Is reactivating spent (used-up) industrial activated carbon by burning off its absorbed impurities "manufacturing" or "processing" for Texas sales tax purposes, or is it just a taxable repair service?

Plain-English summary

Activated carbon is used industrially to filter impurities out of vapor and emissions, and eventually becomes "spent" (saturated with absorbed chemicals) and needs reactivating or discarding. A permitted Texas carbon-reactivation plant receives spent carbon from customers, heats it to about 1,800°F in a furnace to vaporize off the absorbed contaminants, cools and screens it, and returns roughly 20% to the customers who supplied it while selling the remaining 80% on the open market. Reactivated carbon is sometimes supplemented with "make-up" virgin or reactivated carbon (unmixed, just added before shipment) to offset weight lost in processing. The company doesn't take title to spent carbon while it's still contaminated — only afterward, if the customer chooses to cede rather than reclaim it — and it bills the reactivation service separately from any make-up carbon. It asked whether the reactivation process itself qualifies as exempt "manufacturing" or "processing" under Texas's manufacturing exemption.

The Comptroller ruled it's neither — it's a taxable repair service. The key fact was ownership: manufacturing/processing exemptions under § 151.318 apply to property a manufacturer transforms and then sells, but this company never owns the spent carbon while working on it (only takes title after reactivation, if at all) — meaning it's repairing property that belongs to someone else, which Rule 3.300(a)(9)-(10) expressly excludes from the manufacturing/processing definitions. The heat treatment itself also didn't help: it burns off impurities to restore the carbon to functional condition (classic repair, per Rule 3.292(a)(11)'s definition — mending/restoring something broken, worn, or defective), but it doesn't restore or improve the carbon's original absorptive surface area the way a true manufacturing process would (reactivated carbon actually has lower absorptive quality than virgin carbon) — so it's cleaning, not enhancement. The Comptroller also rejected the taxpayer's argument by distinguishing it from a prior case where a taxpayer did own second-hand fabric it cut and re-rolled into a "first quality" product (that was processing, because ownership and genuine improvement were both present) — here, neither element existed. Finally, adding unmixed make-up carbon just to replace weight lost in cleaning isn't manufacturing either, since manufacturing requires actually combining components to create something new, not simply topping off quantity.

What this means for you

Industrial recycling, reclamation, and reconditioning service providers

If your business reconditions, reactivates, or restores a customer's used material and returns it (or sells it after the customer cedes title) without ever taking ownership of the raw defective material, expect the Comptroller to treat that as a repair service rather than exempt manufacturing — regardless of how much heat, chemistry, or industrial processing is involved. Ownership timing and whether the treatment "restores" versus "improves beyond original" the material's core characteristics are the two threshold questions.

Businesses adding "make-up" or supplemental material to offset processing losses

Simply adding unmixed replacement material to make up for quantity/weight lost during a repair or cleaning process does not, on its own, convert the whole operation into manufacturing — the Comptroller wants to see actual combination/transformation into a new product, not just quantity restoration.

Accountants and tax professionals

The core citations are Rule 3.300(a)(9) (manufacturing includes repair of property the manufacturer owns for sale, but excludes repair of property belonging to another) and Rule 3.292(a)(11) (repair definition). The taxpayer's citation to Rylander v. Haber Fabrics, 13 S.W.3d 845 (Tex. App.—Austin 2000), was distinguished on both ownership and quality-improvement grounds; Houston Wire & Cable Co. v. Combs, No. 03-07-00006-CV (Tex. App.—Austin 2008), was cited for the proposition that a process not changing intrinsic characteristics isn't manufacturing.

Common questions

Q: If a company chemically or physically changes an item, is that automatically "manufacturing" for the sales tax exemption?
A: No. Ownership matters — manufacturing/processing exemptions apply to property the company owns and transforms for its own sale. Restoring someone else's property to working condition, even with significant physical/chemical change, is repair, not manufacturing, if the company doesn't own the property being treated.

Q: Does reactivated carbon's lower absorptive quality compared to virgin carbon matter to the analysis?
A: Yes — it showed the process was cleaning/restoring functionality, not creating an improved or "first quality" product the way a genuine manufacturing process would. That distinguished the taxpayer's cited precedent, where cut/re-rolled fabric became a first-quality product.

Q: Does adding extra reactivated or virgin carbon before shipment count as manufacturing?
A: Not here — because the make-up carbon is simply added (not mixed) to offset weight lost during cleaning, rather than combined to create a new product, and it's billed separately from the reactivation service.

