Which parts of a new manufacturing plant — wiring, air conditioning, the building itself — qualify for New Mexico's manufacturing investment credit?

Plain-English summary

A manufacturer's supplemental wiring and plant air conditioning qualified for New Mexico's investment credit even though they were depreciated as long-life building property, because the credit does not depend on federal depreciation life — but the specially built "high bay" section of the building did not qualify, because it is a structure, not equipment. Protest GRANTED IN PART and DENIED IN PART.

Rea Magnet Wire Company manufactures magnet wire and, in 1998, built a plant in Las Cruces, New Mexico — a choice influenced in part by the tax credits under New Mexico's Investment Credit Act. That Act gives manufacturers a credit equal to 5 percent of the value of "qualified equipment." After a Deloitte & Touche cost-segregation study, the company applied in January 1999 for $318,700 of credit. The Department approved $293,706 and denied $24,994, tied to $499,871 of purchases it said were not "equipment" under Section 7-9A-3(B).

Three categories were in dispute:

1. A supplemental electrical system installed to feed the plant's sensitive manufacturing equipment (though some of its power inevitably served general plant use). The company split its cost for federal depreciation — the equipment portion as 7-year property, the plant portion as 39-year property. The Department allowed the 7-year portion and denied the 39-year portion.
2. Air conditioning (HVAC) units, which kept the plant comfortable for workers and were depreciated as 39-year property. The Department denied the credit entirely.
3. The "high bay" area — a section built with a raised roof and reinforced concrete floor to house 70-foot vertical enameling ovens, depreciated as 39-year property. The Department allowed the credit on the ovens but denied it on the building area built to hold them.

The Department's "7-year property only" theory failed

The Department's position was essentially that only property depreciated as 7-year equipment qualifies, and that anything depreciated as 39-year "nonresidential real property" (IRC § 168) does not. The hearing officer found no support for that in the Investment Credit Act or its regulations. The parties agreed the pre-April-2000 versions of the rules governed (the plant was built and the application filed before the 2000 amendments), and under Section 7-1-60 the Department is bound by its own regulations. Those rules cut against the Department:

• 3 NMAC 13.6.10 said equipment "need not be employed exclusively in the manufacturing process as long as the equipment is employed in the plant," and expressly listed air conditioners and electrical control equipment as examples of qualifying equipment.
• 3 NMAC 13.6.7.1 defined "subject to depreciation" without requiring any particular recovery period — property depreciated under IRC § 168 or expensed under § 179 qualified too.

The Department leaned on a "building" definition in 3 NMAC 2.1.11.11 that keys off depreciation life — but the hearing officer pointed out that rule interprets the word "construction" for the gross receipts tax under Section 7-9-3(C), and there was no reason to use a GRT building rule to decide what is "qualified equipment" under a different Act that has its own equipment regulations.

The result: wiring and HVAC yes, building area no

Because the supplemental electrical system and the air conditioning units were each a machine, mechanism, or tool used directly and exclusively in the manufacturing plant and were depreciated on the company's books and federal returns, they met the regulatory definition, and the Department was estopped from denying the credit. The high bay area was different: the portion of the building built to house the ovens is not a machine, mechanism, or tool (or a component or fitting of one), so it did not meet Section 7-9A-3(B). That it was designed solely to accommodate the ovens was "irrelevant" — only property that fits the equipment definition earns the credit.

Result: protest GRANTED IN PART and DENIED IN PART — credit allowed on the supplemental electrical system and the air conditioning units; denied on the high bay construction.

What this means for you

The manufacturing investment credit is not limited to 7-year property

Under the regulations in force here, whether equipment qualifies turns on whether it is a machine, mechanism, or tool (or a component or fitting) used in the manufacturing plant — not on how many years it is depreciated over for federal tax. Property depreciated as long-life real property can still qualify if it meets the equipment definition.

Support systems for the plant can qualify — the building itself cannot

Wiring and HVAC that serve the plant were creditable equipment. But the structural building — even a specialized section built to hold particular machines — is not equipment. Draw the line at the machine/mechanism/tool test, and expect the building shell to fall outside it.

