Mauch v. South Dakota Department of Revenue & Regulation

#23966-aff in pt, rev in pt & rem-SLZ

2007 SD 90

IN THE SUPREME COURT
OF THE
STATE OF SOUTH DAKOTA

* * * *

GARY MAUCH, License No.
13-001-000141941T-ST-001, Petitioner and Appellant,

v.

SOUTH DAKOTA DEPARTMENT
OF REVENUE AND REGULATION, Respondent and Appellee.

* * * *
APPEAL FROM THE CIRCUIT COURT OF
THE FIRST JUDICIAL CIRCUIT
CLAY COUNTY, SOUTH DAKOTA

* * * *
HONORABLE STEVEN R. JENSEN
Judge

* * * *

JEFFREY L. BRATKIEWICZ
WILLIAM G. TAYLOR
CHERI S. RAYMOND of
Woods, Fuller, Shultz & Smith, P.C. Attorneys for petitioner
Sioux Falls, South Dakota and appellant.

JACK C. MAGEE
DONALD W. HAGEMAN
South Dakota Department of
Revenue and Regulation
Pierre, South Dakota Attorneys for respondent
and appellee.

* * * *
ARGUED AUGUST 29, 2006
REASSIGNED FEBRUARY 20, 2007

OPINION FILED 08/22/07
#23966

ZINTER, Justice (on reassignment).

[¶1.] Gary Mauch appeals a Department of Revenue and Regulation

decision assessing sales tax on engineering services he provided. Mauch also

appeals the Department’s assessment of use tax for accounting and legal services

that were provided to Mauch by out-of-state accountants and attorneys. We reverse

the assessment of sales tax on the engineering services, affirm the assessment of

use tax, and remand.

I.

[¶2.] Mauch obtained a one-year technical degree in drafting and design

technology in 1972. Thereafter, he started working as a draftsman for Beehive

Machinery Inc., in Salt Lake City, Utah. Beehive manufactured specialized

machinery used in the meat processing industry to separate meat from bone.

During his employment with Beehive, Mauch held the positions of Chief Draftsman,

Acting Engineering Director, and Chief Products Engineer. Mauch’s duties

included design and modification of standard and custom food processing

machinery. He also trained the new Engineering Director.

[¶3.] Mauch met Eldon Roth during Mauch’s employment with Beehive.

Roth is the founder and majority owner of Beef Products Inc. (BPI), a company that

uses custom designed meat processing machinery to eliminate bacteria and

pathogens from meat and sells meat to other food processing companies. In 1986,

Mauch accepted an engineering position with BPI in its Nevada City, California

facility. After six months, Mauch left BPI’s Nevada City facility and began working

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as an independent contractor. He continued to provide services for BPI and was

also hired by Multi-Fill 1 to design and improve its equipment.

[¶4.] In 1994, Roth contacted Mauch in an effort to obtain his engineering

services more exclusively in connection with BPI’s facilities. BPI’s headquarters are

in Dakota Dunes, South Dakota. However, all of its processing facilities are located

outside South Dakota. Roth wanted Mauch to help design new machinery for use in

BPI’s out-of-state facilities. Mauch accepted the offer. He and his family bought a

home in Burbank, South Dakota, where he lives and works.

[¶5.] In the course of this employment, Mauch attended meetings with Roth

in which the two “brainstormed” for ideas to improve and design BPI equipment.

The meetings were either held at Mauch’s home or at BPI headquarters in Dakota

Dunes. Mauch drafted most of BPI’s dimensional drawings with the assistance of

BPI’s drafters. The designs were then reviewed at BPI headquarters to ensure that

they met BPI’s quality standards. If BPI approved the designs, it sent them to out-

of-state machine shops for construction. After construction, the machines were sent

to BPI plants for installation. Mauch occasionally visited the out-of-state plants to

ensure proper installation.

[¶6.] In 2003, the Department audited Mauch’s engineering business. The

audit resulted in an assessment of tax, interest, and penalties in the amount of

$70,641.32. The assessment was imposed for sales tax on the engineering services

1. Multi-Fill sells food packaging equipment. The Department did not assess
any tax for Mauch’s services provided to Multi-Fill.

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Mauch provided to BPI and use tax on legal and accounting services that were

provided to Mauch’s business by out-of-state firms.

