TAX COURT OF NEW JERSEY

R.J. Hughes Justice Complex

GAIL L. MENYUK P.O. Box 975

JUDGE Trenton, New Jersey 08625-0975

(609) 943-4761 Fax: (609) 984-0805

NOT FOR PUBLICATION WITHOUT THE APPROVAL

OF THE TAX COURT COMMITTEE ON OPINIONS

February 14, 2012

Robert S. Seguin, Esq.

2 Booream Avenue

Milltown, NJ 08850

Jill C. McNally, DAG

Division of Law

Hughes Justice Complex

25 Market Street

P.O. Box 106

Trenton, NJ 08625-0106

Re: Schweitzer-Mauduit International Inc. v. Director,

Division of Taxation

Docket No. 007376-2005

Dear Counsel:

Plaintiff, a manufacturer of cigarette papers with a plant in Spotswood, New Jersey, contests the defendant’s assessment of use tax on certain of its purchases and also contests the defendant’s denial of a claim for a refund of sales and use taxes. Plaintiff contends that the purchases on which tax was assessed or paid consisted of: (1) exempt manufacturing equipment; (2) exempt machinery, apparatus, equipment, building materials or structures used in a cogeneration facility; and, (3) services rendered in installing property which constituted an addition or capital improvement to real property.

The court concludes that, with the exception of two purchases of machinery parts, plaintiff failed to carry its burden of proof.

*

The New Jersey Sales and Use Tax Act, N.J.S.A. 54:32B-1 to -29 (the “Act”), imposes a tax on receipts from every retail sale of tangible personal property not otherwise exempt. N.J.S.A. 54:32B-3(a). There is a compensating use tax imposed on the use of any tangible personal property in this state purchased at retail unless the property has already been or will be subject to New Jersey sales tax. N.J.S.A. 54:32B-6; Cosmair, Inc. v. Director, Div. of Taxation, 109 N.J. 562, 566 (1988). The Act also imposes a sales tax on certain enumerated services. N.J.S.A. 54:32B-3(b).

This action arises from a sales and use tax audit of plaintiff conducted by the Division of Taxation (“Division”) for the period October 1, 1995 through March 31, 1999, a forty-two month period. The audit was conducted at the plaintiff’s corporate headquarters in Alpharetta, Georgia and consisted of a review of plaintiff’s books and records pertaining to plaintiff’s purchases for use at its Spotswood, New Jersey facility.

Following the audit, the Division issued a notice of assessment on April 19, 2000, assessing tax in the amount of $125,630 and interest calculated through May 20, 2000 of $43,223.89. By letter dated July 14, 2000, plaintiff protested the entire assessment1 and, at the same time, filed a claim for refund in which it contended it had made overpayments of sales and use tax in the amount of $371,559.89 during the audit period. The original refund claim did not specify which purchases plaintiff claimed to be exempt or the grounds for exemption. During the course of the review of plaintiff’s protest by the Conference and Appeals Branch of the Division, plaintiff submitted schedules of purchases that it contended were exempt.

Jeffrey Schwab is employed by the Division as a conferee.2 He was assigned to handle plaintiff’s protest and refund claim in early 2004, after the original conferee became ill. Mr. Schwab testified that he reviewed the material that had been submitted by plaintiff to the first conferee, as well as additional material that was submitted by plaintiff during his review of the protest. He testified that he reviewed schedules of purchases compiled by the plaintiff, some invoices, cancelled checks, appropriation documents, plaintiff’s accruals for sales tax, and plaintiff’s chart of accounts. He toured plaintiff’s Spotswood plant twice, accompanied by Clifford Hogan, plaintiff’s representative in connection with the audit and protest, and with James Stairiker, plaintiff’s supervising plant engineer at the Spotswood facility. In advance of his tours, Mr. Schwab selected invoices and asked plaintiff’s representatives to identify where in the plant the purchases shown on those invoices were located. Mr. Schwab testified that his discussions with plaintiff’s representatives centered on whether the purchases were exempt manufacturing equipment and machinery and, in the case of parts, whether the useful life of the parts was more than one year. Those were the issues reflected in his conference report.

Mr. Schwab issued a final determination letter dated August 17, 2005. He also prepared a conference report dated August 5, 2005, setting forth his findings of fact and conclusions. Mr. Schwab testified that he based his final determination on the material that had been submitted, information gathered during the tours of the plant, and his discussions with plaintiff’s employees and representatives.3 Appended to the final determination letter were the schedules of the contested items. Each item was noted with Mr. Schwab’s determination as to taxability, together with his comment as to why a particular item was taxable or why it was not taxable. As set forth in the final determination letter, the Division reduced the assessment from $125,630 to $99,133.42. With respect to the refund claim, Mr. Schwab determined that plaintiff was entitled to a refund in the amount of $71,671.82. After applying the credit for the refund to the reduced assessment, the Division concluded in its final determination that plaintiff owed a tax liability of $27,461.60, plus interest of $30,128.44, for a total amount due of $57,590.04.

Plaintiff timely filed a complaint with the Tax Court contesting the revised audit assessment as well as the denial of the balance of the refund claims. The complaint did not identify the specific statutory basis for plaintiff’s claims of exemption. Following the filing of the complaint with the Tax Court, the parties engaged in an extended discovery period during which the parties attempted to sort out which items were claimed to be exempt, and the basis for the claim of exemption for each item. As a consequence of that discovery, the Division approved an additional refund amount of $1,085.04, and plaintiff conceded that some items in issue were taxable.

