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Horsehead Corp. v. Department of Revenue

Supreme Court of Illinois

November 21, 2019

THE DEPARTMENT OF REVENUE et al. The Department of Revenue, Appellee.

          JUSTICE THEIS delivered the judgment of the court, with opinion. Chief Justice Burke and Justices Thomas, Kilbride, Garman, Karmeier, and Neville concurred in the judgment and opinion.



         ¶ 1 Petitioner, Horsehead Corporation (Horsehead), filed a petition for review with the Illinois Independent Tax Tribunal of notices of tax liability issued by respondent the Department of Revenue (Department). The notices were issued due to Horsehead's failure to pay Illinois use tax (35 ILCS 105/1 et seq. (West 2012)) on its out-of-state purchases of metallurgical coke between January 2007 and June 2011. The tax tribunal affirmed the notices of tax liability and the imposition of use tax, interest, late filing penalties, and late payment penalties. The appellate court affirmed the tax tribunal's decision. 2018 IL App (1st) 172802, ¶ 31. For the reasons that follow, we affirm in part and reverse in part the judgment of the appellate court.

         ¶ 2 BACKGROUND

         ¶ 3 Horsehead is a Delaware corporation with its primary place of business in Pittsburgh, Pennsylvania. It has a manufacturing facility located in Calumet City, Illinois, where it operates a zinc refining facility.

         ¶ 4 On October 3, 2014, the Department issued Horsehead two notices of tax liability for the period of January 1, 2007, through June 30, 2011, in an amount totalling $1, 521, 041. This amount constituted use tax, interest, late payment penalties, and late filing penalties related to its out-of-state purchases of metallurgical coke, a solid material consisting almost entirely of carbon, for which it had not paid any Illinois use tax.[1] Use tax is imposed in Illinois on tangible personal property purchased at retail from outside the state. 35 ILCS 105/3 (West 2012).

         ¶ 5 On December 1, 2014, Horsehead filed a petition for hearing with the Illinois Independent Tax Tribunal. The company argued that it was exempt from paying use tax on the coke under section 3-5(18) of the Use Tax Act (Act) (id. § 3-5(18)) for machinery and equipment used primarily in the manufacturing of tangible personal property.

         ¶ 6 Specifically, Horsehead relied upon the "chemical exemption" found in section 3-50(4) of the Act, which contains, in pertinent part, a definition of "equipment" that includes certain chemicals that are exempt from paying use tax:

"(4)" 'Equipment'" includes an independent device or tool separate from machinery but essential to an integrated manufacturing or assembly process ***. Equipment includes chemicals or chemicals acting as catalysts but only if the chemicals or chemicals acting as catalysts effect a direct and immediate change upon a product being manufactured or assembled for wholesale or retail sale or lease." (Emphases added.) Id. § 3-50(4).

         Horsehead claimed that it was entitled to this tax exemption because the chemical coke effected "a direct and immediate change" on the zinc and iron products manufactured by it.[2]

         ¶ 7 The parties stipulated to the following facts concerning Horsehead's use of coke in its manufacturing process.

         ¶ 8 At its Calumet City facility, Horsehead is primarily in the business of recovering zinc from electric arc furnace dust (EAF dust) generated by steel mill producers. Under a process referred to as the "Waelzing process," based on the Waelz kiln in which it takes place, rotary kilns are used to reduce and recover the zinc as crude oxide. As part of this overall manufacturing process, Horsehead purchases metallurgical coke outside of Illinois.

         ¶ 9 Prior to the start of the Waelzing process, the EAF dust is converted into pellet form. The coke can either be mixed into the EAF dust pellets or can be added separately. The kiln is preheated to initiate the process. The furnace dust and coke mixture is fed into the rotary kiln. Thereafter, a natural gas burner is used as necessary to adjust the process temperature. The process requires the heating of the coke in order to release the carbon in the coke.

         ¶ 10 When the coke is burned in the oxygen-poor atmosphere of the kiln, some of the carbon forms carbon monoxide. Because the bed in a Waelz kiln is very hot- between 1600 to 2400°F-and contains very little oxygen (less than 0.01%), the carbon in the coke is converted almost entirely to carbon monoxide. The carbon monoxide then reacts with the zinc oxide in the EAF dust. In this chemical reduction reaction, the carbon monoxide produced from the coke acts on the zinc oxide in the EAF dust. The zinc also reacts with oxygen in the air space in the kiln. Secondary reactions between carbon monoxide and cadmium, lead, copper, and iron in the EAF dust also occur. The zinc oxide is ultimately gathered and cooled and moved to the next step of refining for ultimate sale. Separately, the iron and copper remains are collected and also sold by the company.

