric signals for the network; it has 
copper ports and is used to convert the signaling to fiber cabling. 

24. Comptroller records reflect that Petitioner filed two late returns during 
the audit period: June 2000 and September 2000.

25. Petitioner’s two proofs of mailing contain a listing of names of addressees 
and streets for mail sent October 19, 2000 and July 19, 2000.  Both proofs of 
mailing show that mail was sent to the Texas Comptroller of Accounts on those 
dates, but they do not identify what documents were actually sent.

Refund Claim:

26. During the redetermination hearing process, Petitioner filed a claim for 
refund, which was incorporated into this hearing.  Mr. ************** of 
************** is involved in the refund claim, but Ms. ************** is the 
designated representative for this hearing.

27. The Tax Division has agreed to give credits for tax paid on manufacturing 
items. See Finding of Fact No. 5.

28. The Tax Division disallowed refund of sales tax paid on servers and other 
related equipment similar to the ones that have been scheduled in the audit.

29. Petitioner submitted a refund schedule and invoices showing that it paid 
tax on purchases made from **************, **************, and **************.  
The invoices show that Petitioner purchased photographs and/or printed 
materials.  

30. Petitioner presented no evidence to show that the items acquired from 
**************, **************, and **************. were used in the 
manufacturing process.

31. Petitioner seeks a refund of tax paid to ************** on four 
transactions.  Petitioner provided two invoices (Nos. 56945 and 56946) issued 
by the vendor, located in **************, Utah, reflecting shipment to 
**************, California, and **************, North Carolina.  Neither 
invoice shows payment of sales tax.  For the other two transactions, Petitioner 
submitted printout pages of charge back adjustment transfer system identifying 
the invoices as 407853 and 407854.  The printouts indicate an address for 
************** in **************, Texas, and do not contain any evidence of 
sales tax paid.

32. Petitioner seeks a refund of tax paid to ************** on 10 transactions. 
 The refund schedules identify the description as “plastic packaging.”  The 
refund schedule is supported by printouts from the charge back adjustment 
transfer system and none of the documents show evidence of sales tax paid.

CONCLUSIONS OF LAW AND DISCUSSION:

The Tax Division’s proposed adjustments should be adopted.  Petitioner’s  
contention that servers and related parts qualify for the manufacturing 
exemption should be granted in part and denied in part.  All other contentions 
should be denied.

I. Audit

A. Manufacturing Exemption

The auditor scheduled purchases of servers and other items in Petitioner’s 
audit.  Each purchase of tangible personal property is subject to sales and use 
tax unless an exemption applies.  Petitioner contends that the manufacturing 
exemption under Section 151.318 applies to exempt many of the scheduled 
transactions and seeks their deletion from the audit.  The Tax Division has 
agreed to delete numerous transactions, and the remaining dispute centers on 
Petitioner’s servers and items related to the servers.  

Section 151.318(a)(2) exempts “tangible personal property used or consumed in 
or during the actual manufacturing, processing, or fabrication of tangible 
personal property for ultimate sale if the use or consumption of the property 
is necessary or essential to the manufacturing, processing, or fabrication 
operation.”  However, effective October 1, 1997, Section 151.318(a)(2) was 
amended to further require that the tangible personal property directly make or 
cause a chemical or physical change to the product being manufactured.  See, 
SECTION 151.318(a)(2)(A) and (B).  Petitioner contends that the servers and the 
related equipment at issue satisfy the statutory requirements because they are 
used directly in manufacturing, are necessary and essential to the 
manufacturing process, and cause a physical change to the product manufactured. 
 According to Petitioner, the servers are necessary and essential to the 
printing process because when they fail, the entire processing production 
ceases.  Petitioner argues that the contested items cause a physical change to 
the product when the network users manipulate the product through the servers 
or when the date time stamp is placed on the files by the servers to document 
its creation or last modification.  

