Does incinerating waste into ash for disposal count as tax-exempt 'processing' or 'manufacturing' of tangible personal property, or is it a nontaxable waste-disposal service instead?

Plain-English summary

This letter is a detailed follow-up in an ongoing dispute between a limited partnership ("LP") and the Comptroller's Tax Policy Division over whether LP's waste incineration equipment qualifies for the Texas manufacturing exemption (§ 151.318). LP incinerates waste material into ash, then sells the ash to a related company ("Company A") for disposal, at an agreed price that produces LP a profit.

LP's legal argument was carefully constructed: it pointed to Fleming Foods v. Rylander for the principle that an unambiguous statute can't be construed beyond its plain language, and argued that because § 151.318 and the Comptroller's own definition of "processing" (Rule 3.300(a)(10) — "the physical application of materials and labor necessary to modify or change the characteristics of tangible personal property") never explicitly require added marketable value, the Comptroller's insistence on that requirement was an improper judicial gloss on the statute. LP argued that simply changing waste into ash (a change in "characteristics") was enough. LP also argued that even under a marketable-value test, the ash did have market value — since LP and Company A had agreed on a price and LP made a profit — drawing an analogy to a T-shirt silk-screening business that adds value for one buyer (Lions Club) even though its product has no value to a different buyer (Rotary Club), citing Comptroller's Accession No. 200104171L as precedent that such value is still legally sufficient.

The Comptroller disagreed and held firm. Citing Alamo Hardwoods v. Bullock, the Comptroller explained that Texas courts read "processing" to require a change resulting in a marketable tangible personal property — and that every context where "processing" appears in Texas exemption law (food service, agricultural, timber, manufacturing, newspapers) involves a commercial operation creating a marketable product to meet market demand. Citing Sharp v. Tyler Pipe Industries, the Comptroller explained the manufacturing exemption's purpose is to encourage economic development and avoid pyramiding sales tax on successive buyers/sellers — which presumes the end product is genuinely marketable. Applying that purpose here: LP's operation is not conducted to meet a market demand for ash — its intended result is a waste disposal service. The fact that a related company (Company A) agreed to pay a price for the ash doesn't transform the underlying activity into manufacturing a marketable product; it's still fundamentally a disposal arrangement dressed up with a transfer price.

Notably, the Comptroller left an open door. LP asked about an alternate scenario: what if LP or Company A instead sold the resulting ash to an unrelated third party? The Comptroller responded that in that scenario, it would presume genuine market demand for the ash product, which would cause the operation to qualify as manufacturing/processing/fabricating tangible personal property for sale — analogizing to Comptroller Decision No. 34,221, which was found to qualify as a manufacturing operation on similar facts.

What this means for you

Waste management and disposal companies incinerating or transforming waste

Selling your byproduct to a related company at an agreed (even profitable) price does not, by itself, convert a waste-disposal operation into exempt manufacturing — the Comptroller looks at whether the overall purpose of the operation is meeting genuine market demand for a marketable product, not merely whether a transaction price exists. Selling the same byproduct to an unrelated third party, however, is a meaningfully different fact pattern that this letter suggests would likely qualify for the exemption.

Companies structuring waste-to-byproduct sales through related entities

Be cautious about assuming that transfer pricing between related entities creates "market value" for tax-exemption purposes — the Comptroller specifically rejected that reasoning here, distinguishing it from a genuine arm's-length sale reflecting real market demand.

Accountants and tax professionals

This letter is a rich, citation-dense resource on the "marketable product" requirement embedded in Texas's manufacturing/processing exemption — cite Alamo Hardwoods v. Bullock and Sharp v. Tyler Pipe Industries for the market-demand rationale, and note the related-party vs. unrelated-third-party distinction the Comptroller drew when evaluating whether a transfer price reflects genuine market value.

Common questions

Q: Does changing the physical characteristics of waste (like incinerating it into ash) automatically count as tax-exempt "processing"?
A: No — per this ruling, Texas courts and the Comptroller require the result to be a genuinely marketable product created to meet market demand, not merely a change in physical characteristics.

Q: Does getting paid for a byproduct prove it has market value for exemption purposes?
A: Not necessarily, according to this ruling — a price paid by a related company as part of what is fundamentally a waste-disposal arrangement doesn't establish the kind of market demand the exemption requires.

Q: Would selling the ash to an unrelated third party change the answer?
A: Yes — the Comptroller indicated that scenario would likely qualify as manufacturing/processing, since it would reflect genuine market demand for the ash as a product.

Q: Can another waste-to-byproduct company rely on this letter?
A: No. It resolves a specific, ongoing dispute over one company's facts; a different arrangement — especially one involving genuine third-party sales — would need its own analysis, though the Comptroller's reasoning here is a useful guide.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318 (Manufacturing Exemption)
• 34 Tex. Admin. Code Rule 3.300(a)(10) (Definition of Processing)
• Fleming Foods v. Rylander, 6 S.W.3d 278, 284 (Tex. 1999)
• Alamo Hardwoods v. Bullock, 614 S.W.2d 600 (Tex. Civ. App.—Texarkana 1981, writ ref'd n.r.e.)
• Sharp v. Tyler Pipe Industries, 919 S.W.2d 157 (Tex. App.—Austin 1996, writ ref'd)
• Calvert v. Kattar, 301 S.W.2d 318, 320 (Tex. Civ. App.—Austin 1957, writ ref'd)
• Comptroller's Accession No. 200104171L; Comptroller Decision No. 34,221

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200105259L

Original ruling text

May 28, 2001

Dear **:

Thank you for your letter providing supplemental information. The supplemental
information, alternative scenario and questions that you provided are restated
below followed by my response. The alternate scenario and question that we
discussed in our telephone conversation of May 15, 2001, are presented also
below.