Counsel for the parties were finally able to agree to a form of pretrial order shortly before trial.4 The pretrial order set out the concessions of both parties regarding the taxability of certain items, and specified the three statutory sections noted above as the basis for plaintiff’s remaining claims of exemption. Incorporated by reference in and attached to the pretrial order were twenty pages of schedules, with each such page listing several line items. Each line represented either (1) an item or items on which the Division had assessed use tax and for which the plaintiff claimed exemption, or (2) an item or items as to which the plaintiff contended it had paid sales tax that should be refunded because the item or items were exempt.

As noted above, James Stairiker is the supervising plant engineer at plaintiff’s Spotswood facility. He has been employed by plaintiff for twenty-seven years. At trial, he narrated a video tape showing the operations at plaintiff’s plant. His narration explained the various steps in plaintiff’s manufacturing process and identified machinery and equipment used by plaintiff there. The facility consists of a power plant, a pulp mill, paper machines and what Mr. Stairiker called “converting,” which he testified was where the large rolls of paper that are manufactured at the plant are slit into appropriate sizes, with the resulting end product being called a bobbin. There is also a storage facility and a machine shop.

Mr. Stairiker described the operation of the plant as a “cascade event,” where each step is dependent on the one that precedes it: that is, if one machine fails, the entire production line fails, resulting in down time. The first step in the manufacturing process is the pulp mill, where raw material (flax) is pulped and made into stock that it is fed into the machines that make the paper. During most of the audit period, plaintiff operated six paper machines which, according to Mr. Stairiker, are quite old, most more than seventy years old. From the paper machines, the paper goes through the converting section, where the large rolls of paper are slit, with the ultimate end product being bobbins of paper.

In addition to the foregoing operations, Mr. Stairiker testified during cross-examination that plaintiff maintained a quality control room in the plant. Quality control tests paper samples are taken during production and following production. The tests measure several parameters, the results of which are eventually passed along to plaintiff’s customers. Various pieces of equipment, such as tensile testers, porosity meters, and scales, are used in the quality control room. According to Mr. Stairiker, the testing that takes place during production assists the machine operators in the plant by telling them whether or not they are “making bad paper.”

On cross-examination, Mr. Stairiker also described plaintiff’s research and development group, which operates from a separate office in the plant. He testified that the research and development people could be working on one specific element of a machine or they could be working on a prototype machine. He stated that they primarily work on prototypes, trying to develop a machine that would be mill-worthy and capable of operating twenty-four hours a day. As pertinent here, he testified that the one prototype that was being developed at the plant during the audit period wore through an unusually high number of belts manufactured by a vendor called Belt Technologies. Plaintiff withdrew at trial its claim that these belts were exempt as machinery and equipment used directly in manufacturing.

Mr. Stairiker explained that the plant operates twenty-four hours a day, seven days a week. He testified that perhaps once a month, generally when there is a change in the grade or type of paper being manufactured, the paper machines only are taken out of operation for six or seven hours. During that period, the stock system is washed out, certain chemical systems are cleaned up, machines are lubricated, and small repairs and tuning are performed. Once a year, the entire plant is shut down for three or four days for maintenance and repair.

According to Mr. Stairiker, if any of the machines fail, it is costly for plaintiff, not only because it cannot manufacture paper during any period of down time, but also because it is paying for idle workers while repairs are being made. Consequently, it is of utmost importance to plaintiff that there is little or no down time. Plaintiff employs plant personnel called tour workers that maintain the machines on a twenty four hour schedule. The primary responsibility of tour workers is to fix a broken machine as quickly as possible. Mr. Stairiker testified that they do not rebuild machine parts because they do not have the time. If something breaks, tour workers pull it off the machine and replace it with a part kept in stock.

Mr. Stairiker further testified that the power plant is a cogeneration facility that the United States Department of Energy has designated as a “qualifying facility.” He identified documents entitled “Annual Electric Generator Report – Nonutility” that had been filed by plaintiff for 1998, 1999 and 2000 with the Department of Energy. Mr. Stairiker conceded on cross-examination that he had not prepared the reports, which were nevertheless moved into evidence without objection. The reports indicated that the primary purpose of the power generating facility was for operation as a paper mill. The section of the reports which requests information as to how the useful thermal output was used, (Schedule IV(A), question 3b), was left blank. The report for 1998, which is the only one that had statistics attached, indicated that all of the output of the electric generating facility was used for the operation of the machinery and equipment comprising the paper manufacturing plant. The statistics further indicated that plaintiff did not generate all of the electricity required for the operation of its plant, and that it purchased the bulk of its electricity requirements from outside sources.

Mr. Stairiker was also asked to testify as to each item on the schedule of purchases that plaintiff contended were exempt from tax. On direct examination, Mr. Stairiker was asked to look at each invoice, state the item in issue (which was listed on the invoice), state the nature of the item, and whether the item would last over a year or under a year. In almost every case, Mr. Stairiker indicated that the item in question would last more than a year. Mr. Stairiker was also asked whether an item was “part of the process.” He conceded that a few items were used in the shop (presumably a maintenance shop), but except for those few items, his answer was invariably “yes,” the item in question was part of the process.

Mr. Stairiker was asked on cross-examination to describe what he meant when he testified that an item in issue was “part of the process.” He responded that he looked at the entire endeavor of making paper as part of the process, from the time that flax is removed from a rail car at the plant, including cooking it, cleaning it, refining it, putting it on the paper machines, drying it, cutting it, and slitting it.

