When it comes to sales tax, “manufacturing” is often defined as a physical application of materials and labor to change the characteristics of tangible personal property (TPP). Seems clear, but what about your tax obligations and exemptions?
Every state has nuances on how sales tax applies to the manufacturing process, equipment and materials. These gray areas can create big exposure for your business.
Several terms in manufacturing are key to understanding how sales tax impacts this industry. First is the definition of the industry itself.
Ohio, for example, says “a manufacturer must be changing the state or form of a material in order to sell it.” Texas grants exemptions for TPP that’s an ingredient or component of an item manufactured for sale; TPP that makes a chemical or physical change in the manufactured product and is essential in the manufacturing process (though not hand tools); and taxable services performed on a manufactured product to make it more marketable.
(“Services” is a whole other area of sales tax evolution, including services performed for manufacturing.)
Among other important definitions:
Consumables: Materials purchased and used during manufacturing that don’t attach themselves directly to the tangible property that leaves a manufacturing facility. Examples might include gases or chemicals used to change the physical nature of tangible property during manufacturing. Different states can treat consumables differently for sales tax purposes.
Raw materials: These can also be exempt depending on their use and the state. Let’s say you buy materials in bulk, exempt from sales tax, that have a predominant use in your manufacturing process. You place these materials in inventory but pull from that inventory to build items for use in the manufacturing facility or otherwise use the materials in a non-manufacturing capacity. At that point the inventory can be deemed mixed-use inventory and its sales tax exemption questioned.
Machinery: Sales tax exemptions apply to the machinery and equipment that direct impact the manufacture of the TPP. Again, there are variables: Depending on your type of manufacturing, equipment ancillary from the manufacturing process itself could qualify. For example, if your raw materials must be kept at a certain temperature or agitated constantly, special equipment may be required. Some states expand their exemption to include this type of machinery, some give complete exemptions and some a discounted tax rate.
California offers a good example of how intricate exemptions and other sales tax breaks can be for manufacturing. The state provides a sales tax exemption of 3.9375% for basic manufacturing equipment; equipment for food processing, research and development and biotechnology are also eligible. The partial exemption does only apply to the state sales and use tax rate and not to myriad local, city, county or district taxes in California.
Often equipment for manufacturing is exempt in many states, though some states exclude such equipment from exemption if it moves raw materials from storage to the beginning of the manufacturing process. (If you split use of that equipment between exempt and non-exempt activity, most states will say your predominant use of the equipment is the guiding rule.)
Other examples of potentially exempt equipment are controls, piping, conveyors and other devices allowing for the operation of your manufacturing process; quality control and, in some cases, computers and related equipment.
Also potentially exempt are the costs of utilities such as electricity and water and chemicals used to facilitate cooling. Other items possibly qualifying for exemption include hand tools, lubricants and metered fuels.
A few other points
Manufacturing has, of course, been just as affected by global problems and conditions as any other industry. Manufacturers should understand that often changes in inventory usage might trigger use tax on the storage, use or consumption of a taxable item or service on which no sales tax has been paid.
- Documenting how and when you use purchased materials and equipment can help minimize your sales tax exposure, as can effective filing and updating of your exemption certificates. Consider Florida, which now has an exemption for machinery and equipment to produce electrical or steam energy that results from burning hydrogen (the latter is also exempt under certain conditions): Affidavits are required to validate the exemptions.
- Sales tax laws are constantly changing for manufacturers. Vermont, for example, recently expanded its sales and use tax exemption for manufacturing machinery and equipment so that manufacturing machinery and equipment that is part of an integrated production process will be exempt.
TaxConnex has assisted companies in many industries alleviate the burden of sales tax. Connect with TaxConnex to learn how they can take sales tax off your plate entirely, and check out their webinar on sales tax complexities within the manufacturing industry.