In addition to the argument that the servers satisfy the statutory requirements 
of Section 151.318(a)(2), Petitioner contends that the Comptroller has 
recognized servers as qualifying manufacturing items and cites to Comptroller’s 
Decision No. 42,916 (2005).  In that hearing, the contested issue was whether 
server racks were components parts of a qualifying manufacturing item.  
According to Petitioner, the issue implicitly demonstrates the Comptroller’s 
acceptance that servers qualify for the manufacturing exemption.  To further 
support its position of the claimed exemption, Petitioner contends that the 
Comptroller did not schedule similar items in an earlier audit of September 1, 
1996 through March 31, 2000.  The Tax Division rejects Petitioner’s reliance on 
Comptroller’s Decision No. 42,916 on the basis that the decision does not 
explicitly or implicitly address the taxability of servers.  The Tax Division 
contends that Petitioner’s claim of detrimental reliance must be rejected 
because the audit in question was the audit of its predecessor, ************** 
for the period of September 1, 1996 through May 31, 2000, and because no 
evidence was presented to show that the auditor specifically addressed the 
taxability of servers in the audit.  

The Tax Division contends that the auditor’s adjustments were proper because 
servers and other equipment are used to store or maintain electronic data.  The 
application server may allow the users to create images, texts, and logos for 
the catalogs, but the Tax Division argues that no manufacturing exemption can 
be given because the application database is integrated with the database 
server into a single functional unit.  The Tax Division argues that the 
database server is a storage device because the image, text, and logo created 
by the application software are stored on the server.  Because the cost of the 
hardware associated with the application server and the database servers cannot 
be segregated, the Tax Division contends that the divergent use principle 
applies and that tax should be assessed until Petitioner can prove that the 
divergent use is less than the amount of tax assessed.  Additionally, the Tax 
Division contends that the networked file server and tape libraries store and 
maintain the images, text, and logos for the catalogs.  Because Section 
151.318(c)(4) excludes items used to maintain or store tangible personal 
property from the manufacturing exemption, the Tax Division contends that the 
disallowance of the claimed exemption should be upheld.

Before discussing the applicability of Section 151.318, the ALJ will first 
address Petitioner’s reliance on Comptroller’s Decision No. 42,916.  The ALJ 
agrees with Petitioner that the server in Hearing No. 42,916 was accepted as 
exempt, but disagrees with Petitioner’s reading that the decision stands for 
the proposition that all servers purchased by a manufacturer are automatically 
exempt.  The decision cannot be read so broadly as urged by Petitioner because 
a taxpayer’s eligibility to claim an exemption from tax is fact based.  The 
burden is on Petitioner to establish by clear and convincing evidence that it 
qualifies for the manufacturing exemption.  Bullock v. National Bancshares 
Corp., 584 S.W.2d 268 (Tex. 1979).  The findings of fact in Comptroller’s 
Decision No. 42,916 are limited, but it is clear that the products manufactured 
by the taxpayer in that hearing and by Petitioner differ significantly; thus, 
the acceptance of the server as being exempt by the Tax Division in Hearing No. 
42,916 does not establish the exemption for Petitioner here.  Similarly, 
Petitioner’s reliance on a prior audit is not evidence of its entitlement to 
the claimed exemption.  Neither argument warrants further discussion.

The substantive tax issue is whether Petitioner’s purchases qualify for the 
manufacturing exemption under Section 151.318.  Petitioner briefly referenced 
Section 151.318(t), but both parties’ extensive arguments focused on whether 
the contested items directly make or cause physical or chemical changes as 
required by Section 151.318(a)(2).  The parties appear to believe that Section 
151.318(a)(2) must first be satisfied before the exemption provided by Section 
151.318(t) can be available.  Section 151.318(t) reads as follows: 

In addition to the other items exempted under this section, pre-press 
machinery, equipment, and supplies, including computers, cameras, photographic 
props, film ... color separation negatives, proofs of color negatives, 
production art work, and typesetting or composition proofs, that are necessary 
and essential to and used in connection with the printing process are exempted 
from the tax imposed by this chapter if they are purchased by a person engaged 
in:

(1) printing or imprinting tangible personal property for sale; or

(2) producing a publication for the dissemination of news ... that is printed 
on newsprint and distributed to the general public ....”