[¶7.] Mauch disputed the Department’s assessment and requested a hearing

under SDCL 10-59-9. Following the hearing, an independent hearing examiner

proposed findings of facts and conclusions of law reversing the sales tax assessment

and upholding the use tax assessment. The Department rejected the hearing

examiner’s findings of fact and conclusions of law and imposed its original

assessment. Mauch appealed to circuit court. The circuit court affirmed the

Department’s assessment, and Mauch appeals raising the following issues:

1. Whether the engineering services Mauch provided BPI were exempt
from sales tax under SDCL 10-45-12.2.

2. Whether the engineering services Mauch provided BPI were exempt
from sales tax under SDCL 10-45-12.3 (repealed SL 2003, ch 61,
section 3).

3. Whether the accounting and legal services provided to Mauch were
exempt from use tax under SDCL 10-46-2.1.

4. Whether Mauch was entitled to an abatement of interest and
penalties under SDCL 10-59-6 or SDCL 10-59-28.

[¶8.] “Questions of law, such as the question whether a statute imposes a

tax under a given factual situation, are reviewed de novo.” In the Matter of Choice

Hotels International, Inc. v. SD Dept. of Rev. and Reg., 2006 SD 25, ¶9, 711 NW2d

926, 928. Further, “[s]tatutes allowing tax exemptions are exactingly and narrowly

construed in favor of the taxing entity.” Watertown Coop. Elevator Ass’n v. S.D.

Dept. of Rev., 2001 SD 56, ¶10, 627 NW2d 167, 171.

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II.

Engineering Services Exemption Under SDCL 10-45-12.2

[¶9.] Four statutes govern sales taxation on engineering services. SDCL 10-

45-4 imposes a broad sales tax on services in general:

There is hereby imposed a tax at the same rate as that imposed
upon sales of tangible personal property in this state upon the
gross receipts of any person from the engaging or continuing in
the practice of any business in which a service is rendered. Any
service as defined by § 10-45-4.1 shall be taxable, unless the
service is specifically exempt from the provisions of this chapter.

SDCL 10-45-4.1 defines “service” as “all activities engaged in for other persons for a

fee, retainer, commission, or other monetary charge, which activities involve

predominantly the performance of a service as distinguished from selling property.”

“Engineering services” are specifically captured by SDCL 10-45-5.2. However,

SDCL 10-45-12.2 provides an exemption if the “engineering services” are classified

in Group No. 871 of the Standard Industrial Classification Manual, 1987 (SIC

Manual) and they are for projects located entirely out-of-state:

There are specifically exempted from the provisions of this
chapter and from the computation of the amount of tax imposed
by §§ 10-45-4 and 10-45-5, the gross receipts from engineering,
architectural, and surveying services ([G]roup [N]o. 871,
Standard Industrial Classification Manual, 1987, as prepared by
the Statistical Policy Division of the Office of Management and
Budget, Office of the President) rendered for a project entirely
outside this state.

Id. Therefore, in order for Mauch to be entitled to the exemption provided by SDCL

10-45-12.2, he had the burden of showing that his services were classified as

“engineering services” under SIC Group No. 871 and that such services were

rendered for projects outside of South Dakota.

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[¶10.] Industry Group No. 871 of the SIC Manual is titled “Engineering,

Architectural and Surveying Services.” Industry No. 871 describes “Engineering

Services” as “[e]stablishments primarily engaged in providing professional

engineering services.” (Emphasis added.)

[¶11.] The hearing examiner acknowledged that Mauch was not licensed as a

“professional” engineer in South Dakota and did not have an engineering degree.

However, the hearing examiner concluded that Mauch provided professional

engineering services because of his knowledge and experience. On the other hand,

the circuit court agreed with the Department’s position that in order to be entitled

to the tax exemption, Mauch was required to be licensed as a “professional”

engineer by the South Dakota Board of Technical Professions under SDCL ch. 36-

18A, the chapter regulating the practice of architecture and engineering.

[¶12.] At the outset it must be noted that the statutes capturing and

exempting these services do not refer to “professional” engineering services: those

statutes only refer to “engineering services.” There is also no statutory reference in

the tax statutes requiring licensure. With respect to SIC Manual Group No. 871, it

is equally important to note that it is only intended to classify types of economic

activity rather than the status of the individuals providing the economic activity in

that industry. 2 Additionally, although the SIC Manual contains “professional

2. The Standard Industrial Classification (SIC) is a system for classifying
establishments by type of economic activity. Its purposes are: (1) to facilitate
the collection, tabulation, presentation, and analysis of data relating to
establishments, and (2) to promote uniformity and comparability in the
presentation of statistical data describing the economy. The SIC is used by
agencies of the United States Government that collect or publish data by
(continued . . .)
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engineering services” language, there is no definition of a “professional engineer” in

the SIC Manual. Finally, one specific example for this industry included services

provided by “machine tool designers,” the service that Mauch appears to have

provided. Nevertheless, the Department concluded that SDCL ch 36-18A, the

chapter regulating the practice of architecture and engineering, should be

incorporated into the tax code to determine the taxability of engineering services.