On cross-examination, Mr. Stairiker conceded that during the audit period, plaintiff kept no records as to when a part was replaced. He also testified that there was no log book maintained that would indicate when a machine was being repaired. He stated that during the audit period, plaintiff maintained a storage facility that he described as a Butler building, approximately 300 feet long by 150 feet wide, where plaintiff stored critical spare parts such as controllers, valves and ball bearings. When asked whether plaintiff catalogued when parts were received and when and where they were used, Mr. Stairiker testified that he could probably tell when a part was withdrawn from storage and when it was replenished, but not where it was used. He also conceded that, with respect to what he called generic parts, such as wire, he wouldn’t really know where that part went. He also testified that where a large quantity of stainless steel was purchased, it would indicate to him that “somebody was fabricating something” for use in the plant.

The following general principles are pertinent here and guide the decision of the court. Assessments made by the Director, Division of Taxation (“Director”) are presumed to be correct.5 Atlantic City Trans. Co. v. Dir., Div. of Taxation, 12 N.J. 130, 146 (1953); Yilmaz, Inc. v. Dir., Div. of Taxation, 22 N.J. Tax 204, 231 (Tax 2005), aff’d, 23 N.J. Tax 361 (App. Div.), certif. denied, 192 N.J. 69 (2007); H.J. Bradley, Inc. v. Taxation Div. Dir., 4 N.J. Tax 213, 229 (Tax 1982). The Act plainly provides that all receipts from sales of tangible personal property and the enumerated services are presumptively subject to tax until the contrary is established, and the taxpayer has the burden of establishing otherwise. N.J.S.A. 54:32B-12(b); Campo Jersey, Inc. v. Dir., Div. of Taxation, 22 N.J. Tax 251, 270 (Tax 2005), aff’d, 23 N.J. Tax 370 (App. Div.), certif. denied 190 N.J. 395 (2007); Adamar of New Jersey v. Dir., Div. of Taxation, 17 N.J. Tax 80, 86 (Tax 1997), aff’d, 18 N.J. Tax 70 (App. Div. 1999) (explaining that the Act is intended to be broadly inclusive and any doubt as to taxability should be resolved in favor of the Director, Division of Taxation).

Moreover, tax exemptions and exclusions are strictly construed against the claimant. GE Solid State, Inc. v. Dir., Div. of Taxation, 132 N.J. 298, 306 (1993). The taxpayer has the burden of establishing its entitlement to an exemption. See, e.g., Metpath, Inc. v. Dir., Div. of Taxation, 96 N.J. 147, 153 (1984); RCN Telecom Services, Inc. v. Dir., Div. of Taxation, 25 N.J. Tax 409, 420 (Tax 2010); ADVO, Inc. v. Dir., Div. of Taxation, 25 N.J. Tax 504, 511 (Tax 2010). However, the Division of Taxation “may not, under the guise of interpretation, extend a statute to give it a greater effect than its language permits.” GE Solid State, supra, 132 N.J. at 306; RCN Telecom Services, Inc. v. Dir., Div. of Taxation, 23 N.J. Tax 520, 524 (Tax 2007)(“the interpretation should not distort the statutory language”).

Mr. Stairiker credibly testified as to the manufacturing process conducted at plaintiff’s plant. Even though he was very familiar with plaintiff’s Spotswood facility and testified knowledgably about its operations, the court finds that the testimony elicited from him was, for the most part, insufficient to establish the statutory requirements for exemption.

Plaintiff’s primary contention is that its purchases of tangible personal property are exempt pursuant to N.J.S.A. 54:32B-8.13(a), which exempts “[s]ales of machinery, apparatus or equipment for use or consumption directly and primarily in the production of tangible personal property by manufacturing, processing, assembling or refining.” N.J.S.A. 54:32B-8.13 further provides, however, that “[t]he exemptions granted under this section shall not be construed to apply to sales, otherwise taxable, of machinery, equipment or apparatus whose use is incidental to the activities described in subsections a., b., c., d. and e. of this section.” The exemption also does not apply to parts with a useful life of one year or less or tools or supplies used in connection with exempt machinery, equipment or apparatus. Ibid.

Some of the items as to which Mr. Stairiker testified were plainly nonexempt supplies rather than exempt parts. See N.J.A.C. 18:24-4.2, which defines “supplies” as:

[I]tems of tangible personal property used in the maintenance of a building, work area, or machinery, apparatus, and equipment, and may include items of tangible personal property consumed or used in production whose uses are incidental to such production. Supplies include, but are not limited to, such items as lubricants, cleaning materials, boiler compounds and light bulbs.

For example, plaintiff claimed that a purchase evidenced by an invoice from Richco Products was exempt. Mr. Stairiker testified that the product invoiced was a cleaner that is “basically soap.”

Some of plaintiff’s purchases were neither machines nor parts of machines. For example, plaintiff purchased quantities of stainless steel, which plaintiff used to fabricate various items used in the plant. This material does not fall within the definition of either “machinery, apparatus, or equipment” or “part”:

“Machinery, apparatus or equipment” means any complex, mechanical, electrical or electronic device, mechanism or instrument which is adapted to the accomplishment of a production process, and which is designed to be used, and is used, in manufacturing, converting, processing, fabricating, assembling, or refining tangible personal property for sale.

. . . .

“Part” means an item used as a replacement for any portion of a machine and which is attached or affixed to the machine of which it is a part permanently or during periods of use. A part cannot accomplish the work for which it was designed independently of the machine of which it is intended to be a component.

[N.J.A.C. 18:24-4.2.]

Plaintiff’s purchase of other materials also did not fall within these definitions. For example, plaintiff claimed exemption for materials used in erecting platforms for workers to access machinery; non-skid fiberglass material used on the platforms to keep workers from slipping; stainless steel rod used to suspend pipes and conduit; copper coated pipe hangers; tape used to insulate piping; cement, rebar, steel and anchors used in the equipment foundations; couplers, clamps, gaskets and washers used to connect or hold up hosing and piping; and steam line insulation material.

