Domestic manufacturers’ growth could bring sales tax problems

“Made in America” is back in the headlines. Tariff talk and hard lessons of supply chains during the pandemic are driving new interest in basing manufacturing operations in the United States.

Covid exposed the vulnerabilities of traditional global supply chains, and experts expect reshoring (bringing manufacturing back to the U.S.) to become more common soon. This means new manufacturers of all sizes, from those who market directly to consumers to those who supply those manufacturers with equipment and raw materials, are likely to soon see more sales coast to coast.

And we all know what more domestic sales mean: more sales tax obligations. What do manufacturers have to watch for?

General details

For generations, the U.S. has ranked among the most significant manufacturing nations (especially in such areas as chemicals and high-tech), and recent legislative initiatives and geopolitical factors stand to make manufacturing here even more attractive: Nearly 90% of respondents to a recent survey expect to switch most or some manufacturing facilities and suppliers to U.S. ones.

Yet probably few manufacturers understand all the ways sales tax can affect their business. Our latest annual survey of top finance execs (including in manufacturing) showed that almost half (48%) are “not fully satisfied” with how their business handles sales tax compliance. Among respondents’ top-cited challenges are keeping up with tax code changes and sales tax rates, retaining experts to help with sales tax obligations and the time and expense needed to manage the process. Past sales tax liabilities are also popping up more in due diligence as a deal-breaker in M&As.

In each state with a sales tax (and sometimes in Alaska, where localities have banded together to mandate that remote companies collect from customers and remit to the state sales tax), a certain volume of annual sales ignites “nexus.” This connection between a company and a tax jurisdiction creates sales tax obligations on the part of the company.

Nexus can be economic via remote sales; we recommend that a company with $100,000 in revenue in a state during a 12-month period or 200 separate transactions in annual sales should explore whether they have economic nexus in that state. Nexus can also be physical, created by the presence of a company’s offices, sales reps, service personnel or warehoused inventory or equipment. Other factors contribute to a manufacturing company’s nexus thresholds, including the taxability of their products and whether those products qualify for a sales tax exemption in a state.

No matter the contributing factors to obligation or exemption, penalties for sales tax non-compliance can be stiff. Companies with nexus must register with states and begin filing periodic sales tax returns, often quarterly or semi-annually though deadlines vary greatly.

Sales tax and the industry

Manufacturers, of course, make things – and in that role they may qualify for unusual sales tax breaks even as they incur complex obligations for compliance.

For sales tax, “manufacturing” is often defined as a physical application of materials and labor to change the characteristics of tangible personal property (TPP). Every state has nuances on how sales tax applies to the manufacturing process, equipment and materials.

How a tax jurisdiction such as a state treats a manufacturer for sales tax purposes can depend heavily on how that jurisdiction defines a manufacturer. In Ohio, for example, a manufacturer “must be changing the state or form of a material in order to sell it.” 

Among other definitions that sales tax jurisdictions might treat differently:

Consumables. These are materials purchased and used in manufacturing but that don’t attach themselves directly to the tangible property that leaves a manufacturing facility. Examples might include gases or chemicals.

Raw materials. If a manufacturer buys materials in bulk sales tax-exempt that have a predominant use in a manufacturing process, how those materials are inventoried and used can create a “mixed-use inventory” with sales tax exemptions that a jurisdiction might question.

Equipment. Many states exempt equipment for manufacturing, though some states exclude such equipment from exemption if it moves raw materials from storage to the beginning of the manufacturing process. Other examples of potentially exempt equipment are controls, piping, conveyors and other devices; and, in some cases, computers and related equipment.

Machinery. Sales tax exemptions apply to the machinery and equipment that directly impact manufacturing of TPP, but depending on the type of manufacturing, equipment ancillary from the process itself could qualify for exemptions or sales tax discounts.

Leasing. An equipment “lessor” owns TPP and leases the use of it to a lessee. This property that is owned by the lessor creates sales tax nexus (see below) wherever the equipment resides. TPP is generally taxable whether through sales, lease or rental. Operating and finance (capital) leases also have different tax treatment. In most states, sales tax is imposed on the stream of payments for an operating lease and sales tax is imposed on the upfront purchase price for a capital lease.

Miscellaneous. 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.

If you’re a manufacturer, you probably know a lot about what you make. As we’ve seen, though, if you’re returning operations to the U.S. never assume you can say the same about sales tax.

(Check out our webinar on sales tax complexities in manufacturing.)

TaxConnex has assisted companies in many industries alleviate the burden of sales tax. Contact us to learn more about how we can take sales tax off your plate.