The manufacturing sector is often one of the most targeted industries by states to grow their economies and increase the number of good paying jobs for their residents. For years, one of the ways states have incentivized manufacturing companies to create and/or expand operations, assist in managing their operating costs or otherwise stay competitive with other states is to provide a variety of manufacturing sales tax exemptions. The manufacturing exemptions do not provide a broad sales tax exemption, similar to what is provided for non-profit tax-exempt organizations, but instead typically focus on three areas: manufacturing equipment, materials that become a component part or ingredient of the product being manufactured or materials consumed and destroyed during the manufacturing process1.
Manufacturing equipment often includes not only the equipment, but also the repair parts. Typically states require that the equipment be dedicated for use either principally (usually greater than 50 percent) or exclusively (usually greater than 90-95 percent) in the company’s direct step-by-step manufacturing process. The manufacturing process often starts when raw materials are removed from storage to the first step in the manufacturing process and ends when the manufactured product is placed in finished goods storage. Exempt manufacturing equipment may or may not include waste reduction and recycling, research and development and packaging equipment.
Inventory that will become a component or ingredient part of the product being manufactured is arguably already exempt pursuant to the various states resale exemptions, but many states leave no doubt providing specific exemption for materials that become a part of the product being sold.
The exemption for materials consumed in the manufacturing process has not been adopted by all states that exempt manufacturing equipment. For states which do not provide this exemption, the main issue is whether or not any of the materials either somehow become a part or ingredient of the product as it is consumed or if the materials actually cause some direct change or effect on the product being manufactured2. In essence the attempt is to see if the consumed materials can qualify for exemption either under the state’s exemption for manufacturing equipment or for the component part or ingredient exemption mentioned above.
Most states that provide sales tax exemptions to manufacturers provide a full exemption from their state’s sales or use tax. However, some states just significantly reduce the applicable sales tax rate3 or may exempt the purchase from state sales taxation, but local sales taxes continue to apply4. Otherwise, states that do not provide any or only limited manufacturing sales tax exemptions may still provide exemptions related to new or expanded manufacturing facilities5.
There have been several state tax developments regarding the above sales tax exemptions for manufacturers in the last couple of years. The following summarizes the more significant developments, which are quite favorable for manufacturers.
Reduced Sales Tax Rate from July 1, 2014 – June 30, 2022
Until recently, the sales or purchase of machinery to be used for manufacturing in California was taxable. However, starting with sales, use, storage or consumption of tangible personal property used primarily (at least 50 percent) in manufacturing on or after July 1, 2014 and through June 30, 2022, a partial sales tax rate reduction applies. For the period of July 1, 2014 through December 31, 2016, the state sales tax rate is reduced by 4.1875 percent to 3.3125 percent, plus applicable local taxes. For the period beginning on or after January 1, 2017 and through June 30, 2022, the state tax rate is reduced by 3.9375 percent to 3.5625percent, plus applicable local taxes. Interestingly, the reduction in the state sales tax rate also has been extended to property used in research and development, and for use in constructing a facility to be used for manufacturing or research and development purposes.
Qualified property that is available for the sales tax rate reduction includes machinery and equipment, devices used to operate, regulate or maintain the machinery including computers and computer software and certain pollution control equipment. Property that does not qualify includes consumables with a useful life of less than one year, property used to store finished goods and property used primarily for administrative or general management purposes6.
Important to note – manufacturers should make sure to provide a timely completed exemption certificate. The sales tax exemption statute specifically implies that without such certificate the reduced sales tax rate will not apply7. Finally, long-lived consumables (with a useful life of at least one year) should be reviewed for possible eligibility for the reduced sales tax rate.
Manufacturing Equipment Exemption from May 1, 2014 through April 30, 2017
It is not surprising that Florida has only provided a limited sales tax exemption, since the state does not impose a personal income tax8. However, that has recently changed. Beginning on May 1, 2014 and ending April 30, 2017, the purchase and use of industrial machinery and equipment to be used at a fixed location for manufacturing purposes is exempt from Florida sales and use taxation9.
Georgia has recently expanded its sales and use tax exemption for consumables. For 2015, energy used that is necessary and integral in the manufacturing process is currently in a phase-in period where 75 percent is exempt. Effective January 1, 2016, the exemption for energy consumed in the manufacturing process is fully phased-in. In addition, effective back to July 1, 2014 purchases of consumable supplies (not including energy) used in the manufacturing process are exempt as well. Previously the supplies had to become a part or component of the product for at least some part of the manufacturing process10.
Equipment Can Be Purchased Exempt Starting July 1, 2015
Through June 30, 2015, sellers of exempt capital equipment to Minnesota manufacturers were required to collect and remit the Minnesota sales tax11. The Minnesota manufacturers would then file refund claims for the sales taxes paid to their equipment suppliers. This was a cumbersome process put in place to help reduce the benefit of the exemption (not all manufacturers will go through the effort of filing refund claims), create additional revenue through assessments (equipment sellers would be assessed interest and penalties for their failure to collect and remit taxes on otherwise exempt equipment) and of course to create additional cash flow and related interest income for the state due to receiving and holding on to cash revenues that would otherwise never have flowed into its coffers.
Thankfully, this cumbersome process has finally been eliminated. Beginning on July 1, 2015, the sale of manufacturing equipment is exempt. Equipment that qualifies for the exemption includes machinery and equipment used to operate, control or regulate the manufacturing equipment, research and development, design quality control and testing equipment and environmental control devices. Materials used to construct manufacturing equipment foundations and special purposes buildings for the manufacturing process are also exempt. The manufacturer should provide the equipment supplier a completed ST3 exemption certificate. If sales taxes were paid on exempt equipment, a refund can be requested using Form ST1112.
Kerford Limestone, NE Sup Ct. (3/14/14) – Any Manufacturing Use Qualifies For Exemption
In a very interesting case, the Nebraska Supreme Court ruled with the taxpayer that equipment principally used to maintain roads leading into a limestone quarry qualified for the manufacturing sales tax exemption because it was also used to maintain stock piles of rock inventory (an activity that qualifies as part of the manufacturing process in Nebraska). It did not matter that equipment was used principally for real property improvement services (i.e. maintain roads). All that is required for the exemption is that the equipment be used at least in part for manufacturing purposes. Therefore, manufacturers with Nebraska locations may want to review their purchases to see if additional items and equipment purchases can qualify for exemption from Nebraska sales and use taxes.
Developing Software Now Qualified Manufacturing Activity
Effective August 1, 2015, Washington expanded its sales tax exemption for manufacturing equipment to software developing companies that deliver the pre-written software they produce electronically. Such companies now qualify under the definition of a “manufacturer” for Washington sales tax purposes13.
As seen from the above developments, there are a number of general sales tax exemptions available and the trend has been increasingly favorable for manufacturers. However, each state often has its own unique application of these exemptions. This can create opportunities in select cases to possibly utilize exemptions which were previously thought not applicable such as in the Nebraska Kerford Limestone case. Unfortunately, it also creates pitfalls where exemptions are improperly used leaving manufacturers vulnerable to significant assessment of state sales and use taxes, plus related interest and penalties. Because of these complexities, manufacturers should perform periodic reviews of their sales and use tax procedures to make sure exemptions are appropriately taken on purchases and that sales taxes are collected or exemption certificates received from customers in states where physical presence exists.