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Appeal from the Circuit Court of Kane County. No. 96--TX--5 Honorable Melvin E. Dunn, Judge, Presiding.

The opinion of the court was delivered by: Justice Hutchinson

Defendants, the Department of Revenue (the Department) and Kenneth E. Zehnder, Director of Revenue (Zehnder), appeal from an order of the trial court upon administrative review reversing defendants' decision that plaintiff, Richard's Tire Company, is liable to pay taxes on certain machinery and equipment plaintiff used in the process of manufacturing retread tires. The trial court held that defendants' final administrative decision was against the manifest weight of the evidence. Defendants raise two issues on appeal: (1) whether plaintiff's failure to name the Department as defendant deprived the trial court of jurisdiction, and (2) whether the manufacturing and assembling machinery and equipment exemption in section 3--5(18) of the Use Tax Act (35 ILCS 105/3--5(18)(West 1996)) applied to the machinery and equipment used by plaintiff in producing retread tires. We affirm the order of the trial court.

The administrative hearing record, including Zehnder's decision, reveals the following salient facts. Plaintiff was engaged in the business of retreading motor vehicle tires from 1966 until 1992, when substantially all of its assets were sold and the corporation dissolved. In December 1992 the Department issued a notice of tax liability to plaintiff. The notice stated that plaintiff owed $11,449, which represented unpaid use tax due, plus penalties and interest for the period between July 1989 and December 1991. The Department assessed the use tax on machinery that plaintiff purchased during this period and used to retread tires. Plaintiff filed a timely protest of this assessment and contended that the statutory exemption for manufacturing and assembling machinery and equipment (see 35 ILCS 105/3--5(18) (West 1996)) applied to the machinery.

In October 1994 the Department held an administrative hearing before Administrative Law Judge (ALJ) Alan Osheff. The Department contended that (1) plaintiff's assets were tangible personal property purchased at retail from a retailer; (2) no retailer's occupation tax had been paid to the sellers; and (3) use tax should be imposed. ALJ Osheff allowed into evidence the notice of tax liability and certificate of mailing.

The Department's sole witness was David Wheet, an auditor employed by the Department. Wheet testified that, in reviewing plaintiff's records, he found that plaintiff had purchased certain items of machinery and equipment during the audit period for which no use tax had been paid. Wheet described the process of retreading tires: a customer would bring in a tire casing, and the machines that the Department assessed would be utilized in the process of retreading the casing; when the process was complete, the tire would be returned to the customer. Wheet determined that no sale or lease occurred in this process, and on that basis Wheet concluded that the machinery was taxable. Upon the conclusion of the cross-examination of Wheet, the Department rested its case.

Testifying on behalf of plaintiff was Richard Weagley, plaintiff's former president, chief executive officer, secretary-treasurer, and sole stockholder throughout the relevant period. Weagley testified that the machinery and equipment at issue included expandable chuck conversion kits, compressors, a tank, a twin line conversion kit, a tread kit, a buffer, and a builder. All of these items were used to produce a retread tire. The finished products were sold to individual customers or dealers who resold such tires. Weagley explained the pricing structure of selling retreaded tires. Sales tax was not charged to customers who possessed an interstate carrier exemption; sales tax would be charged to end users who were not interstate carriers.

Weagley also explained the retreading process. Tire casings are first procured by plaintiff, a customer, or some other third party; then the casings are inspected. If the tire casing is unsuitable for retreading, it is rejected. If the tire casing is suitable for retreading, it will then be cut down, reshaped, and resurfaced with a buffer. Damaged areas are skived and the resulting holes are refilled with rubber compound. The refurbished casing is then cleaned and, if necessary, repaired. Resized and reconditioned, the casing is next placed on a machine called a "builder," where strips of manufactured cushion gum and tread rubber are cut to size and applied to the casing along with bonding agents. Next, a United States Department of Transportation assigned number is embossed on the tire to identify it as a retread and to show its place of origin. The tire is next mounted on a rim or ring, enclosed in an "envelope," and pressurized. A number of mounted pressurized tires are then inserted into a large curing chamber where, through the application of heat and a pressure differential, a chemical change takes place resulting in the vulcanization of the cushion gum and the integration of the tread rubber with the casing. During Weagley's examination, plaintiff and the Department stipulated that a total of $24,036 representing certain leasehold improvements should not have been assessed and, therefore, should be deleted from plaintiff's tax liability.

Plaintiff also introduced into evidence correspondence from 1985 between Bandag, Inc. (Bandag), and the Department. Plaintiff was a franchise of Bandag, which engaged in the tire retreading business. In a May 30, 1985, letter from Bandag to the Department, Bandag requested a written ruling that the purchase or lease from it by its franchisees of machinery and equipment for use in its retreading process was exempt from taxation under the manufacturing and assembling machinery and equipment exemption. Bandag's letter informed the Department that its franchisees engage in two types of transactions: (1) when customers supply their own tire casings, or (2) when the franchisee supplies the tire casing. A Department staff attorney initially replied that the exemption would not apply; however, the same attorney responded nine days later, reversing the Department's earlier ruling, stating that the previous letter should be disregarded and that the Department ruled that Bandag's machinery did qualify for the exemption. In ruling that the exemption applied, the attorney cited to a private letter ruling issued January 25, 1985, by the Department, stating that "machinery used in the retreading of tires does qualify for the manufacturing machinery and equipment exemption."

In his recommendation for Disposition, ALJ Osheff determined that the assets at issue were manufacturing and assembling machinery and equipment used primarily in the process of manufacturing retread tires for wholesale or retail sale. He summarized as follows:

"he evidence reveals that the process involved was one of manufacturing and the taxpayer in fact sold a retreaded tire to his customer. In my opinion a sale occurred in those instances where the customer had supplied a casing since the casing was only an ingredient that became incorporated in the newly transferred product. A substantial ingredient that was supplied by the taxpayer was the rubber and the product received by the customer was not the same as received by the taxpayer."

ALJ Osheff recommended to Zehnder that the assessment be canceled.

In his final administrative decision, Zehnder declined to follow ALJ Osheff's recommended Disposition. Zehnder acknowledged that "the process of producing retread tires is obviously manufacturing." However, Zehnder defined the issue as "whether the transactions which take place between and its customers in situations where the customer supplies the casing, are in actuality a service or a retail (sometimes wholesale) sale." Zehnder noted that the exemption applies only if the machinery and equipment in question are used to manufacture personal property for wholesale, retail sale, or lease. Zehnder relied upon a Department regulation codified at 86 Ill. Adm. Code § 130.2015 (1996), which states, inter alia, that the retreading of tires would not be considered a product sale subject to the retailer's occupation tax. Instead, Zehnder considered the retreading of tires a service subject to the service occupation tax.

Zehnder's decision also disagreed with ALJ Osheff's Conclusion that the product the customer ultimately received was different from the product brought in by the customer. Zehnder stated that the customer brought in a worn tire, and plaintiff returned a reconditioned tire to the customer. He further stated that, under ALJ Osheff's logic, "persons who bring their shoes to be resoled and/or reheeled, buffed and shined, are in fact buying new shoes from the corner cobbler."

Zehnder affirmed the auditor's notice of tax liability, and the Department issued the final assessment to plaintiff on December 11, 1995. The final assessment stated that plaintiff owed $14,077.81 in use tax, interest, and penalties. Both parties agree that the final assessment failed to take into account the Department's stipulation at ...

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