The Department is bound by the regulation in effect when you applied

The rules changed in 2000, but the company's application was judged under the earlier version. If a credit or deduction depends on regulatory language, identify the version in effect for your tax period; under Section 7-1-60 the Department is bound by its own regulations as they then read.

Don't let the Department borrow a rule from a different tax

Here the Department tried to use a gross-receipts-tax "building" definition to decide an Investment Credit Act question. A regulation adopted to interpret one statute does not automatically govern another — especially where the second statute has its own targeted regulations.

Common questions

Q: Does the New Mexico investment credit only cover machinery depreciated as 7-year property?
A: No. The hearing officer found nothing in the Investment Credit Act or the applicable regulations that limits the credit to a particular depreciation life. The test is whether the item is a machine, mechanism, or tool (or a component or fitting) used in the manufacturing plant.

Q: Can wiring and air conditioning for a plant qualify for the credit?
A: Yes, they did here. The Department's own pre-2000 rule listed air conditioners and electrical control equipment as examples of qualifying equipment, so long as they are used directly and exclusively in the plant where manufacturing occurs.

Q: We built a special part of our building just to house a machine. Does that construction qualify?
A: No. The building — including a section built specifically to hold equipment — is not a machine, mechanism, or tool, so it does not meet the definition of equipment. The credit was allowed on the ovens but not on the high bay area built to house them.

Q: Which version of the rules applies to my credit?
A: Generally the version in effect when you built and applied. The Department is bound by its regulations as they then read (Section 7-1-60), and later amendments did not govern this 1998–1999 application.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-9A-2 — the Investment Credit Act's purpose: a favorable tax climate for manufacturing and increased employment
• NMSA 1978, § 7-9A-3(B) — "equipment" means an essential machine, mechanism, or tool (or a component or fitting) used directly and exclusively in a manufacturing operation and subject to depreciation
• NMSA 1978, § 7-9A-3(C), (D) — definitions of "manufacturing" (excludes construction, farming, power generation, natural-resource processing) and "manufacturing operation" (the plant)
• NMSA 1978, § 7-9A-6 — qualified equipment (not previously used in New Mexico and incorporated into a manufacturing operation)
• NMSA 1978, § 7-9A-7 — the value of qualified equipment is its adjusted basis under the Internal Revenue Code
• NMSA 1978, § 7-1-60 — the Department is bound by its own regulations (estoppel)
• Regulation 3 NMAC 13.6.7.1 — "subject to depreciation"; does not require any particular depreciation period
• Regulation 3 NMAC 13.6.9 — items that are not "equipment" (furniture, shelving, supplies)
• Regulation 3 NMAC 13.6.10 — items that may be "equipment," including air conditioners and electrical control equipment used in the plant; equipment "need not be employed exclusively in the manufacturing process"
• Regulation 3 NMAC 2.1.11.11 — a "building" definition under Section 7-9-3(C) of the Gross Receipts and Compensating Tax Act (held not to govern the investment credit)
• IRC § 168 — depreciation; the 39-year "nonresidential real property" class the disputed items fell into for federal purposes

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Rea Magnet Wire Company, Inc.
• Decision PDF: D&O 00-30

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
REA MAGNET WIRE COMPANY, INC. No. 00-30
CRS ID NO. 02-336367-003
DENIAL OF INVESTMENT CREDIT

DECISION AND ORDER

A formal hearing on the above-referenced protest was held October 17, 2000 before

Margaret B. Alcock, Hearing Officer. Rea Magnet Wire Company, Inc. (“Taxpayer”) was

represented by Jody Grunden, CPA, its Tax & Treasury Supervisor. The Taxation and Revenue

Department ("Department") was represented by Monica M. Ontiveros, Special Assistant Attorney

General. Based on the evidence and arguments presented, IT IS DECIDED AND ORDERED AS

FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer is engaged in the business of manufacturing magnet wire.

2. In 1998, the Taxpayer constructed a manufacturing facility in Las Cruces, New

Mexico.

3. The Taxpayer’s decision to locate its facility in New Mexico was influenced, at least

in part, by the tax credits available under New Mexico’s Investment Credit Act.

4. During construction of the plant, the Taxpayer hired Deloitte & Touche, LLP, to

perform a cost segregation analysis on the construction costs to determine the useful lives of the

plant components and the items qualified for the tax credits provided under the Investment Credit

Act.