Where a purchase was indisputably machinery, apparatus or equipment, or was a replacement part for machinery, apparatus or equipment, there was little or no evidence that the purchases were used “directly and primarily” in manufacturing. The Director has promulgated regulations construing the phrase “directly and primarily” as used in N.J.S.A. 54:32B-8.13(a). As pertinent here, N.J.A.C. 18:24-4.4 provides:

(b) Production is limited to those operations commencing with the introduction of raw materials into a systematic series of manufacturing, processing, assembling, or refining operations, and ceases when the product is in the form in which it will be sold to the ultimate consumer, and does not include any activities which are distributive in nature. For example, a machine which packs a product into shipping cases after the product is in the form in which it will be purchased by the ultimate consumer is not considered to be used in production.

(c) Machinery, apparatus, or equipment is considered to be directly used in production only when it is used to initiate, sustain or terminate the transformation of raw materials into finished products. In determining whether property consisting of machinery, apparatus or equipment is "directly" used, consideration must be given to the following factors:

1. The physical proximity of the property in question to the production process in which it is used:

2. The proximity of the time of use of the property in question to the time of use of other property used before and after it in the production process; and,

3. The active causal relationship between the use of the property in question and the production of a product. The fact that particular property may be considered essential to the conduct of manufacturing, processing, assembling or refining because its use is required either by law or practical necessity does not, of itself, mean that the property is used directly in manufacturing, processing, assembling or refining. For example, property used to prevent accidents, which may be required by law, is not considered directly used.

See also, RCN Telecom Services, Inc., supra, 23 N.J. Tax at 524, which construed N.J.S.A. 54:32B-8.13(c) and (e) (exemptions for equipment used directly in providing telephone services and broadcasting services, respectively), to exclude apparatus or equipment not directly used in the provision of the specified services, “even if essential or necessary for, or integral to, the operation of a cable television system and service.”

Mr. Stairiker testified that he regarded everything in the plant as part of the manufacturing process, commencing from the unloading of the raw material from the railcars and, presumably, continuing through the packaging of the final product and loading it for distribution. Consequently, in most cases, he did not or could not identify with specificity where or in what machine particular parts were used. His testimony was only that it was used in the process or was part of the process or similar terminology. Consequently, it is impossible to determine whether many of the parts at issue were directly used in the manufacture of paper or incidental to the manufacturing process.

Many of the items as to which Mr. Stairiker testified were clearly not directly used in the manufacture of paper. Those items include, among other things: surge protectors; surge suppressors, power supplies for computers; control cabinets; shims used to align machines; eye bolts used in connection with the installation of equipment and thereafter removed; a lift used to remove plates inside the pulper; safety valves for the steam system; computer system components and cables; parts used in a machine that makes labels that are affixed to the finished bobbins; a tool used to align the actual manufacturing equipment; equipment used to measure the brightness of the manufactured paper as part of the quality control process; flow meters measuring the flow of oil from tanks to boilers in the powerhouse; wheels for carts used to take rejected paper from the machine to recycle back into the paper-making process; meters for measuring tank contents; parts for a scrubbing system used to remove chlorine from the air; chlorine gas detectors; a mobile boom and platform used to install and access pieces of equipment; storage racks; safety gates; safety guards; boxes to transport rolls for regrinding; a dryer in the quality control laboratory; tensile testers; pressure gauges; a portable filtration system for cleaning machine lubrication systems; grinders for sharpening slitter blades; a printer used to print bar codes on the finished bobbin; the ulma camera system used for inspecting the paper; a machine used to measure the amount of solids in water for purposes of determining whether the water can be reclaimed.

Other parts may or may not have been used directly and primarily in the manufacture and production of cigarette paper, but there was simply insufficient testimony to establish what, if any, machine they were a part of and/or exactly what the machine did. Items in this category include, among other things: hosing, fittings, circuit breakers, trip units for circuit breakers, fuses, and other items of electrical equipment (contact blocks, button kits, wire, electrical fittings, electrical components), potentiometer components, valves, a dryer system for removing water from compressed air, and cylinders.

At times, Mr. Stairiker testified about the function and useful life of a particular machine when the invoice indicated that the charge in question was for labor performed on that machine. For example, in testifying about an invoice from R-V Industries, Inc., Mr. Stairiker described a roll used on a paper machine. However, the invoice describes labor charges for modifying that roll, rather than charges for the purchase of a roll. Charges for labor on personal property furnished by the customer do not qualify for exemption under N.J.S.A.54:32B-8.13(a). Rather, such charges are taxable pursuant to N.J.S.A. 54:32B-3(b)(1). See, e.g., Panta Astor, Inc. v. Taxation Div. Dir., 8 N.J. Tax 464 (Tax 1986)(service of placing new engravings on printing rollers owned by the plaintiff was taxable under N.J.S.A. 54:32B-3(b)(1)). In another case, Mr. Stairiker stated that an invoice was for a machine that analyzed the length of flax fibers as part of quality control, when the invoice clearly stated it was for a 12-month preventative maintenance agreement on that machine. The machine itself was not, in any event, eligible as equipment used directly in manufacturing. Rather, it was equipment used off the line for quality control purposes.

