If a company sells compressed air (not the compressor itself) to a manufacturer under a long-term service contract, does the sale qualify for Tennessee's industrial machinery sales tax exemption?

Plain-English summary

An industrial air compressor distributor rolled out a new business model: instead of selling or leasing compressors, it installs and maintains its OWN compressor equipment at a customer's facility under a ten-year contract, keeps full ownership and control of that equipment, and bills the customer a monthly fee based on how much compressed air the customer actually uses (with an overage charge if usage exceeds the contracted volume). The distributor already pays Tennessee use tax on the equipment itself. It asked whether these compressed-air sales qualify for Tennessee's industrial machinery exemption when sold to a manufacturing customer.

The Department said no, for two separate, independently sufficient reasons:

1. There's no equipment sale to exempt. The industrial machinery exemption only applies to a purchase of "machinery, apparatus and equipment." Here, the customer never buys, leases, or rents anything -- the distributor retains full title and control of the compressor and its parts, and the customer only ever buys the compressed air itself (a product, not equipment). Compressed air isn't machinery, apparatus, or equipment, and it isn't a device that conveys materials through a manufacturing process either -- so there's simply no exempt-eligible purchase happening.
2. Even if that weren't fatal, this customer's actual use would independently fail the exemption. The ruling looked at how this specific customer (a cement manufacturer, per the ruling's use of "the cement sold by the Customer" in describing its output) actually used the air: about 80% went to blasting dust off bag filters in its dust-collection system -- essentially facility cleaning -- with the rest split among pressure-vessel cleaning, valve/gate actuation, and running emissions-monitoring equipment. Facility cleaning, even when it supports manufacturing operations generally, isn't "necessary to and primarily for" the actual fabrication of the product being sold -- so this specific usage pattern would have failed the exemption's use-based test on its own, independent of the equipment-ownership issue.

What this means for you

Companies selling "as-a-service" utilities (compressed air, industrial gases, and similar) to manufacturers

Structuring a sale as a service (you keep the equipment, customer pays for output/consumption) takes the transaction out of the industrial machinery exemption entirely -- that exemption is built around purchasing equipment, not consuming a utility-like output. If your customers want the exemption to apply, the sale needs to be structured as an actual equipment purchase, lease, or rental.

Manufacturers considering "compressed air as a service" or similar utility contracts

Don't assume a utility input used in your plant automatically qualifies for a manufacturing exemption. Beyond the equipment-ownership issue, the exemption also turns on how you actually USE the input -- if most of it goes to cleaning, maintenance, or emissions monitoring rather than directly fabricating your product, that alone can defeat the exemption even for equipment you do own.

Accountants and tax professionals

This ruling is a clean two-track denial: a structural failure (no machinery purchase occurred) plus, in the alternative, a use-based failure (majority use was facility cleaning, not fabrication) -- useful for spotting either failure mode independently in similar utility-as-a-service arrangements.

Common questions

Q: Does selling compressed air (instead of the compressor) ever qualify for Tennessee's industrial machinery exemption?
A: Not under this ruling's reasoning -- the exemption requires a purchase of machinery/apparatus/equipment, and compressed air itself isn't any of those things, regardless of how it's used.

Q: If a manufacturer buys the compressor equipment outright instead, would that change the analysis?
A: This ruling didn't address that scenario (no equipment purchase occurred here), but even then, the exemption would still require the equipment to be necessary to and primarily used for actual fabrication -- facility cleaning uses like this customer's dust-collection air likely wouldn't qualify.

Q: Is compressed air used to clean manufacturing equipment considered part of the manufacturing process for tax purposes?
A: Not under this ruling -- the Department found that even though cleaning supports manufacturing operations generally, it isn't "necessary to and primarily for" the actual fabrication of the product sold.

Q: Can another compressed-air or utility-as-a-service provider rely on this ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to, and it can be revoked or modified by the Commissioner. Confirm your own contract structure and customers' actual usage with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-6-206(a) (Supp. 2010) (industrial machinery exemption)
• § 67-6-102(47)(A)(i) (Supp. 2010) ("industrial machinery" definition -- necessary to and primarily for fabrication/processing, by a manufacturer as its principal business)
• § 67-6-102(79), § 67-6-102(81)(A), § 67-6-102(92)(A) (Supp. 2010) ("retail sale," "sale," "tangible personal property")
• § 67-6-101 et seq. (Retailers' Sales Tax Act)

Tennessee cases cited by the ruling:

• Eastman Chemical Co. v. Johnson, 151 S.W.3d 503 (Tenn. 2004) ("machinery, apparatus, and equipment" includes devices conveying materials between process stages -- compressed air itself doesn't qualify)
• American Airlines, Inc. v. Johnson, 56 S.W.3d 502 (Tenn. Ct. App. 2000); Rogers Group, Inc. v. Huddleston, 900 S.W.2d 34 (Tenn. Ct. App. 1995); Tibbals Flooring Co. v. Huddleston, 891 S.W.2d 196 (Tenn. 1994); United Canners, Inc. v. King, 696 S.W.2d 525 (Tenn. 1985) (taxpayer bears burden of proving an exemption)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/sales/11-39.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 11-39
WARNING
Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This presentation of the ruling in a redacted form is
informational only. Rulings are made in response to particular facts presented and are not
intended necessarily as statements of Department policy.

