Is natural gas converted by a supermarkets fuel cell to electricity exempt from sales tax?

Plain-English summary

A supermarket chain leases a fuel cell at one store that converts purchased natural gas into electricity (the store also draws grid electricity). It asked whether the natural gas converted by the fuel cell qualifies for the production exemption for gas/electricity used in production.

The Office of Counsel concluded the gas is exempt to the extent used directly and exclusively in production:

• The store does production activities (baking, cutting/packaging meat, slicing deli items) and sells those goods, so it produces tangible personal property for sale.
• The fuel cell can qualify as exempt production machinery (20 NYCRR 528.13) if it is used directly (it creates the energy that powers production equipment — energy-creating machinery counts, per Niagara Mohawk) and predominantly (more than 50% of its use powers production equipment).
• The natural gas is exempt under Tax Law section 1115(c) to the extent used directly and exclusively in the production process (20 NYCRR 528.22).
• Because energy is received in bulk and also serves non-production uses (e.g., lighting), the store must allocate — keep records and use an acceptable method such as an engineering study (subject to Department review) — and claim a refund or credit for the production portion. The non-production portion stays taxable.

What this means for you

Manufacturers, supermarkets, and on-site generators

Energy used directly and exclusively in production (and the machinery that makes it) can be exempt — and on-site generation like a fuel cell can itself be exempt production machinery if it predominantly powers production equipment. Mixed-use facilities dont get a full pass; only the production share is exempt.

Allocation is mandatory for bulk energy

Because gas/electricity comes in bulk and powers both production and non-production loads, you must allocate (typically via an engineering study) and claim the production portion by refund or credit, keeping records the Department can review.

Two different standards

Production machinery/equipment uses the directly and predominantly (>50%) test; utilities (gas/electricity) use the stricter directly and exclusively test (with allocation/refund for the qualifying portion).

Common questions

Q: Is all the natural gas for the fuel cell exempt?
A: No. Only the portion used directly and exclusively in production is exempt; the portion powering non-production uses (like lighting) is taxable.

Q: Can the fuel cell itself be exempt?
A: Yes, as production machinery, if it creates energy that powers production equipment and is used predominantly (more than 50%) for that.

Q: How do I claim the exemption on mixed-use energy?
A: Allocate the production vs. non-production use with an acceptable method such as an engineering study, keep records, and claim a refund or credit for the production portion.

Q: Can I rely on this opinion?
A: It binds the Department only as to the petitioner. Use it as guidance and confirm your own facts.

Citations and references

• Tax Law section 1115(c) (exemption for gas/electricity used directly and exclusively in production)
• Tax Law section 1115(a)(12) (production machinery and equipment exemption)
• 20 NYCRR 528.13 (directly and predominantly used production machinery)
• 20 NYCRR 528.22 (directly and exclusively used utilities; refund/credit and allocation)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2016.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a16_25s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-16(25)S
Sales Tax
August 29, 2016

Office of Counsel
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S130221A

The Department of Taxation and Finance received a Petition for Advisory Opinion from
REDACTEDREDACTEDREDACTEDREDACTEDREDACTED. “Petitioner” asks whether
charges for natural gas used and converted by a fuel cell to electricity are eligible for the sales tax
exemption for gas and electricity used directly and exclusively in production. We conclude that
Petitioner’s purchase of fuel and utilities to power a fuel cell will be exempt from sales tax if used
directly and exclusively in the production process.
Facts
Petitioner operates a chain of retail supermarkets. Petitioner leases a fuel cell for use at one
of its stores. This building is powered mainly by fuel cell technology using natural gas. Petitioner
states that there are three sources of energy at this particular store: a natural gas account; the fuel
cell account (400 kilowatt hours); and electricity supplied by a third-party supplier.
Petitioner purchases natural gas from a third party supplier; the natural gas is then converted
by the fuel cell to kilowatt hours of electricity. The 400 KWH produced through the fuel cell is
incorporated with electricity separately obtained through a third-party supplier. Petitioner states
that it is almost impossible to determine whether a particular fuel source is powering particular
equipment in the building.
Analysis
Petitioner is engaged in certain production activities at its store where the fuel cell is in use
(e.g., baking, cutting and packaging meat, slicing deli meats and cheeses to order, etc.). Petitioner
sells these items to its customers. Accordingly, Petitioner is engaged in the production of tangible
personal property for sale.
In order to qualify for exemption, Petitioner’s fuel cell and the parts, tools and supplies used
in conjunction with such fuel cell must be used “directly and predominantly” in the production of
tangible personal property for sale. “Directly” means that the equipment, during the production
phase of a process, must: “(i) act upon or effect a change in material to form the product to be sold;
or (ii) have an active causal relationship in the production of the product to be sold; or (iii) be used
in the handling, storage or conveyance of materials of the product to be sold; or (iv) be used to place
the product to be sold into the package in which it will enter the stream of commerce.” 20 NYCRR
§ 528.13(c)(1). Machinery and equipment to create energy used in the production process also can
qualify as “directly” used in production. See Matter of Niagara Mohawk Power Corp. v.
Wanamaker, 286 AD 446 (4th Dep’t 1955); Matter of Deco Builders, Inc., Tax Appeals Tribunal,
May 9, 1991. Petitioner’s fuel cell would meet the “directly” requirement if the fuel cell creates the
energy used to power equipment used in production.