The phrase “[i]n addition to the other items exempted under this section” 
indicates legislative intent that Section 151.318(t) is a specific stand-alone 
exemption.  Stated differently, certain items may be exempt from tax under 
Section 151.318(t) even if they do not directly make or cause physical or 
chemical change as required by Section 151.318(a)(2).  Because there is no 
dispute that Petitioner is engaged in printing tangible personal property for 
sale, Petitioner may claim the manufacturing exemption if it can establish that 
the contested items qualify under either Section 151.318(a)(2) or Section 
151.318(t). 

The SUN SparcCenter 2000e server was a combined or integrated application and 
database server.  Similarly, the SUN6500E server was an integrated server that 
performed all three functions of an application server, a database server, and 
a networked file server.  These two servers allowed Petitioner to create 
images, texts, or logos that were used in the production of the catalogs or 
other printed materials for sale.  The evidence clearly establishes that the 
SUN SparcCenter 2000e and the SUN6500E servers were directly used in or during 
the actual processing of the catalogs or other printed materials for sale, were 
necessary and essential to the printing process, and directly made or caused 
physical change to the product being manufactured.  The evidence further 
establishes that the servers were used exclusively in the production area.  The 
SUN SparcCenter 2000e server and the SUN6500E server appear to qualify for the 
manufacturing exemption under Section 151.318(a)(2).  This conclusion is 
consistent with the Comptroller’s prior ruling that servers that are used to 
create, design, combine articles, and other similar actions qualify for the 
manufacturing exemption.  See, STAR Accession No. 9705472L (May 29, 1997, 
superseded for other reasons).  To the extent there were any doubt that the SUN 
SparcCenter 2000e and the SUN6500E servers were eligible for the manufacturing 
exemption under Section 151.318(a)(2), the Legislature eliminated all doubts 
when it enacted Section 151.318(t) in 1999. [ENDNOTE: (1)]  Section 151.318(t) 
broadly exempts items purchased by printers if they are necessary and essential 
to and used in connection with the printing process are exempt from tax.  The 
SparcCenter 2000e and the SUN6500E servers clearly fall within the statutory 
requirements of Section 151.318(t).

The Auspex NS700/800 server was connected to the SUN SparcCenter 2000e server 
and allowed additional capacity.  The images, text, or logos, as they were 
being worked on, were placed the Auspex NS700/800, in ready mode for use by 
numerous users in the various work points of the printing production process.  
The Tax Division contends that the networked file server serves a storage 
function and is excluded from the manufacturing exemption.  Petitioner contends 
that the server in question makes physical change by placing date stamp on the 
file, but the date stamping provided is a means for Petitioner to manage its 
files and does not directly make or cause physical change to the product being 
sold as required by Section 151.318(a)(2).  The Auspex NS700/800 server does 
not qualify under Section 151.318(a)(2), so the question presented is whether 
the server qualifies for the manufacturing exemption under Section 151.318(t). 

Until the images, texts, or logos were sent to print, they resided on the 
networked file server.  Through the application-database server, i.e., SUN 
SparcCenter 2000e, Petitioner’s employees pulled the images, texts, or logos 
from the networked file server to modify the assets during production.  The 
Auspex NS700/800 server stored data in the same way that the hard disk drivers 
of a personal computer would store data, but jointly operated with the SUN 
SparcCenter 2000e server to allow multiple users to pull up the file to create 
and modify the file throughout the production process.  The Auspex NS700/800 
and SUN SparcCenter 2000e servers in effect performed the same functions as a 
personal computer would do in the printing process, except the servers allowed 
for multiple network users at the same time.  The 1997 amendment requiring 
physical or chemical change was the Legislature’s rejection of the integrated 
concept articulated by the Texas courts, [ENDNOTE: (2)] but Section 151.318(t), 
enacted in 1999, was deliberately worded broadly to encompass the integrated 
concept to some degrees for printers.  Based on the evidence, the ALJ concludes 
that the Auspex NS700/800 server was necessary and essential to and used in 
connection with the printing process; therefore, it qualifies for the 
manufacturing exemption under Section 151.318(t).