Mr. Stairiker testified that some purchases found taxable by the Division were of software used in running the paper machines. Prior to its amendment in 2003, N.J.A.C. 18:24-25.2(b) generally provided that prepackaged or “canned” software was taxable. However, software that required analysis for the customer’s requirements or adaptation by the vendor to be used in a specific environment, was considered intangible personal property and, thus, not subject to tax. See 35 N.J.R. 2165(a)(May 19, 2003), 35 N.J.R. 3848(a)(August 18, 2003). It is possible that some or all of the software in issue was software customized for plaintiff’s use, and thus nontaxable under N.J.A.C. 18:24-25(b) as in effect during the audit period, but no testimony to that effect was elicited.

Although Mr. Stairker’s testimony regarding the operations of the plant was credible, his testimony as to the useful life of the parts and equipment was not. Apart from his familiarity with paper mill operations, and with the operation of this particular plant and its machines, he rarely provided any testimony as to why or how he knew that any of the hundreds of parts at issue had a particular useful life. On cross-examination, Mr. Stairiker conceded that, at the time of the audit, plaintiff did not keep any records of when or how often a machine was repaired, or when or how often parts were replaced. He also testified that he personally did not repair machines, and was not aware of when a part was replaced. In some cases, his testimony was ambiguous. For example, when asked about the useful life of doctor blades, he stated that they “usually lasted a year.” There were only two purchases as to which Mr. Stairiker specifically and credibly testified as to the useful life of the parts purchased. Both purchases were on invoices from Andritz, Inc. Mr. Stairiker testified that the parts were several shims and a main key shaft for a machine located in the pulp mill used to compress water out of the paper stock. He further testified that this machine is rebuilt every two years, and that these parts were part of such a rebuild.

In some cases, it appeared that, when Mr. Stairiker was asked about the useful life of a part whose purchase was in issue, he responded with respect to the entire machine, rather than with respect to the particular part in issue. For example, he was questioned about an invoice from Century Conveyor Service. The invoice was plainly for parts for a “scaglia,” which Mr. Stairiker explained was a bobbin lift apparatus used in converting. When he was asked whether “it” lasted more than one year, he responded affirmatively, but both the question and answer were ambiguously phrased so that it was unclear whether Mr. Stairiker’s response was with respect to the apparatus as a whole or as to the part in issue.

Mr. Stairiker’s testimony did make clear that plaintiff kept a substantial inventory of spare parts in order to avoid a shut-down of manufacturing operations. According to the audit workpapers, and to the schedules prepared by Mr. Schwab and attached to the final determination letter, the very quantity of some of the parts purchased suggested that they were being replaced more often than every twelve months. For example, invoices for some of the purchases in issue were for 300 split lock washers, 100 socket set screw cup points, 300 flat washers, 4 turnbuckles, 25 couplers, 100 Lincoln fittings, 70 grease fittings, 10 wheels used in the Measurex system, and so forth. Plaintiff never satisfactorily established why it needed such large quantities of parts if the useful life of those parts was more than a year. Mr. Stairiker’s testimony instead indicated that parts were replaced by tour workers as soon as it was suspected that a part was wearing out in order to avoid machine failure and the shutdown of production.

One of the reasons for the Division’s rejection of plaintiff’s contention that the parts in question had a useful life of a year or more, as required by N.J.S.A. 54:32B-8.13(a), was plaintiff’s tax accounting for these parts. The Director’s regulation, N.J.A.C. 18:24-4.3(a)(4), provides that, “[i]n determining whether a part has a useful life of one year or less, the purchaser’s own treatment of the item for accounting purposes should be taken into consideration.” Mr. Schwab testified that he had been supplied with a chart of plaintiff’s general ledger accounts, and account numbers had appeared on the invoices he reviewed. According to the audit work papers and the schedules attached to Mr. Schwab’s final determination letter, many of the parts at issue had been accounted for in plaintiff’s general ledger account called “spare parts, maintenance, repair, supply,” which apparently indicated to the Division that these were short-lived parts that had been expensed.

Seeking to disprove that conclusion, James Arogeti, plaintiff’s senior corporate tax manager, testified at trial that plaintiff’s general ledger accounts had not been set up for sales tax, and that a part might appear in the spare parts, maintenance, repair and supply account whether it was a capital or non-capital expense. Plaintiff also attacked Mr. Schwab’s testimony that parts had been accounted for in that particular account. Although Mr. Schwab conceded that the invoices plaintiff had produced at trial had no account numbers on them, there was no evidence that the trial exhibits were the invoices that Mr. Schwab had in fact reviewed. During cross-examination, plaintiff’s attorney instead demanded of Mr. Schwab that he produce the invoices that he had reviewed. Plaintiff’s counsel did not appear to fully understand that it was plaintiff’s burden to overcome the presumption of the correctness of the Director’s determinations, and also plaintiff’s burden to establish its entitlement to exemption. The Director is not required to reproduce audit and conference determinations at trial.

More significantly, the particular general ledger account in which these parts appeared was not the only basis for the Division’s conclusion that plaintiff had treated them as having been expensed. During the course of the protest, Mr. Schwab had written to plaintiff’s representative and inquired, among other things: “Were the parts and/or assets that are under protest expensed or depreciated? If they were depreciated, provide the appropriate depreciation schedules.” In response, he received a letter from the senior financial manager of the Spotswood plant as follows: “Repair parts are typically expensed unless the asset they are being installed on is fully depreciated and the repair part is at least 50 or more [percent] of the original asset cost. Given that our paper machines have costs ranging from 10 to 25 million dollars, it is unlikely any parts were capitalized.”