5. On January 26, 1999, the Taxpayer filed an application for $318,700 of investment

credit, which represented 5 percent of the value of various items of equipment listed on schedules

submitted by the Taxpayer.

6. On May 14, 1999, the Department partially approved the Taxpayer’s application for

investment credit in the amount of $293,706; the Department denied the Taxpayer’s application for

$24,994 of investment credit.

7. On June 16, 1999, the Taxpayer protested the Department’s partial denial of the

Taxpayer’s application for investment credit. The protest was initially denied as untimely, but was

subsequently accepted after the Department granted the Taxpayer’s July 8, 1999 retroactive request

for an extension of time to file the protest.

8. The disputed investment credit was denied based on the Department’s determination

that $499,871 of the purchases listed on the Taxpayer’s equipment schedules did not meet the

definition of “equipment” set out in Section 7-9A-3(B) NMSA 1978 of the Investment Credit Act.

9. The disputed items fall into one of the following three categories of property: (1) the

plant’s supplemental electrical system; (2) the plant’s air conditioning units (HVAC units); and (3)

the plant’s “high bay area”.

10. A supplemental electrical line and breaker system was installed in the Taxpayer’s

manufacturing plant to provide adequate electrical flow to the sensitive equipment used in the

manufacturing process.

11. Although the supplemental system was installed for the sole purpose of providing

adequate electricity to plant equipment, it was not possible to limit the flow of electricity from the

system strictly to the equipment. For this reason, some of the electricity from the supplemental

system is used for general plant operations.

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12. Pursuant to federal tax regulations and IRC § 168, the Taxpayer allocated the cost of

the supplemental electrical system between operation of the equipment and operation of the plant.

The portion allocated to the equipment was depreciated as 7-year property and the portion allocated

to the plant was depreciated as 39-year property (described in IRC § 168 as “nonresi-dential real

property”).

13. The Department approved the Taxpayer’s application for investment credit on the

portion of the supplemental electrical system depreciated as 7-year property, but denied the credit on

the portion depreciated as 39-year property

14. The Taxpayer installed air conditioning units in its manufacturing plant. Although

not specifically necessary to the operation of the manufacturing equipment, the air conditioning was

necessary to maintain a comfortable climate for personnel working in the plant.

15. For federal tax purposes, the Taxpayer depreciated the air conditioning units as 39-

year property.

16. The Department denied the Taxpayer’s application for investment credit on the value

of the air conditioning units.

17. The Taxpayer’s plant was constructed with a raised roof over one section of the

building to accommodate special 70-foot ovens known as “high bay vertical enameling ovens”. This

high bay area of the building also required special concrete flooring to support the weight of the

ovens.

18. The high bay area of the plant is not a machine, mechanism or tool, nor is it a fitting

or component of a machine, mechanism or tool.

19. For federal tax purposes, the Taxpayer depreciated the enameling ovens as 7-year

property and depreciated the high bay area of the plant as 39-year property.

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20. The Department granted the Taxpayer’s application for investment credit on the

value of the ovens but denied the credit on the cost of constructing the high bay area of the plant.

DISCUSSION

The Investment Credit Act was enacted in 1979 to provide a favorable tax climate for

manufacturing businesses and to promote increased employment in New Mexico. Section 7-9A-2

NMSA 1978. The Act provides a credit equal to 5 percent of the value of “qualified equipment”,

which is defined in Section 7-9A-6 NMSA 1978 as equipment not previously used in New Mexico or

previously approved for the credit which is incorporated into a manufacturing operation in New

Mexico. Pursuant to Section 7-9A-7 NMSA 1978, the value of qualified equipment is its adjusted

basis under the applicable provisions of the Internal Revenue Code. Section 7-9A-3 defines the terms

equipment, manufacturing, and manufacturing operation as follows:

B. "equipment" means an essential machine, mechanism or tool, or a
component or fitting thereof, used directly and exclusively in a manufacturing operation
and subject to depreciation for purposes of the Internal Revenue Code by the taxpayer
carrying on the manufacturing operation. "Equipment" does not include any vehicle
that leaves the site of the manufacturing operation for purposes of transporting persons
or property or any property for which the taxpayer claims the credit pursuant to Section
7-9-79 NMSA 1978;