SUBJECT
The applicability of the Tennessee sales and use tax industrial machinery exemption.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;
(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.

FACTS
[TAXPAYER] sells and distributes industrial air compressors and related parts, supplies, and
services. The Taxpayer’s customers are located throughout the United States, and include
[TYPES OF CUSTOMERS].
The Taxpayer has introduced a new venture, [REDACTED], whereby the Taxpayer provides
compressed air to the customer’s place of business. The Taxpayer anticipates that the majority of
its [COMPRESSED AIR] customers will be manufacturers, who typically utilize compressed air
to operate tools and production line equipment required for the manufacturing of products for
resale.
Upon implementation of a ten-year contract for the [COMPRESSED AIR], the Taxpayer installs
and maintains its equipment at the customer’s location. The Taxpayer retains full ownership and
control over the equipment, which includes an air compressor, spare parts, and accessories. The
compressor takes in air from the surrounding environment, which it then compresses and
delivers. The Taxpayer invoices the customer a standard monthly fee based upon the anticipated
range of consumption of compressed air. If the maximum contractual volume of compressed air
is exceeded, the Taxpayer invoices a supplementary charge, which is calculated by a
predetermined method. The Taxpayer does not lease or rent the [COMPRESSED AIR]
equipment to the customer and does not charge the customer for any lease or rental.
Additionally, the Taxpayer remits Tennessee use tax with respect to its [COMPRESSED AIR]
equipment located in Tennessee.
The Taxpayer recently installed [COMPRESSED AIR] equipment at the [CITY], Tennessee,
plant of [NAME OF PLANT] (the “Customer”). The Customer is in the business of
manufacturing [PRODUCT]. The Customer describes its use of the compressed air as follows:
Approximately 80% of the volume of compressed air is used to clean bags for dust collection
devices; the compressed air is used by releasing high pressure pulses to recover product from the
dust collection units around the Customer’s facility.
Approximately 10% of the volume of compressed air is used in tanks that accumulate pressures
above 90 psi and that deliver a high impact shock, to remove product build-up and accumulation
from the walls of pyro-process vessels.
Approximately 5% of the volume of compressed air is used to operate pneumatic actuators as
flow valves, natural gas valves, material conveying gates; and other process flow control
mechanisms.
Approximately 5% of the volume of compressed air is used to operate analysis instruments and
continuous emissions monitors. Specifically, the compressed air is used to perform cleaning and
purging cycles to maintain continuous emissions monitors in a clean state, free from debris and
plugs, as well as actuate analyzer valves.

