Siding with the utility taxpayer, the Appellate Court of Maryland (Court) issued a decision granting Potomac Edison Company (Potomac), a Maryland electric utility company, a $2.4M sales tax refund. The Court held that Potomac’s process of transporting electricity from a power plant to the final customer constituted a “production activity” and was qualified for a sales tax exemption under Maryland law.
“The fact that an activity may be taxable as a service does not negate the possibility that there are [nontaxable] production activities that must be performed in order to provide the service.”
Background
Potomac Edison is a public utility company that operates in Maryland, Virginia and West Virginia. In 2006, Potomac was audited by the Comptroller of Maryland (Comptroller), which Potomac believes was triggered by an assertion that most of its equipment was not taxable under Maryland law. Potomac purchases electricity that is generated at a plant outside of Maryland, then uses its own equipment to transport the electricity into Maryland to be used by Maryland customers. Some of the equipment that Potomac believes qualifies for the exemption includes “conductors, substations, circuit breakers, switches, transformers, capacitors, cables, wires, and related equipment.”
Five years after the audit commenced, the Comptroller finally issued a Notice of Assessment for approximately $1.7M in sales tax, $1.3M in interest, and $175,000 in penalties, ~ $3.2M. Immediately thereafter, Potomac requested a Redetermination of Sales and Use Tax Liability. Not wavering from its original determination, the Comptroller maintained that the exemption Potomac was claiming for its equipment used in a “production activity” during processing equipment did not apply.
On appeal, the Maryland Tax Court agreed with Potomac stating that some of the equipment was “used directly and predominantly in processing electricity” thus entitling Potomac to a partial refund and an offset credit, effectively reducing the total liability from $3.2 million to under $600,000. Irrespective of the Tax Court’s analysis and determination, the Circuit Court denied the refund claim and affirmed only the offset credit necessitating their appeal to the Appellate Court of Maryland.
trust the process
Included in Potomac’s process in transporting electricity, the voltage of electricity that leaves the plant is “stepped up” by Potomac’s equipment to enter their system, and then “stepped down” by Potomac’s equipment to enter a customer’s building. In agreement with Potomac, the Court determined the process of stepping up or down constitutes “processing” for purposes of the exemption.
Rejecting the Comptroller’s argument that the equipment was not used in a production activity because it was used to maintain and not process electricity, the Court referenced a recognized electric power engineer industry expert, a Texas A&M University professor, among several other qualified experts, who pointed out that electric energy is not usable to customers at the voltage at which it comes out of the power plant, and must be processed into a “useful form.” The expert further emphasized that Potomac delivers the end product in different form from which it was purchased, changed by the process of being transferred through Potomac’s equipment.
Daunting deadlines
Ultimately, Potomac’s confidence with their understanding of the exemption and application to their processes was a critical factoring in secured the $2.4M refund.
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