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“Predominantly” means more than 50%. See 20 NYCRR § 528.13. In order to satisfy the
“predominantly” requirement, the machinery or equipment must be used more than 50% during the
production process. If machinery or equipment that is used in the production process is also used
50% or more in the administrative or distribution phase, it would not qualify for the production
exemption. See 20 NYCRR § 528.13(c)(4). Petitioner’s fuel cell would meet the “predominantly”
requirement if more than 50% of the use of the fuel cell provides the energy used to power
production equipment.
Tax Law § 1115(c) also exempts from sales tax gas, electricity, refrigeration and steam, and
gas, electric, refrigeration and steam service used “directly and exclusively in the production of
tangible personal property, gas, electricity, refrigeration or steam, for sale, by manufacturing,
processing, assembling, generating, refining, mining, extracting, farming, agriculture, horticulture
or floriculture….” “Directly” means that such energy sources and services “must during the
production phase of a process, either: (i) operate exempt production machinery or equipment, or (ii)
create conditions necessary for production, or (iii) perform an actual part of the production
process.” 20 NYCRR § 528.22(c). “Exclusively” means that all of such energy sources or services
must be used in the production process. See id.
Because energy sources and services are typically received in bulk, which would make the
exemption inapplicable if any of such energy sources or services were used for non-production
purposes (e.g., providing electricity for lightning), a purchaser that uses a portion of such energy
sources and services in production is permitted to claim a refund or credit for the portion of those
energy sources or service used directly and exclusively in production. See 20 NYCRR §
528.22(c)(3). However, the purchaser must maintain adequate records with respect to the allocation
of energy sources and services used for production and non-production purposes and must submit
an engineering survey or the formulae used to arrive at such allocation. See id.
As noted above, Petitioner is engaged in certain production activities at its store that
uses a fuel cell. Therefore, purchases of natural gas that are converted by the fuel cell to
electricity will be exempt from sales tax to the extent they are used directly and exclusively in
the production process. Petitioner is required to employ a method (e.g. engineering study) to
allocate the portion of energy used in production processes. That method will be subject to
review by the Department. See Publication 852 Sales Tax Information For: Manufacturers,
Processors, Generators, Assemblers, Refiners, Miners and Extractors, and Other Producers of
Goods and Merchandise; TSB-M-82 (25)(S) -- Determining Electricity Used in the Production
of Tangible Personal Property for Sale. The portion of Petitioner’s utility purchases that are not
used or consumed in an exempt manner are subject to sales tax.

DATED: August 29, 2016

NOTE:

/S/
DEBORAH R. LIEBMAN
Deputy Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to the
facts set forth therein and is binding on the Department only with respect to the person
or entity to whom it is issued and only if the person or entity fully and accurately

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August 29, 2016

describes all relevant facts. An Advisory Opinion is based on the law, regulations, and
Department policies in effect as of the date the Opinion is issued or for the specific time
period at issue in the Opinion. The information provided in this document does not
cover every situation and is not intended to replace the law or change its meaning.