Q: Can another industrial reclamation company rely on this ruling for a similar process?
A: No. It binds the Comptroller only for the taxpayer and facts presented; a company that takes title to material before treatment, or that genuinely improves the material's original characteristics, could be analyzed differently.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318(a)(2)(A) (manufacturing exemption — chemical/physical change requirement); § 151.318(d) (manufacturing definition)
• Tex. Tax Code § 151.005(4) (sale/purchase — processing for others who furnish the property)
• 34 Tex. Admin. Code § 3.300(a)(9), (a)(9)(B) (manufacturing excludes repair of property belonging to another); (a)(10) (processing definition)
• 34 Tex. Admin. Code § 3.292(a)(11) (repair, remodeling, maintenance, and restoration definition)

Cited case law and prior guidance:

• Rylander v. Haber Fabrics, 13 S.W.3d 845 (Tex. App.—Austin 2000, no pet.) — distinguished (taxpayer there owned the material and created a first-quality product)
• Houston Wire & Cable Co. v. Combs, No. 03-07-00006-CV (Tex. App.—Austin 2008) — cutting cable didn't change intrinsic characteristics, not manufacturing
• STAR Accession No. 201902003L (Feb. 7, 2019) — mixing components to make a product for sale is manufacturing

Source

• Landing page (STAR search): https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201905003L

Original ruling text

May 9, 2019

RE: Private Letter Ruling No. 20181101101213

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE: (10)] We are responding to your request dated Oct. 22, 2018 and additional information received via e-mail on Nov. 20, 2018 and April 23, 2019. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on whether ***** (Taxpayer) is engaged in manufacturing, as defined in Section 151.318 (Property Used in Manufacturing) and Rule 3.300 (Manufacturing; Custom Manufacturing; Fabricating; Processing), when it reactivates spent carbon.

Facts Presented

In November 2017, the Texas Commission on Environmental Quality issued Taxpayer a permit to operate a carbon reactivation plant in Texas. Manufacturing and industrial applications use activated carbon as a filter for removing impurities, such as harmful chemicals from vapor and other emissions often found in refineries and industrial facilities. After some time, activated carbon must be reactivated for continued use or discarded as waste.

Taxpayer receives the spent carbon that remains from waste treatment systems that utilize carbon, which Taxpayer has and has not sold. Taxpayer’s customers have the option after each reactivation to keep title of the carbon or cede it to Taxpayer.

Taxpayer’s plant is designed to reactivate spent carbon by de-watering it and scrubbing off, or vaporizing, any chemical gases. Taxpayer’s process removes unnecessary organic materials from the spent carbon, allowing reuse of the carbon.

Approximately 80 percent of Taxpayer’s reactivated carbon will be sold on the open market, and roughly 20 percent will be returned or sold back to the customers who provided the spent carbon. Orders for reactivated carbon will be supplemented, as necessary, with new (virgin) or other reactivated carbon to meet size, absorption, and weight criteria. Taxpayer anticipates that approximately 25 percent of the carbon sold to its customers will be virgin and 75 percent will be reactivated.

A furnace will heat the carbon to approximately 1800 degrees Fahrenheit, after which it will be mixed and cascaded multiple times until drying and reactivation are complete. Taxpayer states that the furnaces will vaporize the organic contaminants that were previously absorbed by the carbon and new fractures or surface areas will be created in the carbon granules. The reactivated carbon will exit the furnace and drop through a chute into the cooler drum where it will be cascaded repeatedly. The cooled carbon will then be filtered, or sized, through several mesh screens located at the end of the cooling drum. The carbon granules will then be collected in a container or transferred by elevator to product silos.

Once the carbon is reactivated, it may or may not be packaged with virgin carbon. When virgin or reactivated carbon is added, it is done to make up (make-up) for loss in the weight of the carbon during the reactivation process.

Customers can determine whether their make-up consists of either virgin or reactivated carbon. Customers can also demand that their make-up consist of a higher quality carbon or the same quality carbon as was originally provided. Additionally, the customers can determine the mesh size of the make-up, depending on their preferences.

The make-up is added, but not mixed, just before shipment to the customer. The make-up can be shipped in separate bags and mixed with the reactivated carbon at the customer site. This is an individual customer choice. Customers may want Taxpayer, a third party, or their own laborers to do the mixing.

Taxpayer does not acquire title to spent carbon as waste material due to liability issues. Taxpayer only acquires carbon post reactivation when it is not waste but rather an item in commerce. When Taxpayer receives spent carbon and reactivates it, Taxpayer provides a Certificate of Destruction, which shows that the waste on the carbon has been destroyed.

Taxpayer bills for the service of carbon reactivation separately from providing the make- up, regardless of whether the make-up consists of virgin or reactivated carbon.

Questions, Rulings, and Analysis

Your questions are restated below, followed by our responses and analysis.

Question One: Is the carbon reactivation process “manufacturing” or “processing” as defined in Section 151.318 and Comptroller Rule 3.300?

Ruling One: Taxpayer’s carbon reactivation process does not qualify as manufacturing or processing as defined in Section 151.318 and Rule 3.300.