We conclude that the incorporation of this regulatory engineering practice chapter

into the unrelated sales tax statutes was incorrect for three independent reasons.

[¶13.] First, the incorporation of these unrelated statutes is at odds with the

statutory rule governing when definitions in one part of the code may be used in

others. SDCL 2-14-4 provides: “Whenever the meaning of a word or phrase is

defined in any statute such definition is applicable to the same word or phrase

wherever it occurs except where a contrary intention plainly appears.” Here, the

words and phrases are not the same and a contrary intention plainly appears.

SDCL 36-18A-1(24) defines a “professional engineer” as a person who is licensed

and legally authorized to practice engineering in the state. However, neither the

tax statutes imposing the tax on services (SDCL 10-45-4 and 10-45-5.2) nor the

engineering exemption (SDCL 10-45-12.2) use the words “professional” or

___________________
(. . . continued)
industry. It is also widely used by state agencies, trade association, private
businesses, and other organizations.

SIC Manual, Appendix B: “Principles and Procedures for the Review of the
SIC,” §A, p699.

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“engineer.” Rather, the words used in the tax statutes 3 only refer to “engineering

services.” See SDCL 10-45-5.2; SDCL 10-45-12.2. Therefore, because the phrase in

the tax statutes is not the same as the phrase used in the regulatory statutes, the

general rule of incorporation under SDCL 2-14-4 is inapplicable.

[¶14.] Moreover, even if the general rule were applicable, the regulatory

definition may not be incorporated into the tax exemption because the exception in

SDCL 2-14-4 applies. This exception prohibits incorporation “where a contrary

intention plainly appears.” Id. In this case, SDCL 36-18A-1 provides that

definitions in SDCL ch. 36-18A only apply to “[t]erms used in this chapter [SDCL ch

36-18A].” (Emphasis added.) Therefore, the regulatory definition of a professional

engineer is expressly confined to SDCL ch. 36-18A, and it does not apply to other,

unrelated chapters like SDCL ch. 10-45.

[¶15.] Second, by incorporating the regulatory definition of a professional

engineer into the tax code, the Department failed to follow this Court’s precedent.

In two recent cases this Court concluded that analogous statutory definitions,

unrelated to sales taxation, may not be incorporated into the tax code to define and

determine a sales tax exemption. In Cooperative Agronomy Services v. S.D. Dept. of

Rev., 2003 SD 104, ¶18, 668 NW2d 718, 723, we held that the definition of “farm

products” found in SDCL 57A-9-102(34) (Article 9 of the UCC) could not be used to

define the term, and therefore determine entitlement to a tax exemption for, “farm

products” in SDCL 10-45-12.1. We explained:

3. We also note that the phrase “professional engineer” only appears in the SIC
Manual, a reference to which SDCL 2-14-4 does not purport to apply.

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[W]e do not believe that the Legislature intended that the UCC
definition of “farm products” would also determine which “farm
product warehousing and storage services” are exempt from
sales taxation under SDCL ch 10-45. After all, SDCL ch 57A-9
regulates the procedure and rights of debtors and creditors
engaged in secured transactions, a purpose wholly unrelated to
sales taxation.

Id. ¶20.

[¶16.] Similarly, in Wharf Resources (USA) Inc. v. Farrier, 1996 SD 110, 552

NW2d 610, this Court was required to determine whether equipment and other

things affixed to a mine were exempt from taxation because of a general, unrelated

real property definition of a “mine” in SDCL 43-1-5. We again rejected the

incorporation of unrelated statutes to define and determine taxability, explaining:

SDCL 43-1-5 is a statute of general application, intended to aid
in determining which of those items commonly associated with a
mine would be deemed appurtenant to the land. There is no
corresponding definition of “mine” contained in the South
Dakota taxation statutes found under SDCL 10-4-2 and 10-6-35.

Wharf Resources, 1996 SD 110, ¶42, 552 NW2d at 618.