The Tax Division contends that even if the servers qualify for the 
manufacturing exemption, the divergent use principle should be applied because 
storage occurs.  However, unlike a server that holds previously written 
articles, which the Comptroller ruled in STAR Accession Nos. 9705472L would be 
disqualified from the manufacturing exemption under Section 151.318(a)(2), the 
storage capacity or function at issue here takes place during the production 
process.  The items do not serve only a storage function, but are exempt as 
necessary and essential to and used in the printing process under Section 
151.318(t).  Section 151.318(c)(4) excludes machinery and equipment or supplies 
that are used to maintain or store tangible personal property “to the extent 
not otherwise exempted under [Section 151.318].”  Under the plain meaning of 
Section 151.318(c)(4), the exclusion is inapplicable here because the servers 
are otherwise exempt - i.e., specifically under Section 151.318(t). [ENDNOTE: 
(3)]  

In contrast, the eligibility of the tape libraries for the manufacturing 
exemption is not clear.  The primary function of the tape libraries is to back 
up files and to allow recovery of those files if necessitated by a certain 
event.  The libraries serve an important security function by protecting assets 
from loss, but the question is whether they are necessary and essential to the 
printing process.  The evidence suggests that Petitioner’s printing process can 
continue without the tape libraries; therefore, they are not indispensable or 
integral to Petitioner’s printing process as required by Section 151.318(t)(1). 
 Petitioner’s argument that the back-ups were temporary, and not permanent, 
does not change the nature of storage.  The tape libraries do not make or cause 
physical or chemical changes so they do not qualify under Section 
151.318(a)(2), and are excluded from qualifying for the exemption under Section 
151.314(c)(4). 

In summary, the ALJ concludes that Petitioner’s contention should be granted 
for the SUN SparcCenter 2000e server, the Auspex NS700/800 server, the SUN6500 
server, and for the component parts of or accessories of those three servers.  
Petitioner’s contention with respect to the tape libraries and any items 
related to them, however, should be denied. 

B. Late-Filed Penalties

The second issue in the audit relates to penalties.  Penalties are 
automatically imposed on delinquent sales tax.  SECTIONS 111.061 and 
151.703(a). The Comptroller has discretionary authority to waive penalty if a 
taxpayer has exercised reasonable diligence to comply with the tax laws.  
SECTION 111.103(a).  However, it is well established that the Comptroller does 
not waive penalties for periods in which returns were not timely filed because 
the late filings demonstrate a lack of reasonable diligence.  See, 
Comptroller’s Decision No. 41,908 (2002) (citing to Comptroller’s Decision Nos. 
41,296, 41,301 and 41,302 (2002)).  In Petitioner’s audit, the auditor waived 
penalties on all timely-filed periods.  Comptroller records reflect that 
Petitioner had two late-filed returns, namely June and September 2000, so 
penalties were not waived for those two periods.  Petitioner contends that the 
Comptroller’s records are erroneous and that it timely filed the two returns in 
question.  Petitioner’s evidence consists of two proofs of mailing showing mail 
was sent to the Comptroller on July 19, 2000, and October 19, 2000.  The Tax 
Division contends that the proofs of mailing relate to Petitioner’s regular 
sales and use tax returns, and not to Petitioner’s direct pay returns at issue 
here. 

The evidence is insufficient to prove Petitioner’s claim.  Petitioner holds 
both a sales and use tax permit and a direct pay permit.  Returns must be filed 
under each permit, and the due dates for both the direct pay returns and sales 
and use tax returns are the same.  Other than showing that documents were 
mailed on July 19, 2000, and October 19, 2000, to the Comptroller, Petitioner 
did not present any evidence to show that the documents that were mailed on 
those dates were Petitioner’s June and September 2000 returns filed under its 
direct pay permit.  Thus, Petitioner’s request for penalty relief must be 
denied.

II. Refund Claim

Petitioner incorporated a refund claim into the redetermination proceeding.  
There are four contested refund issues, and Petitioner has the burden to prove 
its entitlement to the claimed refund by a preponderance of the evidence in 
non-exemption cases, or by clear and convincing evidence in the case of an 
exemption.  See, Comptroller’s Decision No. 36,149 (1999). 