C. "manufacturing" means combining or processing components or
materials, including recyclable materials, to increase their value for sale in the ordinary
course of business, including genetic testing and production, but does not include:
(1) construction;
(2) farming;
(3) power generation; or
(4) processing natural resources, including hydrocarbons;

D. “manufacturing operation” means a plant, including a genetic testing
and production facility employing personnel to perform production tasks, in
conjunction with equipment not previously existing at the site, to produce goods;

At issue in this case is whether the Taxpayer is entitled to the investment credit on the value of

the supplemental electrical system and air conditioning units installed in its manufacturing plant and

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on the cost of constructing the high bay area of the plant. The Department maintains these items do

not qualify for the credit because they are components of the building depreciated for federal tax

purposes as 39-year property (described in IRC § 168 as “nonresidential real property”). It is the

Department’s position that only equipment depreciated as 7-year property is eligible for the

investment credit. For this reason, the Department approved the investment credit on the portion of

the supplemental electrical system allocated to operation of plant machinery and depreciated as 7-

year property, but disallowed the credit on the portion of the same system allocated to general

operation of the plant and depreciated as 39-year property. The Department disallowed the credit on

the air conditioning units because the units were designed to cool the entire plant and depreciated as

part of the building. The Department disallowed the cost of constructing the high bay area because

this area is a structural component of the building depreciated as 39-year nonresidential real

property.

The Taxpayer acknowledges that the Department’s position is consistent with Regulations

3.13.2.9 NMAC and 3.13.2.10 NMAC under Section 7-9A-6 NMSA 1978, the statute defining

qualified equipment. The Taxpayer concedes that the items in dispute would not qualify for the

investment credit under the current regulations. It points out, however, that these regulations only

became effective April 28, 2000. A substantially different version was in effect during 1998 and

1999 when the Taxpayer constructed its plant and filed its application for investment credit. The

Taxpayer argues that it qualified for the credit under the earlier version of the regulations and the

Department is estopped from denying the credit based on subsequent amendments. See, Section 7-1-

60 NMSA 1978. The Department does not dispute that the Taxpayer’s protest is governed by the

regulations in effect prior to April 2000. Rather, the Department maintains that its position can be

supported even under this earlier version.

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The regulations at issue, which were in effect from September 1996 until April 2000, read as

follows:

3 NMAC 13.6.9 - ITEMS NOT “EQUIPMENT”

Tangible personal property which is not a machine, mechanism or tool, or a
component or fitting thereof, is not equipment for the purpose of the Investment
Credit Act. Accordingly such items as furniture, shelving and supplies are not
“equipment”.

3 NMAC 13.6.10 - ITEMS WHICH MAY BE INCLUDED AS “EQUIPMENT”

The term “manufacturing operation” is defined to be the plant in which
manufacturing takes place. Equipment need not be employed exclusively in the
manufacturing process as long as the equipment is employed in the plant in which the
manufacturing process occurs. Therefore, for the purpose of the Investment Credit
Act, “equipment” may include, but is not limited to, such items as manufacturing
process equipment, lights, boilers, air conditioners, computers and peripherals, air
compressors, water chillers, refrigeration equipment, water treatment equipment,
packaging equipment, warehousing equipment and electrical control equipment if
such items are used directly and exclusively in the plant in which the manufacturing
takes place.

Based on these regulations, the Taxpayer must establish that each item of property for which it seeks

the investment credit is a machine, mechanism or tool, or a component or fitting thereof, and is

employed in the plant in which the manufacturing process occurs. There is nothing in the

regulations to support the Department’s contention that equipment is not eligible for the credit unless

it is sufficiently tied to the plant’s manufacturing process to be depreciated as 7-year personal

property. To the contrary, 3 NMAC 13.6.10 specifically provides that “equipment need not be

employed exclusively in the manufacturing process as long as the equipment is employed in the plant

in which the manufacturing process occurs.” The regulation goes on to state that for purposes of the

Investment Credit Act, the term equipment may include air conditioners and electrical control

equipment—two of the items in dispute in this protest—“if such items are used directly and

exclusively in the plant in which the manufacturing takes place.”