Plaintiff’s second witness, Clifford Hogan, also testified about the eligibility of plaintiff’s purchases for exemption pursuant to N.J.S.A. 54:32B-8.13(a). Mr. Hogan testified on direct examination that his professional background was primarily in real estate appraisal. On cross-examination, he testified that he had been employed by plaintiff for about twenty-five years working on real estate taxes and eventually on sales and use taxes. There was nothing in his testimony and nothing in his curriculum vitae that indicates whether he had ever received any special education or training in the fields of accounting or sales and use taxation. Mr. Hogan testified that he was quite familiar with the paper business because of his prior employment by the plaintiff and because of his work for other paper companies. At some point in time subsequent to his employment by plaintiff, he became a consultant to various businesses in connection with sales and use tax audits. He was retained by plaintiff to assist in the defense of the sales and use tax audit that is at issue in this action, and was plaintiff’s representative in connection with its administrative protest of the resulting assessment and refund claim.

Mr. Hogan’s testimony took more than a day of trial and consisted of a review of each item on which sales and use tax had been assessed or with respect to which a refund had been claimed. He identified the invoices for each of those items, and testified as to the reason, in his opinion, that each item should have been exempted from the tax. Each time, he referred to a sheet that he had prepared that cited sixteen statutory exemptions or exclusions from the sales and use tax, including the three that were listed in the pretrial order. Mr. Hogan’s testimony was conclusory. He did not explain how or where a particular part was used. His testimony principally consisted of reading the invoices for the purchases at issue and stating his opinion that the item was exempt pursuant to a specific statutory exemption.

Mr. Hogan was listed on the pretrial order as an expert witness for plaintiff but was never offered as such at trial. On the other hand, defendant never objected to the opinions as to taxability offered by Mr. Hogan. See N.J.R.E. 701 (lay witness opinion testimony admissible only if rationally based on witness’s perception and will assist in understanding the witness’s testimony or in determining a fact in issue). On cross-examination, it became clear that Mr. Hogan had no real first-hand knowledge of what exactly the items were or where exactly the items were located in plaintiff’s plant. In developing his opinions as to the basis for exemption, he relied upon information he had obtained from plant engineers and others as to how each item had been used at the Spotswood plant.

The court concludes that Mr. Hogan was not credible on the factual issue of whether any of the purchases were machinery, apparatus or equipment or parts for machinery, apparatus, or equipment for use directly and primarily in the manufacture of tangible personal property. Similarly, there was no testimony as to the basis of his testimony that the parts in question had a useful life of more than one year. Consequently, his testimony as to the useful life of the items in issue was not credible.

After reviewing the testimony and exhibits, the court concludes that plaintiff was able to establish that only the two purchases of parts from Andritz were used in a machine that was directly and primarily used in the manufacture of cigarette paper, and that these parts had a useful life of more than one year. It is only these parts, for which the contested tax totals $98.35, which are eligible for exemption pursuant to N.J.S.A. 54:32B-8.13(a).

The court next considers plaintiff’s contention that some of its purchases qualified for exemption pursuant to N.J.S.A. 54:32B-8.13(d), which provides:

Receipts from the following are exempt from the tax imposed under the Sales and Use Tax Act:

. . . .

d. Sales of machinery, apparatus, equipment, building materials, or structures or portions thereof, used directly and primarily for cogeneration in a cogeneration facility. As used in this subsection, "cogeneration facility" means a facility the primary purpose of which is the sequential production of electricity and steam or other forms of useful energy which are used for industrial or commercial heating or cooling purposes and which is designated by the Federal Energy Regulatory Commission, or its successor, as a "qualifying facility" pursuant to the provisions of the "Public Utility Regulatory Policies Act of 1978," Pub.L.95-617. The Director of the Office of Energy in the Department of Environmental Protection, in consultation with the Director of the Division of Taxation, shall adopt, pursuant to the "Administrative Procedure Act," P.L.1968, c.410 (C.52:14B-1 et seq.), rules and regulations establishing technical specifications for eligibility for the exemption provided in this subsection[.]

[N.J.S.A. 54:32B-8.13(d)(emphasis added).]

Mr. Stairiker’s testimony regarding the power plant and the reports he identified were the only evidence of the operation of the power plant as a cogeneration facility. The testimony and reports support plaintiff’s contention that its power plant has been designated by the Federal Energy Regulatory Commission as a qualifying facility under the provisions of the Public Utility Regulatory Policies Act of 1978, Pub. L. 95-617, and defendant concedes that the plant is a qualifying cogeneration facility.

However, there was no testimony to the effect that any of the purchases in question were directly and primarily used for cogeneration. Mr. Stairiker’s testimony regarding the specific purchases at issue generally addressed only whether an item was located in the power plant. Mr. Hogan’s testimony regarding his opinion as to eligibility for exemption pursuant to N.J.S.A. 54:32B-8.13(d) suffered from the same inadequacies as his testimony regarding eligibility for exemption as manufacturing equipment. The court concludes that there was insufficient evidence to establish that any of plaintiff’s purchases qualified for exemption under this statutory section.

Finally, there are plaintiff’s claims for exemption with respect to certain charges for labor, which plaintiff contends were for installation of property constituting a capital improvement. During the audit period, N.J.S.A. 54:32B-3(b)(2) imposed a tax on receipts from every sale of the service of installing tangible personal property, or maintaining, servicing, or repairing tangible personal property,6 except “(v) services rendered in installing property which, when installed, will constitute an addition or capital improvement to real property, property or land.”7

Many of the labor charges that the Division concluded were taxable were not for installation. Rather, the invoices in question indicated that the labor charges were for maintaining, servicing or repairing tangible personal property or for maintaining servicing or repairing real property and were, thus, not excluded from subjectivity to tax. For example, there was a charge for a service contract for HVAC systems, taxable pursuant to N.J.S.A. 54:32B-3(b)(4). As discussed above, there was also a contested charge for a preventative maintenance agreement for quality control equipment,

