Is natural gas used to heat a factory's production area exempt as used 'directly and exclusively' in manufacturing, if that heat is also needed for employee comfort?

Plain-English summary

MOD-PAC Corp. manufactures packing cartons by cutting, folding, gluing, and imprinting paperboard. It keeps its production area at 68–70°F so that materials (paperboard, cellophane, glue, printing supplies) warm to a workable temperature and the machinery — especially the printing rollers — functions properly. It concedes that gas used to heat its offices (above 70°F) and warehouse (to about 40°F) is taxable, but argues the gas that heats the production area creates conditions necessary for production and is therefore exempt under Tax Law 1115(c).

The Department held the gas is taxable — it isn't used exclusively in production.

• The exemption and its limits. Tax Law 1115(c) exempts gas used directly and exclusively in the production of tangible personal property by manufacturing. But 20 NYCRR 528.22 says fuel/gas used to heat buildings is taxable, and it defines the two key words:
  • "Directly" — during the production phase, the gas must operate exempt production machinery, create conditions necessary for production, or perform an actual part of the process.
  • "Exclusively" — the gas must be used in total (100%) in production; use in activities collateral to actual production doesn't count.
• This heat is a direct production use — but not exclusive. Heating the production space to create a suitable manufacturing environment is a direct use in production. The problem is the "exclusively" requirement.
• Employee comfort defeats the exemption. The gas is exempt only if maintaining the temperature is not also necessary for employee comfort (Fancher Chair Co., TSB-A-83(11)S). Because MOD-PAC would have to heat the production area anyway for employee comfort, the gas is not used exclusively in production.
• Result. The natural gas consumed to heat the production area is subject to New York State and local sales and use tax.

What this means for you

"Directly and exclusively" is a strict, all-or-nothing test. For the 1115(c) fuel exemption, it's not enough that the fuel helps production. If the same fuel also serves a collateral purpose — like keeping workers comfortable — it isn't used 100% in production, and the whole charge is taxable.

Space heating almost always serves people too. Because a workplace generally has to be heated for employees regardless of the process, fuel used to warm a production area typically fails the exclusivity test. The exemption fits fuel that operates production machinery or drives the process itself, not general climate control.

Concede what you can't win and focus on genuine production use. MOD-PAC rightly conceded office and warehouse heat. The lesson is to reserve exemption claims for fuel that is truly and only a production input.

Common questions

Q: We heat our factory floor to make our process work. Is that gas exempt?
A: Probably not. Heating the production area is a direct production use, but the exemption also requires exclusive (100%) production use. If you'd heat the space anyway for employee comfort, the gas isn't used exclusively in production and is taxable.

Q: What kind of gas use does qualify for the 1115(c) exemption?
A: Gas used, during production, to operate exempt production machinery, create conditions necessary for production, or perform an actual part of the process — and used entirely (100%) for that, with no collateral purpose.

Q: Does it help that the heat also protects the machinery and materials?
A: It shows a production purpose, but it doesn't cure the exclusivity problem. As long as the heat also serves a non-production purpose like employee comfort, the exemption is lost.

Citations and references

Tax Law:

• 1115(c) — exempts gas/gas service used directly and exclusively in production of tangible personal property by manufacturing

Regulation:

• 20 NYCRR 528.22 — fuel/gas used to heat buildings is taxable; "directly" (operate machinery, create necessary conditions, or perform part of the process) and "exclusively" (100% production use; collateral use excluded)

Authority cited:

• Fancher Chair Co., Inc., TSB-A-83(11)S — heat also necessary for employee comfort is not used exclusively in production

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1985.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a85_20s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-85 (20)S
Sales Tax
June 12, 1985

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S840308A

On March 8, 1984, a Petition for Advisory Opinion was received from MOD-PAC Corp., 873
Hertel Avenue, Buffalo, New York 14216.
The issue raised is whether natural gas consumed in space heaters in the production area of
a manufacturing plant is used directly and exclusively in the production of tangible personal property
for sale and, as such, exempt from New York State sales and use taxes under Section 1115(c) of the
Tax Law.
Petitioner manufactures packing cartons to customer's specifications by a process of cutting,
folding, glueing and imprinting paper board stock it purchases either in sheet or rolled form. The
plant operates in two shifts, six days a week. Manufacturing functions occupy three main facilities;
administrative and design offices, warehouse, and production area.
Petitioner maintains the temperature in the offices at above 70°F. and does not heat the
warehouse to exceed 40°F. Petitioner concedes that natural gas used for these purpose is subject to
sales tax.
However, Petitioner contends that the gas consumed to keep a constant temperature of 68 to
70°F. in the production area is creating conditions necessary for production and is therefore exempt
from the imposition of sales tax.
Petitioner states that the paperboard, cellophane, glue and the printing supplies are moved
to the production area well before use to permit warming of the material to the temperature necessary
for efficient processing. Also, the machinery, and the printing rollers in particular, must be kept in
the 68 to 70 degree temperature range to function effectively. Petitioner claims natural gas is used
in this area exclusively to maintain an environment necessary for production.
Section 1115(c) of the Tax Law provides an exemption for gas and gas services of whatever
nature for use and consumption directly and exclusively in the production of tangible personal
property by manufacturing.
Sales and Use Tax Regulations Section 528.22 provides, in part, as follows:
"(a) . . . (2) Fuel, gas, electricity . . . consumed in the heating of buildings . . . are
subject to sales tax.
(b) Definitions . . . . (2) The term gas as used in this section means any gaseous
substance . . . used in a production function or to create an atmosphere which is
conducive to or necessary for production.
RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-85 (20)S
Sales Tax
June 12, 1985

(c) Directly and exclusively. (1) "Directly" means the. . . gas. . . 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.
...
(3)(i) "Exclusively" means that the. . . gas . . . is used in total (100%) in the
production process.
(2) Usage in activities collateral to the actual production is not deemed to be used
directly in production."
Inasmuch as Petitioner heats the production space to create an environment suitable for the
manufacturing process the natural gas consumed for this purpose is used directly in production.
However, the statutory exemption applies only to fuel used directly and exclusively in production.
If gas is used for any function other than production, it does not qualify for the exemption.
In consequence, the fuel needed to keep the indoor temperature between 68 and 70 degrees
for proper processing of material is exempt only if maintenance of the temperature is not also
necessary for employee comfort. See Fancher Chair Co., Inc., Advisory Opinion, March 15, 1983,
TSB-A-83(11)S.
Since Petitioner would be required to heat the production area in any event for purposes of
employee comfort, the natural gas so consumed in heating the production area is not used exclusively
in production and, accordingly, is subject to the applicable New York State sales and use taxes.

DATED: May 20, 1985

FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth herein.