Based on your conversations with the agency, it is your understanding that the
Tax Policy Division continues to assert that the Limited Partnership ("LP") is
not processing ash because it is not adding value to the ash.

You want to clarify your position that the Tax Policy Division's conclusion
clashes with the language of TAX CODE 151.318. You point out that the Texas
Supreme Court mandates that an unambiguous statute must not be construed to
imply something other than what the plain language of the statute provides. See
Fleming Foods v. Rylander, 6 S.W.3d 278, 284 (Text 1999). You believe that
because the conclusion that marketable value must be added to a product for
processing to occur does not exist in Tax Code 151.318, the statute cannot be
construed to say that it does.

You believe that such an interpretation also conflicts with the Comptroller's
definition of processing. Under 3.300(a)(10) (West 2001), the Comptroller
defines processing as follows:

[t]he physical application of the materials and labor necessary to modify or to
change the characteristics of tangible personal property. The repair of
tangible personal property, belonging to another, by restoring it to its
original condition is not considered processing of that property. The mere
packing, unpacking, or shelving of a product to be sold will not be considered
to be processing of that property. Processing does not include remodeling.

You maintain that this definition does not discuss whether marketable value
must be added to a product for processing to occur. All that must be shown for
the Comptroller to conclude that a taxpayer is engaged in processing is that a
taxpayer causes a change to the characteristics of tangible personal property.
You believe that LP is engaged in processing under the Comptroller's definition
because LP changes waste by turning it into ash.

You also contend that even if it were held that LP must add marketable value to
the waste in order to qualify for the manufacturing exemption, LP would still
qualify for the exemption because the ash has market value. By concluding that
LP is not adding marketable value, the agency is stating that the ash has no
market value. Market value is defined as "the price property will bring when
offered for sale by one who desires to sell, but is not obligated to sell, and
is bought by one who desires to buy but is under no necessity of buying."
Calvert v. Kattar, 301 S.W.2d 318, 320 (Text Civ. App. - Austin 1957, writ
ref'd) (quoting State v. Carpenter, 126 Tex. 604, 89 S.W.2d 979, 980 (1936)).
In other words, market value is the price agreed upon between the buyer and
seller. In this regard, LP and Company A have established a market value for
the ash because they have agreed to a price for the ash. Furthermore, that
agreed price produces a profit for LP on the ash sales.

You acknowledge that LP may not be able to sell the ash to any person on the
street, but you point out that the same is true for a T-shirt silk screening
business that has screen-printed hundreds of T-shirts for members of the Lions
Club. The T-shirt business may not be able to sell the shirts to the members of
the Rotary Club because the shirts have no value to the Rotary Club members.
But the shirts do have value to the members of the Lions Club, and because they
have value to those persons, the T-shirt business has added value to the
shirts. As a result, there is no doubt that the T-shirt business is processing
the shirts for ultimate sale and may take advantage of the manufacturing
exemption for machinery and equipment it uses. See Comptroller's Accession No.
200104171L.

Similarly, you conclude that because the ash has value to Company A, LP has
added value to the waste. You believe that based on these arguments, LP may
take advantage of the manufacturing exemption under Tax Code 151.318 for the
machinery and equipment it uses to create the ash.

Response: We continue to disagree with your contentions that the agency
position that processing must "add value" clashes with the statutory language.
Contrary to your belief, the agency position is reasonable and consistent with
the statute.

The term "processing" is used in the statutory definition of a "sale or
purchase." Texas court has recognized that "processing" contemplates a change
in form, context or condition by some treatment to result in a marketable
tangible personal property . See Alamo Hardwoods v. Bullock, 614 S.W.2d 600
(Tex. Civ. App. - Texarkana, 1981, writ ref'd n.r.e.). The term "processing"
is also used in exemption provisions for operations on tangible personal
property and including the use of electricity used in such operations. The
operations include food service, agricultural, timber, manufacturing, and
newspapers. The context in all of these operations is that the processing is a
commercial operation creating a marketable product for the purpose of meeting a
market demand and selling the product.

By enacting the manufacturing exemption, the legislature wanted to encourage
economic development and to avoid pyramiding the sales tax on successive buyers
and seller. See Sharp v. Tyler Pipe Industries, 919 S.W.2d 157 (Tex. App. -
Austin, 1996, writ ref'd). The general purposes behind the manufacturing
exemption clearly support the position that the legislature had intended the
end product of the manufacturing process to be marketable.

In your situation the operation is not conducted for the purpose of meeting a
demand for the ash product, but rather the intended result is a waste disposal
service. The fact that a related company pays a price does not transform the
ash into a marketable product.

In a recent phone conversation on this issue you asked us to consider an
alternate scenario where LP, or Company A, would sell the ash resulting from
the incineration of the waste to a third party. You asked if under this
scenario, the equipment used by LP would qualify as manufacturing equipment.

Response: Under this scenario we would presume that there is a market demand
for the product and cause the operation to qualify as a manufacturing,
processing, or fabricating of tangible personal property for sale. The new
scenario is very similar to the scenario described in Comptroller Decision No.
34,221, which was determined to qualify as a manufacturing operation.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, You may e-mail our tax help section at .
You may also call me toll-free at 1-800-531-5441, extension 3-4502. The direct
line is 512/463-4502. You may also write to Tax Policy Division, Comptroller of
Public Accounts.

Sincerely,

Gilbert Zamora
Tax Policy Division

cc: Tom Soto