The disputed installation-related labor charges were for installation of machinery and equipment, and there was no evidence that those installations resulted in an addition or capital improvement to real property. The exclusion from subjectivity to tax provided by N.J.S.A. 54:32B-3(b)(2)(v) pertains only to an installation resulting in a capital improvement to real property. Middlesex Water Co. v. Director, Div. of Taxation, 3 N.J. Tax 233, 239 (Tax 1981). See also Elbert Lively & Co., Inc. v. Director, Div. of Taxation, 5 N.J. Tax 431, 444-45 (Tax 1983)(restating that “the statutory phrase ‘property, real property or land’ means real property”). Notably, the Director has promulgated a regulation providing guidance as to when the installation of personal property results in a capital improvement to real property. N.J.A.C. 18:24-4.6 provides, in pertinent part:

(a) The following enumerated services, purchased or sold by any person engaged in manufacturing, processing, assembling or refining, as defined in N.J.A.C. 18:24-4.2, not purchased for resale, that is, not performed on property offered for sale by the purchaser, are subject to sales and use taxes, as well as services otherwise taxable:

. . . .

2. Installing tangible personal property, except where such installation results in an exempt capital improvement to real property. In determining whether an installation of tangible personal property results in a capital improvement to real property, the following factors should be considered:

i. Whether the improvement results in an increase in the capital value of the real property;

ii. Whether the improvement results in a significant increase in the useful life of the property; and

iii. The treatment, for accounting purposes, of such improvements for Federal Internal Revenue purposes.

While brief testimony was elicited from Mr. Stairiker at the conclusion of his testimony on redirect examination to the effect that machinery at the Spotswood plant was intended to be permanently affixed to the real property, there was no evidence offered to the effect that the affixation of manufacturing machinery to the real estate increased the value of the real property or increased the useful life of the real property. To the contrary, it is quite clear that the manufacturing machinery, apparatus and equipment in question is business personal property, and not fixtures devoted primarily to the real property. See generally, General Motors Corporation v. City of Linden, 150 N.J. 522, 533-37 (1997)(examining whether business personal property may constitutionally be exempted from real property taxation).

A few of the purchases of services warrant some discussion. Mr. Stairiker testified that some labor charges were for rebuilding a well. On direct examination, he responded affirmatively, but without explanation, to the question of whether the well rebuilding project was a capital improvement. The service of maintaining, servicing or repairing real property, as distinguished from adding to or improving real property by a capital improvement, is taxable pursuant to N.J.S.A. 54:32B-3(b)(4). As recognized by the court in Newman v. Director, Div. of Taxation, 14 N.J. Tax 313, 327 (Tax 1994), aff’d, 15 N.J. Tax 228 (App. Div. 1995), there is a distinction between extending the useful life of real property and preventing a decrease in the useful life of real property, the former being in the nature of a capital improvement, the latter being maintenance or repair. There was no testimony on the issue of whether the rebuilding of the well increased the useful life or the value of the real property, or merely prevented a decrease in the useful life of the real property.

There were also several invoices for electrical work in the nature of a rewiring project. To the extent it was explained at all, this work appeared to be a rewiring of the connections to the machinery and equipment, rather than a rewiring intended to benefit the real estate. Once again, other than conclusory statements by Mr. Stairiker and Mr. Hogan to the effect that this project was a capital improvement, there was no testimony as to whether the project increased the useful life or value of the real estate.

In at least one case, Mr. Stairiker’s testimony contradicted what was contained in the invoice. He testified that an invoice from Sylvan Industrial Piping was part of a capital project to reclaim waste water from the processing system. The invoice itself stated that it was “to cover service of a pipefitter/welder to work with your Maintenance Department to make repairs.” There was no attempt to explain why the invoice indicated the work was in the nature of a repair rather than a capital improvement.

In sum, plaintiff failed to overcome the statutory presumption that the services in question were taxable, and failed to prove its entitlement to exemption pursuant to N.J.S.A. 54:32B-3(b)(2)(v).

Significantly, plaintiff has not attacked the validity of any of the regulations relied upon by the Director in this case. Indeed, plaintiff has barely seemed aware that those regulations exist. Moreover, New Jersey courts generally defer to the statutory interpretation of the agency charged with enforcing it. Koch v. Director, Div. of Taxation, 157 N.J. 1, 8 (1999). The Director's interpretation of a tax statute will prevail “as long as it is not plainly unreasonable.” Ibid. (quoting Metromedia, Inc. v. Director, Div. of Taxation, 97 N.J. 313, 327 (1984)). The regulations in question are long-standing, and are not, on their face, unreasonable.

In addition to the three bases for exemption included in the pretrial order (which were the only statutory exemptions included in plaintiff’s pretrial memorandum), Mr. Hogan offered his opinion at trial that some items were exempt under thirteen additional provisions of the Act. Some of these claims were nonsensical. For example, he testified that an invoice for inspection of a railroad siding was eligible for exemption pursuant to N.J.S.A. 54:32B-8.27, which exempts sales of rolling stock and track materials to a railroad whose rates are regulated by the Interstate Commerce Commission or by the Board of Public Utilities.

Most of Mr. Hogan’s new assertions of entitlement to exemption were not supported by any evidence. Other claims had some support in Mr. Stairiker’s testimony. For example, there were certain invoices from ABB for installation and start-up of old equipment that ABB had modified to be operated by computer. Mr. Hogan claimed that these fees were for consulting or professional services. Mr. Stairiker’s testimony indicated that this may have been partly true, but also indicated that the charges included labor for installing the modified equipment and for software. The invoices themselves were not detailed or itemized.