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QUESTION
For Tennessee sales and use tax purposes, does the industrial machinery exemption found under
TENN. CODE ANN. § 67-6-206(a) (Supp. 2010) apply to the Taxpayer’s sales of [REDACTED]
compressed air to the Customer?
RULING
No. For Tennessee sales and use tax purposes, the industrial machinery exemption found under
TENN. CODE ANN. § 67-6-206(a) (Supp. 2010) does not apply to the Taxpayer’s sales of
[REDACTED] compressed air to the Customer. All such sales are subject to the Tennessee sales
and use tax.
ANALYSIS
Under the Retailers’ Sales Tax Act, TENN. CODE ANN. § 67-6-101 et seq., the retail sale of
tangible personal property is generally subject to the Tennessee sales and use tax.1 However,
TENN. CODE ANN. § 67-6-206(a) (Supp. 2010) exempts “industrial machinery” from the sales
and use tax, providing that “[a]fter June 30, 1983, no tax is due with respect to industrial
machinery.”2
TENN. CODE ANN. § 67-6-102(47)(A)(i) (Supp. 2010) defines “industrial machinery” in pertinent
part as “machinery, apparatus and equipment with all associated parts, appurtenances and
accessories, including hydraulic fluids, lubricating oils, and greases necessary for operation and
maintenance, repair parts and any necessary repair or taxable installation labor therefor [sic], that
is necessary to, and primarily for, the fabrication or processing of tangible personal property for
resale and consumption off the premises … where the use of such machinery, equipment or
facilities is by one who engages in such fabrication or processing as one’s principal business.”
Therefore, in order for a purchase of tangible personal property to be exempt from the Tennessee
sales and use tax as industrial machinery, four requirements must be met. First, the purchaser
must be a manufacturer. Second, the tangible personal property purchased must be machinery,
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TENN. CODE ANN. § 67-6-102(79) (Supp. 2010) defines a “retail sale” as any “sale, lease, or rental for any purpose
other than for resale, sublease, or subrent.” The term “sale” is defined under the Tennessee sales and use tax laws in
pertinent part as “any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or
otherwise, in any manner or by any means whatsoever of tangible personal property for a consideration.” TENN.
CODE ANN. § 67-6-102(81)(A). Additionally, TENN. CODE ANN. § 67-6-102(92)(A) defines “tangible personal
property” in pertinent part as “personal property that can be seen, weighed, measured, felt, or touched.”
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The burden is on the taxpayer to establish entitlement to an exemption from taxation. The Tennessee Supreme
Court has stated that “[a]lthough the rule is well-established that taxing legislation should be liberally construed in
favor of the taxpayer and strictly construed against the taxing authority, it is an equally important principle of
Tennessee tax law that ‘exemptions from taxation are construed against the taxpayer who must shoulder the heavy
and exacting burden of proving the exemption.’” Am. Airlines, Inc. v. Johnson, 56 S.W.3d 502, 506 (Tenn. Ct. App.
2000) (quoting Rogers Group, Inc. v. Huddleston, 900 S.W.2d 34, 36 (Tenn. Ct. App. 1995)). The Tennessee
Supreme Court has also stated that the burden is on the taxpayer to establish the exemption, and any well-founded
doubt is sufficient to defeat a claimed exemption from taxation. Am. Airlines, 56 S.W.3d at 506 (citing Tibbals
Flooring Co. v. Huddleston, 891 S.W.2d 196, 198 (Tenn. 1994); United Canners, Inc. v. King, 696 S.W.2d 525, 527
(Tenn. 1985)).

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apparatus or equipment. Third, the tangible personal property must be necessary to the
fabrication or processing of the products sold by the purchaser. Fourth, the tangible personal
property must be primarily for the fabrication of the products sold by the purchaser.
This letter ruling will not address the first requirement, because none of the other requirements
are satisfied.
The second requirement is not satisfied because the Customer does not purchase machinery,
apparatus or equipment from the Taxpayer. The facts indicate that the Taxpayer sells compressed
air, not equipment. The Tennessee Supreme Court has interpreted the phrase “machinery,
apparatus, and equipment” to include “the devices conveying the materials and components from
one part of the manufacturing or fabricating process to another.” Eastman Chemical Co. v.
Johnson, 151 S.W.3d 503, 509-510 (Tenn. 2004). Because compressed air is not machinery,
apparatus or equipment, and is not a device used to convey materials from one part of the
manufacturing or fabricating process to another, it cannot qualify as exempt industrial
machinery.
Note that the Taxpayer does not sell, lease, or rent the [COMPRESSED AIR] equipment to the
Customer. TENN. CODE ANN. § 67-6-102(81)(A) defines the term “sale” in pertinent part as “any
transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise,
in any manner or by any means whatsoever of tangible personal property for a consideration.”
(Emphasis added.) Here, the Taxpayer does not transfer title or possession of the
[COMPRESSED AIR] equipment to the Customer for a consideration. The Taxpayer retains full
ownership and control over the equipment, which includes an air compressor, spare parts, and
accessories. The Taxpayer does not charge the customer for any lease or rental of the equipment.
Additionally, the Taxpayer remits Tennessee use tax with respect to its [COMPRESSED AIR]
equipment located in Tennessee. Rather, the Taxpayer invoices the customer a standard monthly
fee based upon the anticipated range of consumption of compressed air. Thus, the Taxpayer sells
the Customer compressed air that is generated by the [COMPRESSED AIR] equipment.
Additionally, the third and fourth requirements are not met. To meet these requirements, the
compressed air would have to be necessary to the fabrication or processing of the products sold
by the Customer and used primarily for the fabrication of the products sold by the Customer.
Here, the facts indicate that the Customer uses approximately 80% of the volume of the
compressed air generated by the [COMPRESSED AIR] equipment to clean bags for dust
collection devices. Specifically, the compressed air is used by releasing high pressure pulses to
recover product from the dust collection units around the Customer’s facility. In other words, at
least 80% of the compressed air is used for purposes of cleaning the facility. While such use may
benefit the Customer’s manufacturing operations in general, it is not necessary to or used
primarily for the fabrication of the cement sold by the Customer.

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Accordingly, for Tennessee sales and use tax purposes, the industrial machinery exemption
found under TENN. CODE ANN. § 67-6-206(a) does not apply to the Taxpayer’s sales of
[REDACTED] compressed air to the Customer. All such sales are subject to the Tennessee sales
and use tax.

Kristin Husat
Senior Tax Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

07/29/11

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