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With regard to the requirement in Section 7-9A-3(B) that equipment must be subject to

depreciation, the pertinent version of Regulation 3 NMAC 13.6.7.1 defines this term as follows:

For purposes of Section 7-9A-3, “subject to depreciation” means the equipment must
be depreciated on the books and records of the taxpayer and that the expense of the
depreciation shall be reflected on the federal income tax return as a depreciation
expense. Equipment depreciated under the accelerated cost recovery system, I.R.C.
168, and property for which the taxpayer makes an election under Internal Revenue
Code Section 179 shall also qualify for the credit.

Neither the statute nor the regulation require equipment to be depreciated as 7-year property in order

to qualify for the investment credit. The Department relies on Regulation 3 NMAC 2.1.11.11, which

provides, in pertinent part:

11.11.2 A "building" includes the structural components integral to the building and
necessary to the operation or maintenance of the building but does not include
equipment, systems or components installed to perform, support or serve the
activities and processes conducted in the building and which are classified for
depreciation purposes as 3-year property, 5-year property, 7-year property, 10-year
property or 15-year property by Section 168 of the Internal Revenue Code....

This regulation might support the Department’s arguments concerning depreciation—if it were a

regulation intended to interpret or exemplify the meaning of “qualified equipment” in the Investment

Credit Act. It is not. 3 NMAC 2.1.11.11, which is found under Section 7-9-3(C) NMSA 1978,

interprets the term “construction” as used in the Gross Receipts and Compensating Tax Act. The

first sentence of the regulation states: “As used in Subsection C of Section 7-9-3, the noun “building”

means....” (emphasis added). There is no apparent reason—and none was provided by the

Department—to rely on a regulation defining a “building” for purposes of the gross receipts tax to

determine whether property is “qualified equipment” under the Investment Credit Act. This is

particularly true when the Department has adopted separate regulations under the Investment Credit

Act that specifically address which items of property qualify as equipment eligible for the credit.

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Under the estoppel principles set out in Section 7-1-60 NMSA 1978, the Department is

bound by its own regulations. Based on Regulations 3 NMAC 13.6.7, 3 NMAC 13.6.9 and 3 NMAC

13.6.9, as they existed at the time the Taxpayer’s application for investment credit was filed, the

Taxpayer is entitled to the investment credit on both the supplemental electrical system and the air

conditioning units. Each item is a “machine, mechanism or tool” that is “used directly and

exclusively in the plant” in which the Taxpayer’s manufacturing activity takes place. Each item is

depreciated on the Taxpayer’s books and records and reflected as a depreciation expense on the

Taxpayer’s federal returns. With regard to these items, the Taxpayer has met the requirements set

out in the pertinent regulations under the Investment Credit Act.

The Taxpayer is not entitled to the investment credit on the costs related to construction of

the high bay area of the plant. This area does not meet the definition of “equipment” set out in

Section 7-9A-3(B) or Regulation 3 NMAC 13.6.9. Unlike the electrical system and air conditioning

units, the portion of the building constructed to house the enameling ovens is not a machine,

mechanism or tool, or a component or fitting of a machine, mechanism or tool. The fact that the

high bay area was designed solely to accommodate the enameling ovens required by the Taxpayer’s

manufacturing process is irrelevant. Only items of property that meet the definition of “equipment”

under the pertinent statutes and regulations are eligible for the investment credit.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to the Department’s partial denial of the

Taxpayer’s application for investment credit, and jurisdiction lies over the parties and the subject matter

of this protest.

2. The supplemental electrical system and air conditioning units meet the definition of

qualified equipment set out in the applicable version of the Department’s regulations under the

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Investment Credit Act, and the Department is estopped from denying the Taxpayer the investment

credit on the value of these items.

3. The high bay area of the Taxpayer’s plant does not meet the definition of qualified

equipment, and the Taxpayer is not entitled to the investment credit on any of the costs related to

construction of this portion of the plant.

For the foregoing reasons, the Taxpayer's protest is granted in part and denied in part, and the

Department is ordered to grant the Taxpayer’s application for investment credit in accordance with

Conclusion of Law No. 2, above.

DATED November 9, 2000.

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