The first issue involves Petitioner’s claim to the manufacturing exemption 
under Section 151.318.  The Tax Division has agreed to several adjustments, but 
contends that no other refund should be granted because Petitioner failed to 
prove its entitlement the claimed exemption.  It is unclear what the disallowed 
items were, but Petitioner contends that the remaining contested items involved 
the same items and same issues involved in the audit - i.e., whether servers 
and other computer equipment qualify for the manufacturing exemption.  The ALJ 
directs the Tax Division to review the contested items in light of the 
discussion of the audit issue above.  

Petitioner next contends that it paid tax on services that include design 
advertising services and photography services that were incorporated into the 
manufactured products and are therefore exempt from tax under Section 
151.318(a)(3).  To support its claim, Petitioner provided invoices from three 
vendors, and the invoices indicate Petitioner purchased photographs.  However, 
the invoices are insufficient to demonstrate that the photographs in question 
were incorporated into catalogs that were produced and sold.  The denial of the 
refund should be upheld.  

Petitioner alleges that it purchased printed materials from **************, an 
out-of-state vendor, who shipped the materials to **************, California, 
and to **************, North Carolina.  Petitioner seeks a refund on four 
transactions, but submitted only two invoices.  Neither invoice shows that 
Petitioner paid tax to the vendor or accrued tax to the state of Texas; thus, 
no refund can be granted.  With respect to the remaining two contested 
transaction, Petitioner submitted internal accounting documents, but those 
documents also do not support Petitioner’s claim for a refund.  The internal 
documents reflect that Petitioner purchased items from ************** in 
**************, Texas, and there is no evidence of shipment out of state or the 
payment of tax.  No refund is due.

Petitioner claims to have purchased plastic packaging from ************** and 
contends that the purchases are exempt under Rule 3.314(b)(1).  A manufacturer 
may claim an exemption from tax on wrapping and packaging supplies if they are 
used on items manufactured and the packaged items are sold as packaged by the 
manufacturer.  Petitioner did not provide any evidence to demonstrate how the 
packaging materials were used.  The mere assertion in pleadings as to how they 
are used is not evidence.  Moreover, the submitted documents do not even show 
that tax was paid by Petitioner on the purchases.  Thus, Petitioner’s refund 
claim on packaging materials should be rejected without further discussion on 
the merits.

RECOMMENDATION:

Based upon the foregoing findings of fact, conclusions, and discussion, the 
audit should be amended, and the refund should be granted, to the extent agreed 
to by the Tax Division and in accordance with this decision.  Any other relief 
requested by Petitioner should be denied.


ELEANOR H. KIM
Administrative Law Judge


Hearing No. 45,975

ORDER OF THE COMPTROLLER

The above decision resulting in a credit to Taxpayer as set out in “Attachment 
A,” which is incorporated by reference, is approved and adopted in all 
respects.  This decision becomes final twenty days after the date Petitioner 
receives notice of this decision.  If either party desires a rehearing, that 
party must file a Motion for Rehearing, which must state the grounds for 
rehearing, no later than twenty days after the date Petitioner receives notice 
of this decision.  Notice of this decision is presumed to occur on the third 
day after the date of this decision.

Signed on this 2nd day of May 2008.


SUSAN COMBS
Texas Comptroller of Public Accounts

by: Martin A. Hubert
Deputy Comptroller


ENDNOTE(S):

(1) Section 151.318(t) was effective October 1, 1999, and applies to 
Petitioner’s audit period.  Additionally, the statute was applied retroactively 
to earlier periods by the Comptroller as clarification.  See Comptroller’s 
Decision No. 39,444 (2005). 

(2) Sharp v. Tyler Pipe, Inc., 919 S.W.2d 157 (Tex. App. - Austin, 1996, writ 
denied.); Sharp v. Chevron Chemical Company, 942 S.W.2d 429 (Tex. App. - Austin 
1996, writ denied.)

(3) However, if a networked file server was used to hold images, texts, logos, 
or other assets after the manufacturing process, then the policy reflected in 
STAR Accession No. 9705472L would control and the server would not qualify for 
the manufacturing exemption under Section 151.318(t).




ACCESSION NUMBER: 200805111H
SUPERSEDED: N
DOCUMENT TYPE: H
DATE: 05/02/2008
TAX TYPE: SALES