         ¶ 11 At the final hearing before the tax tribunal, Horsehead called three witnesses to explain the Waelzing process. Dr. Mark Schlesinger, professor of metallurgical engineering at Missouri University of Science and Technology, testified as an expert witness. John Pusateri, the director of technology at Horsehead, and Reges Zagrocki, an employee who provides technical support to Horsehead's recycling groups, also testified.

         ¶ 12 These witnesses established that the overall Waelzing process takes approximately two-and-a-half hours. Virtually all of the coke is consumed in the process, which includes four zones. First, the coke and the EAF dust are pelletized and mixed together at a ratio of approximately 25% coke to dust. Water is added to the mixture to produce pellets that are one-quarter of an inch or less in diameter. The pellets are fed into the kiln. During the second zone, several chemical reactions occur. As the coke burns, carbon from the coke reacts with carbon monoxide. Carbon dioxide is also produced and reacts with the burning carbon to create additional carbon monoxide, through repeated cycles in this zone. In the third zone, iron reacts with the oxygen in the air to reform iron oxide, which generates heat. In the fourth and final zone, the zinc oxidizes. This oxidation leaves small particles of zinc oxide that are gathered and later refined. The iron-rich material created during the process is also collected and similarly sold.

         ¶ 13 All three witnesses testified that carbon monoxide, not carbon from the coke, is the agent that reduces EAF dust to zinc oxide and iron oxide. Dr. Schlesinger acknowledged that heated carbon alone does not create carbon monoxide and explained that carbon reacts with carbon dioxide to produce carbon monoxide. He testified that, if he were to take solid iron oxide and place it next to solid carbon, "nothing would happen." He further testified that "what actually happens in this process is that as this reaction generates [carbon dioxide], it reacts with the carbon to produce two carbon monoxides. The carbon monoxide is a gas and can diffuse into the solid feed pellets. And when that happens, the carbon monoxide actually reduces the iron oxide to metallic iron and reduce[s] the zinc oxide to zinc vapor."

         ¶ 14 After taking the matter under advisement, the tax tribunal issued a written decision affirming the two notices of tax liability. The tax tribunal concluded that the coke did not qualify for the claimed exemption because, in the Waelzing process, the coke does not effect a direct and immediate change upon the product being manufactured. The tax tribunal found that the coke did not react with zinc or zinc oxide directly and immediately. As conceded by Horsehead's own witness, simply placing coke next to zinc oxide does not create any chemical reaction whatsoever. The coke does not react directly with either the zinc oxide or the iron oxide to reduce them to zinc and iron.

         ¶ 15 In rejecting Horsehead's claim that it was entitled to the exemption, the tax tribunal found that Horsehead was attempting to collapse and conflate all steps within the Waelzing process into one continuous and singular chemical reaction. It found that such a simplistic view would "turn the chemical exemption statute on its head." The tax tribunal concluded that it would render the language "direct and immediate" meaningless and would allow any chemical that is used in the manufacturing process for any reason, at any time, to qualify for the exemption.

         ¶ 16 Additionally, the tax tribunal upheld the late payment and late filing penalties imposed by the Department under section 12 of the Act (id. § 12), which incorporates portions of the Uniform Penalty and Interest Act (35 ILCS 735/3-1 et seq. (West 2012)). The tax tribunal acknowledged that the Department's audit file had been admitted into evidence, and it noted Horsehead's history of tax compliance. It found that Horsehead had shown good conduct in complying with state tax laws and that such conduct carried some weight in supporting the company's claim of good faith when it failed to pay use tax on the coke.

         ¶ 17 The tax tribunal declined to abate the penalties, however, because Horsehead did not present any witnesses or evidence to support its claim of good faith in taking the position that it qualified for the chemical exemption. The tax tribunal found that the record was silent as to what Horsehead relied upon to conclude that it was entitled to the exemption other than its claim that the statute was unclear because the term "direct and immediate" is undefined.

         ¶ 18 Horsehead filed a petition for review of the tax tribunal's decision in the appellate court, pursuant to section 1-75 of the Illinois Independent Tax Tribunal Act of ...

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