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State, Department of Revenue v. Advanced H2O, LLC

Court of Appeals of Washington, Division 2

December 10, 2019

STATE OF WASHINGTON, DEPARTMENT OF REVENUE Respondent,
v.
ADVANCED H2O, LLC, Appellant. STATE OF WASHINGTON, DEPARTMENT OF REVENUE Respondent,
v.
TYSON FRESH MEATS INC., Appellant.

          CRUSER, J.

         The Department of Revenue (DOR) appeals the Board of Tax Appeals' (Board) orders granting summary judgment to Tyson Fresh Meats Inc. (Tyson) and Advanced H2O LLC (H2O); Tyson and H2O appeal the superior court's reversal of the Board's orders.[1] DOR contends that the Board erred when ruling that Tyson's and H2O's rental payments for the use of pallets are exempt from the retail sales or use tax under RCW 82.04.050(4)(b) because Tyson and H2O did not sublease the pallets to their customers or lease the pallets for the purpose of sublease to their customers and because the leases of pallets were not a lease of "packing materials" under WAC 458-20-115(3)(a) (Rule 115). Tyson and H2O contend that the Board did not err when ruling that their lease transactions are exempt from the retail sales tax under RCW 82.04.050(4)(b) because they leased the pallets for the purpose of subleasing the pallets to their customers and their leases of the pallets were leases of "packing materials" within the meaning of Rule 115(3)(a).

         We agree with DOR and hold that Tyson's and H2O's lease transactions are not exempt from the retail sales and the use tax under RCW 82.04.050(4)(b) and are therefore subject to the retail sales and use tax. Accordingly, we reverse the Board and affirm the superior court.

         FACTS

         I. Background Facts

         The following facts are undisputed. Tyson is a beef manufacturing corporation that processes and sells meat in Washington. H2O is a corporation that manufactures and sells bottled water and other beverages in Washington. During the years at issue, Tyson and H2O packed their products onto wooden pallets-portable platforms for transporting freight-to facilitate the delivery of their products to their customers.

         Tyson and H2O leased wooden pallets from CHEP USA (CHEP), a company that operates a pallet pooling service. CHEP issues, collects, conditions, and reissues pallets, which help companies like Tyson and H2O streamline distribution and transportation of their products to others. Each CHEP pallet is identifiable by a CHEP logo and the words "Property of CHEP" or "Owned by CHEP." H2O Clerk's Papers (CP) at 28.

         Tyson and H2O signed a "Hire Agreement" with CHEP to enter into CHEP's pallet pooling service. The agreement states that CHEP retains ownership and legal title of the pallets at all times:

6. OWNERSHIP OF EQUIPMENT
(a) CHEP never sells or transfers ownership of its Equipment. Customer acknowledges and agrees that each item of Equipment has a special value to CHEP and that CHEP repairs, maintains, handles, and otherwise administers the circulation of all Equipment as part of a pool.
(b) Customer acknowledges and agrees that despite any other clause in the Agreement, CHEP remains the owner of the Equipment at all times. Neither customer nor any other person is entitled to purchase or sell the Equipment, or use, dispose, or otherwise deal with Equipment in any way that is inconsistent with CHEP's ownership of the Equipment or the terms of this Agreement. Payment of the Lost Equipment Fee or any other circumstance or event does not constitute or result in any transfer of any property right or other interest in the Equipment by or from CHEP.

H2O Administrative Record (AR) at 121. The agreement also states that customers may not "assign" their rights under the agreement without CHEP's written consent. Tyson AR at 113. Invoices to CHEP customers repeat the Hire Agreement, stating that CHEP is the exclusive owner and that the payment of any fee does not result in "any transfer of any property right or other interest in any CHEP Equipment by or from CHEP." Id. at 134.

         As part of the Hire Agreement, CHEP customers agree to accept transfers from other CHEP customers. When customers ship their products on pallets to distributors or retailers who were also customers of CHEP, the receiving party is required to notify CHEP as to the quantity received and the location of the pallets. Once a customer accepts a transfer of pallets, the pallets become subject to the receiving customer's contract with CHEP. CHEP then deducts the transferred pallets from the delivering customer's quantity of pallets "on Hire" or quantity of pallets in its possession.[2]H2O AR at 120.