[¶17.] The Department’s interpretation 4 also fails to follow our

4. The premise of the Department’s argument is incorrect. The Department
concedes that Mauch “may fall within the definition of engineer and he may
provide engineering services. However, it is undisputed that he is not
licensed in South Dakota pursuant to SDCL 36-18A.” (Appellee’s Br. 10).
From this, the Department argues that because Mauch is not a professional
engineer, he “is prohibited from providing professional engineering services
within this state.”

Although many engineering services provided in this state must be provided
by a licensed professional engineer, virtually identical engineering services
are simultaneously exempted from the licensure requirement based upon the
user or the size of the project. See SDCL 36-18A-9 (allowing many
engineering services to be provided by unlicensed engineers). For example,
the preparation of plans for two to four family dwellings and ranch buildings
(continued . . .)
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precedent requiring that taxability be determined based on the nature of the

services provided rather than the character or status of the individual providing a

service. This Court has been quite clear that in deciding analogous exemption

disputes, “we use the predominant activity test in deciding if services [are] subject

to sales tax.” Watertown Co-op. Elevator Ass’n v. S.D. Dept. of Rev., 2001 SD 56,

¶12, 627 NW2d 167, 172 (emphasis added) (citing Nash Finch Co. v. S.D. Dept. of

Revenue, 312 NW2d 470, 472 (SD 1981). Accord, EG & G, Inc. v. Director of

Revenue, 94 NM 143, 607 P2d 1161, 1164 (NMCtApp 1979) (“predominant

ingredient” test). “We have also emphasized that ‘determinations of taxability

should focus on the transaction.’” Id. (citing Sioux Falls Newspapers, Inc. v.

Secretary of Revenue, 423 NW2d 806, 809 (SD 1988)) (emphasis added). Therefore,

“[i]t is the similarity in the transactions and not the character of the participants

upon which we must focus” in determining eligibility for service exemptions. Sioux

Falls Newspapers, Inc., 423 NW2d at 808 (emphasis in original). This focus on the

transaction rather than the character of the service provider is understandable

because this is a tax on services, and therefore, the tax statutes specifically refer to

___________________
(. . . continued)
does not require licensure. Id. Similarly, plans for building or remodeling
hospitals, hotels, restaurants, libraries, offices, and retirement homes do not
require licensure if the projects are four thousand square feet or less. Id.
Therefore, the Department is incorrect in arguing that one must be a
professional engineer to render any engineering services in the State. It also
makes little sense that the taxability of virtually identical engineering
services would be determined by the nature of the user of the services or the
size of the project when those additional qualifications do not appear in the
tax statutes or the SIC Manual.

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the nature of the “services” being provided rather than the status of the individual

providing those services. See SDCL 10-45-4; SDCL 10-45-5.2; SDCL 10-45-12.2.

[¶18.] Third, the Department’s interpretation is contrary to legislative intent.

It is hard to imagine that the Legislature had sales taxation on its mind in 1996,

when it revised the regulatory statutes governing the practice of engineering. It is

also hard to imagine that, in revising the regulatory statutes, the Legislature could

have intended that the regulatory definition of a “professional engineer” applied to

the tax code because those words are not in the tax code: they are only found in the

SIC Manual. And, the Legislature could not have intended that licensure be

required because the SIC Manual is only a listing of establishments by type of

economic activity, 5 the SIC Manual was not designed for non-statistical purpose,

such as a state’s sales taxation.

The SIC system is designed for statistical purposes. Although
the classification is also used for various administrative
purposes, the requirements of government agencies that use it
for nonstatistical purposes play no role in development and
revision of the SIC.

SIC Manual, Appendix B: “Principles and Procedures for the Review of the SIC,”

§A, p699.

[¶19.] We finally note that the Legislature could not have intended that the

licensure requirements of SDCL ch 36-18A would determine the taxability of

Mauch’s engineering services. To do so, the Legislature would have had to intend

that SDCL 36-18A-1(24) apply retroactively. The regulatory statutes became

5. See supra note 3.

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effective July 1, 1999; however, the engineering services at issue were provided

between January 1998 and December 2000. Therefore, a substantial portion of the

engineering services had already been provided by the time SDCL 36-18A-1(24) was

enacted, and the Legislature prohibits such retroactive application of its statutes

“unless such intention plainly appears.” SDCL 2-14-21.