The court concludes that the new claims raised for the first time by Mr. Hogan at trial were not adequately supported by the evidence. Moreover, it concludes that plaintiff is precluded from raising claims that it failed to include in its pretrial memorandum and which were not, therefore, included in the pretrial order. There is no evidence that any of the new claims for exempt treatment had been raised with Mr. Schwab during the course of the administrative protest. Subsequent to the filing of the Tax Court complaint, there was an extended discovery period during which the parties were to identify which statutory exemptions and exclusions were claimed with respect to the hundreds of items that plaintiff claimed were exempt. The additional claims were never mentioned during the pretrial conference or during any of the numerous case management telephone conferences conducted by the court. The court concludes that defendant would be severely prejudiced if plaintiff were permitted to claim new rationales for exemption at trial. The pretrial order specifically provides that any issue not set forth in the pretrial order is deemed abandoned, and there was no motion to amend the order to conform to the proofs. See, L & L Oil Service, Inc. v. Director, Div. of Taxation, 340 N.J. Super. 173, 181 (App. Div. 2001)(“oral amendments to the pretrial order, although not encouraged, are permissible in the sound discretion of the trial judge . . . ‘where necessary to subserve the presentation of the merits of the action, provided the adverse party will not be adversely prejudiced thereby.’”)(citation omitted).

The Andritz parts which the court has concluded are eligible for exemption are a part of plaintiff’s refund claim. The court concludes that plaintiff is entitled to an additional refund of $98.35 for tax paid on its purchase of those parts from Andritz. This finding necessitates a discussion of plaintiff’s contention that it is entitled to a refund of the tax paid multiplied by forty-two. This contention is premised upon the audit methodology. As gleaned from the audit report and from Mr. Arogeti’s and Mr. Hogan’s testimony, the auditor categorized plaintiff’s purchases as either expenses or as “fixed asset acquisitions,” which the auditor apparently regarded as one-time expenditures. For purchases that the auditor regarded as recurring expenses, the auditor selected a one-month sample period, October 1998, which was agreed to by plaintiff’s personnel. She reviewed all expense items over $100, and determined that plaintiff had made taxable purchases totaling $33,049.20 during the sample month on which tax had not been paid. That amount was multiplied by the forty-two month audit period, and tax at the six percent rate then in effect was calculated. Presumably, this estimate was based upon the assumption that the taxpayer’s expenses were more or less constant during the audit period. All fixed asset purchases for the entire audit period were examined and tax due was calculated on the actual purchases. The estimated tax on expense items was added to the tax on fixed asset acquisitions to arrive at the total amount of tax due.

Plaintiff maintains that its claims for refund that are not purchases of fixed asset acquisitions should also be multiplied by the forty-two month audit period. This contention has no factual basis in the case of the Andritz parts. The basis for exemption is that the particular purchases were parts for equipment used directly in manufacturing and have a useful life of more than one year. Specifically, it was Mr. Stairiker’s testimony that the parts were purchased to rebuild a machine that is rebuilt approximately every two years. There is no logical reason why the Division should refund tax on the purchase price as though the parts were purchased each month during the audit period.

Moreover, plaintiff fails to appreciate the distinction between a deficiency of tax as determined through audit, and a claim for refund of tax already paid. The Director is given broad authority to determine the amount of tax due as a consequence of an audit. “If necessary, the tax may be estimated on the basis of external indices, such as stock on hand, purchases . . . or other factors.” N.J.S.A. 54:32B-19. A claim for refund, on the other hand, must be made by a customer who has actually paid the tax or by a vendor who has collected and paid over the tax to the Director. See N.J.S.A. 54:32B-20(a). In other words, the Director is explicitly permitted to estimate tax due. The taxpayer is required to establish that the tax was actually paid before there is any entitlement to a refund.

The court concludes that plaintiff is entitled to a refund of tax actually paid on the purchase of the Andritz parts, $98.35.

Finally, the court addresses plaintiff’s contention that the Division erred in concluding that plaintiff failed to pay tax on some items on which it claimed a refund. Mr. Schwab testified that he denied some refund claims because his examination of plaintiff’s records indicated to him that the plaintiff had “backed out” an accrual for payment of sales and use taxes or had otherwise reversed a payment of sales and use taxes.

Mr. Arogeti, plaintiff’s tax manager, testified that if a vendor charged sales tax, plaintiff would pay the tax to the vendor. If the vendor did not charge the tax, plaintiff would self-assess and accrue the tax and pay the tax to the jurisdiction to which it was due on a monthly basis. Mr. Arogeti was asked about a November 1998 purchase from the Tuthill Corporation in the amount of $1,146, for which Mr. Schwab had denied a tax refund claim in the amount of $68.76, with the notation “accrued and then reversed out of use tax”. Mr. Arogeti testified that copies of documents moved into evidence as Exhibit P-8 demonstrated that plaintiff did not “back out” tax accrued for the purchase from Tuthill. The documents or reports comprising Exhibit P-8 were never authenticated. There was no testimony as to who had prepared them, when they had been prepared, or whether they were accurate and complete copies. The documents appear to have been prepared for Mr. Arogeti’s review, and his initials and a date appear on some of them. While it is true that the documents did not show that the tax had been backed out of the accrual, there was no testimony that these were the documents that had been provided to Mr. Schwab. There was no evidence that the tax in question had ever been paid at all. In sum, plaintiff failed to overcome the presumption that the Director’s determination was correct.

For the foregoing reasons, the Director’s final determination is affirmed with the exception of the purchases from Andritz as noted above, and the purchases that the Director has conceded are