         The Hire Agreement strictly prohibits transfers of pallets to "unauthorized locations," which include transfers to nonparticipating parties or parties that did not have a separate agreement with CHEP. Tyson AR at 99. Customers may transfer pallets to only "authorized locations," which include CHEP's distribution centers or other CHEP customers. Id. If a customer transfers pallets to a nonparticipating party, CHEP charges the customer with a "Lost" fee and a "Surcharge." H2O AR at 121, 127. However, if the customer obtains written consent from CHEP to make a transfer to an unauthorized party, CHEP only charges a surcharge and not the lost fee.[3]Conversely, if a customer ships their products using CHEP pallets to another CHEP customer, the customer does not incur a surcharge upon delivery.

         On a weekly basis, CHEP charges each customer for use of the pallets by multiplying the number of pallets used by the number of rental days the pallets were in the customer's possession during the billing cycle. CHEP also charges an "Issue Fee" for each pallet the customer receives from CHEP. Tyson CP at 49. Once the customer pays the issue fee, it has the right to keep the pallet in its possession as long as the Hire Agreement is in place.

         Tyson and H2O did not provide its customers with an itemized bill charge related to the CHEP pallets when the customers received deliveries of their products. Instead, Tyson "pass[ed] the cost of the pallet rental to the customer in either the freight charge or in the product cost." Tyson AR at 155. H2O's pallet costs are "factored into the amounts it charges customers" for its products. H2O AR at 24.

         II. Procedural History: Tyson

         DOR audited Tyson for the period of January 1, 2007 through December 31, 2010. DOR assessed Tyson with a $142, 691.01 use tax on the pallets Tyson leased from CHEP. Tyson unsuccessfully appealed the tax to DOR's Appeals Division.

         Tyson appealed to the Board. Tyson and DOR filed cross motions for summary judgment. Tyson argued that its lease of pallets from CHEP are excluded from the definition of "retail sale" in RCW 82.04.050(1)(a)(i) because Tyson leased the pallets from CHEP for the purpose of subleasing the pallets to its customers and that Tyson's lease of the pallets was a lease of "packing materials" within Rule 115.

         The Board granted Tyson's motion for summary judgment. The Board concluded that the rental fees Tyson paid to CHEP were exempt from the retail sales or use taxes as a lease for sublease under RCW 82.04.050(4)(b). The Board further concluded that Tyson's lease of the pallets qualified as a "lease of 'packing materials' for sublease to its customers" under Rule 115(2), (3)(a), and (6)(c). Tyson AR at 28.

         DOR petitioned for judicial review of the Board's decision. The superior court reversed the Board, ruling that Tyson's pallet lease did not qualify as a "'rental for the purpose of sublease or subrent'" within RCW 82.04.050(4)(b) and the lease transactions were not exempt from the sales or use taxes as "'packing materials'" under Rule 115. Tyson CP at 91.

         Tyson appeals the superior court's reversal of the Board's decision.

         III. Procedural History: H2O

         DOR assessed H2O with $327, 720 in retail sales tax on pallet rental fees from January 1, 2008 through December 31, 2011. H2O requested a refund, arguing that its lease transactions are exempt from the retail sales or use tax because the pallets qualified as nonreturnable "packing materials" under Rule 115.

         DOR denied H2O's request. H2O moved for reconsideration, arguing that its lease qualifies as a lease for sublease and is exempt from the retail sales and use tax under RCW 82.04.050(4)(b). DOR denied H2O's motion for reconsideration.

         After unsuccessfully appealing to DOR's Appeals Division, H2O appealed the assessment to the Board. At the Board, both parties filed cross motions for summary judgment. H2O argued that the lease payments are exempt from the retail sales and use tax as a lease transaction under RCW 82.04.040(3), and as a lease-for-sublease of packing materials under Rule 115. The Board agreed and ruled that H2O's transaction was a lease under RCW 82.04.040(3) for the use of pallets and qualified for the lease-for-sublease exception under RCW 82.04.050(4)(b) and as a lease of packing materials under Rule 115(2), (3)(a), and (6)(c).

         DOR petitioned for judicial review of the Board's decision. The superior court reversed the Board, concluding that the Board erred when it determined that the pallet rentals were exempt from the retail sales and use tax under RCW 82.04.050(4)(b) and Rule 115 as sales of nonreturnable "'packing materials.'" H2O CP at 97.

         H2O appeals the superior court's reversal of the ...


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