[¶20.] For all of the foregoing reasons, the Department erred in incorporating

the regulatory definition of a professional engineer in SDCL 36-18A-1(24) into

SDCL 10-45-12.2, an unrelated sales tax statute that does not define engineering

services. When tax exemption statutes like SDCL 10-45-12.2 do not define their

terms, this Court has consistently looked to plain meaning definitions rather than

unrelated statutes. See Cooperative Agronomy, 2003 SD 104, ¶21, 668 NW2d at 724

(using Black’s Law Dictionary to define “farm products” for purposes of determining

a tax exemption under SDCL 10-45-12.1); Graceland College Center for Prof. Dev.

and Lifelong Learning, Inc., v. S.D. Dept. of Rev., 2002 SD 145, ¶¶7, 8, 654 NW2d

779, 783 (using American Heritage Dictionary to define “vocational school” for

purposes of determining a tax exemption under SIC Manual Group No. 824 and

SDCL 10-45-12.1).

[¶21.] Black’s Law Dictionary defines “professional” as: “A person who

belongs to a learned profession or whose occupation requires a high level of training

and proficiency.” (8thed 2004). The American Heritage College Dictionary defines

“engineer” as, “[o]ne who is trained or professionally engaged in a branch of

engineering.” 456 (3ded 1997). The record in this case reflects that Mauch met

these definitions.

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[¶22.] The Department’s brief concedes that he has had professional training

and extensive experience: “Mauch received a one-year technical degree in drafting

and design technology[,] and has many years of experience in the industry.”

Appellee’s Brief, p6. More specifically, he received formal instruction and has had

more than thirty years of experience in providing professional engineering services,

including the last fifteen years as an independent contractor providing design and

engineering services. He was the acting engineering director of a similar company

and has been designing this type of machinery since 1974. Unquestionably,

through his education and extensive experience, Mauch received adequate training

and proficiency to qualify him to design and engineer the specialized machines at

issue and to qualify him as a professional. Therefore, we conclude that Mauch was

providing professional engineering services.

[¶23.] Because Mauch provided professional engineering services as classified

in SIC Manual Group No. 871, we must next determine whether the services were

provided for projects “entirely outside this state.” See SDCL 10-45-12.2. The

evidence reflects that the services were only for projects and machines in plants

that were located entirely outside South Dakota. The Department concedes this

issue in its brief:

[T]he machines and component parts are manufactured by
vendors outside of South Dakota and are assembled at various
meat packing facilities located around the country. None of the
machines are placed at plants in South Dakota.

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Appellee’s Brief, p4-5. Thus, there is no dispute that Mauch satisfied the second

test for exemption under SDCL 10-45-12.2. 6

[¶24.] We therefore conclude that Mauch’s services fell within the description

of engineering services found in the SIC Manual Group No. 871 and SDCL 10-45-

12.2, and the Department and circuit court incorrectly overruled the hearing

examiner’s decision allowing the sales tax exemption. Because Mauch was entitled

to the exemption for engineering services under SDCL 10-45-12.2, we need not

address Mauch’s entitlement to the sales tax exemption under 10-45-12.3.

III.

Assessment of Use Tax for Accounting and Legal Services

[¶25.] Mauch next argues that he should not have been assessed use tax on

accounting and legal services he obtained from out-of-state firms under SDCL 10-

46-2.1, which provides in part:

For the privilege of using services in South Dakota, except those
types of services exempted by § 10-46-17.3, there is imposed on
the person using the service an excise tax equal to four percent
of the value of the services at the time they are rendered.

However, this Court has previously concluded that when similar out-of-state

services are used to conduct in-state business, the Department may properly impose

use tax. Thermoset Plastics, Inc. v. S.D. Dept. of Rev., 473 NW2d 136, 139 (SD

6. Although there was some dispute concerning where Mauch’s services were
used, the Department agreed at oral argument that this question is
irrelevant to the exemption under SDCL 10-45-12.2:

Q (the Court): Where the services were used, that’s only relevant under
12.3; that are not even relevant under 12.2, is it?
A (Department): That’s correct. . .

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1991). In this case, the hearing examiner, the Department, and the circuit court

found that Mauch failed to establish that any of the accounting and legal services

were provided for something unrelated to his South Dakota business. On the

contrary, the record reflects that he used those services in his engineering service

business. Therefore, the use tax was correctly imposed.

IV.

Abatement of Interest and Penalties

[¶26.] Mauch finally argues that he is entitled to an abatement of interest

and penalties. Because we have concluded that he is entitled to the sales exemption

under SDCL 10-45-12.2, we remand for reconsideration of this issue.

[¶27.] Affirmed in part, reversed in part, and remanded.

[¶28.] GILBERTSON, Chief Justice, and SABERS, KONENKAMP, and

MEIERHENRY, Justices, concur.

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