Analysis: Manufacturing is defined as “each operation beginning with the first stage in the production of tangible personal property and ending with the completion of tangible personal property having the physical properties (including packaging, if any) that it has when transferred by the manufacturer to another.” Section 151.318(d). Persons processing tangible personal property for ultimate sale or who process tangible personal property for others who furnish the property are manufacturers. Sections 151.005(4) (“Sale” or “Purchase”) and 151.318(d).

Processing is defined as “the physical application of the materials and labor necessary to modify or to change the characteristics of tangible personal property.” Rule 3.300(a)(10). Processing is an activity performed during manufacturing. Rule 3.300(a)(9)(B).

Taxpayer’s operation begins with the receipt of spent carbon and concludes with the transfer of reactivated carbon to its customers. Taxpayer’s spent carbon reactivation does not qualify as manufacturing of a product for sale. Taxpayer reactivates carbon prior to taking title to it to sell on the open market or to return to customers who provided it. Rule 3.300(a)(9) states that manufacturing “includes the repair or rebuilding of tangible personal property that the manufacturer owns for the purpose of being sold, but does not include the repair or rebuilding of property that belongs to another.” Rule 3.300(a)(10) states that the repair of tangible personal property, belonging to another, by restoring it to its original condition is not considered processing of that property.

Rule 3.292(a)(11) (Repair, Remodeling, Maintenance, and Restoration of Tangible Personal Property) defines repair as mending or restoring to working order or operating condition tangible personal property that was broken, damaged, worn, defective, or malfunctioning. Spent carbon is defective. Taxpayer repairs spent carbon by cleaning its pores through the use of heat. The heat burns off impurities on the carbon, allowing it to function again.

Taxpayer’s operation is a repair of carbon belonging to another and not carbon it owns (i.e., it cannot take title to it while it is in unpurified form). This repair cannot constitute manufacturing or processing as defined in Rule 3.300(a)(9) or (10).

Taxpayer notes that it changes the surface of the carbon in the heating process when it burns off the impurities. Section 151.318(a)(2)(A) exempts from tax tangible personal property that is directly used or consumed in or during the actual manufacturing or processing of tangible personal property for ultimate sale if the use or consumption of the property is necessary or essential to the manufacturing or processing operation and directly makes or causes a chemical or physical change to the product being manufactured or processed for ultimate sale. While Taxpayer does make a physical change in the surface of the carbon in repairing it, the change does not restore its original surface area or make the surface area more absorptive. Rather, the change actually reduces the porosity compared to that of the original surface of virgin carbon and only occurs as a consequence of burning off the impurities to repair the carbon so that it is functional again.

Taxpayer cites to Rylander v. Haber Fabrics, 13 S.W.3d 845 (Tex. App.—Austin 2000, no pet.) in which it was decided that a taxpayer was engaged in processing when it took second-hand fabric, inspected it, cut out defects, and re-rolled the fabric for sale as a first quality product. Unlike in Haber, however, Taxpayer does not own the tangible personal property in question, and Taxpayer’s product is not a first quality product. Reactivated carbon has a lower absorptive quality than does virgin carbon.

Additionally, Houston Wire & Cable Company v. Combs, No. 03-07-00006-CV, 2008, held that cutting cable does nothing to change the cable’s intrinsic characteristics; it merely provides a shorter length of cable. Similarly, Taxpayer has not changed the intrinsic characteristics of the carbon itself; it has merely repaired it by removing impurities.

Since the change Taxpayer makes to the surface of the carbon is associated with cleaning rather than functional enhancement, and since Taxpayer only takes title to the carbon after it has been reactivated, Taxpayer is repairing the carbon for others as contemplated in Rule 3.300(a)(9) and Rule 3.292(a)(11) rather than making a physical change that qualifies as manufacturing.

Finally, while mixing different components to make a product for sale is manufacturing (see STAR Accession No. 201902003L (Feb. 7, 2019)), Taxpayer states that it only supplements the carbon with make-up carbon (reactivated or virgin) to account for carbon lost in the cleaning. Taxpayer is therefore not manufacturing a product for ultimate sale and its addition of reactivated or virgin carbon as make-up does not qualify as manufacturing or processing.

Question Two: Is Taxpayer a manufacturer with respect to the 20 percent reactivated carbon that is returned or sold to the customers that provided the spent carbon as raw material?

Ruling Two: No. Taxpayer is not a manufacturer with respect to the 20 percent reactivated carbon that it returns to customers, whether carbon is reactivated and returned or reactivated and sold after change of title.

When Taxpayer receives carbon from customers to clean it without taking title, Taxpayer is engaged in repairing the carbon and not manufacturing under Section 151.005(4) (“Sale” or “Purchase”). See the response to Question One.

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20181101101213.

Sincerely,

Tax Policy Division – Indirect Taxes Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.