“Manufacturing” for sales tax purposes is often defined as a physical application of materials and labor to change the characteristics of tangible personal property. Makes sense, but does that mean your business is exempt? Not so easy. Every state has nuances on how sales tax applies to the manufacturing process and the various equipment and materials that are used and consumed. There are many gray areas that can create signification exposure, or savings, for your business.
Being strategic in how you purchase items and the way you design the manufacturing process can affect your sales tax costs.
Some tax exemptions are clearer than others
“Consumables” are materials purchased and used (“consumed”) during manufacturing but that don’t attach themselves directly to the tangible property that leaves your manufacturing facility. Examples might include gases or chemicals used to change the physical nature of tangible property during manufacturing. Depending on the state where you have your manufacturing facility, you could have different tax treatment of these products.
Raw materials are different than consumables and 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 could be put into question.
Raw materials can also come in the form of packaging and labelling. A lot of states either include these items in the definition of raw materials or have a specific exemption for packaging and similar products.
Machinery is an easier call -- slightly
Generally, sales tax exemptions apply to the machinery and equipment that are directly impacting the manufacture of the tangible personal property. But 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 states give complete exemption, some a discounted tax rate.)
Other examples of equipment with exemptions in many states:
Equipment to move your product during the process (a forklift, for instance). Some states exclude such equipment from exemption if it moves raw materials from storage to the beginning of the process. If you split the use of such equipment between exempt and non-exempt activity, most states will say your predominant use of the equipment is the guiding rule.
Controls, piping, conveyors and other devices allowing for the operation of your manufacturing process.
Quality control, research-and-development equipment and, in some cases, computers and related equipment.
Utilities such as water (when used as a coolant, for example) and chemicals added to the water to facilitate cooling. Some states allow percentage deductions for utilities such as electricity directly involved in manufacturing.
Other items possibly qualifying for exemption include hand tools, lubricants, and metered fuels.
Documenting exactly how and when you use purchased materials and equipment can go help minimize your tax exposure.
Sales tax is complex for all industries, but what seems simple for manufacturing, may be more complex than you realize. Be sure to understand the rules associated with the states in which you have nexus and monitor them regularly. If you need additional help, working with a sales tax expert can be extremely beneficial so you aren’t left figuring out the complexities on your own.
TaxConnex has assisted companies in many industries alleviate the burden of sales tax. We are experts when it comes to navigating tax regulations. Contact us to learn more about how TaxConnex can take sales tax off your plate entirely.
Check out our webinar on sales tax complexities within the manufacturing industry.