Manufacturing Tax Exemptions

The basics on where items used and consumed in manufacturing fit in.

Most manufacturers understand that they are exempt from paying sales tax on items that become incorporated into the product that is eventually sold to a customer. What about the sales tax paid on the purchase of machinery and equipment that is used within a facility – directly or indirectly on a product for resale – and necessary to the manufacturing process of the product?

Changes to sales tax exemptions over the past several years have caused murky interpretations and guidance on exactly what activities and materials are exempt in the manufacturing process.

Many types of machinery and equipment are exempt from both state and local sales taxes.Together, the exemptions can amount to a 5-8%savings on purchases in some jurisdictions.

Sales tax refund opportunities for manufacturers are one of the greatest ways for both small and large businesses to reduce up-front costs on business purchases and maintain a healthy product inventory. Yet, this opportunity to save money is often overlooked or underutilized.  How confident are you that your business is taking full advantage of your manufacturing sales tax exemptions?

Changing Regulations – What is Exempt?

Every state has its own nuances with sales and use tax law, as we examine these exemptions it is critical to understand how any given state will apply them. For example, certain states are “direct use” exemption states, meaning the items being exempted must directly touch the product being manufactured, or enact some chemical or physical change on the product itself. This only allows a narrow application of sales tax law and certain items to be exempt, and in some cases those items must have a useful life of greater than a year.  

Other states, such as Georgia, employ an integrated plant theory approach to sales tax exemptions. This allows for a broader application of the sales tax law and a much more favorable treatment of many items used in the manufacturing process, and many processes that support manufacturing itself.

Part of the problem regarding the application of these exemptions is that the rules are constantly changing. That makes it challenging for busy manufacturers to know what’s covered, what might have been included with a recent law change or interpretation, or what types of exemptions might have expired. Most businesses know they shouldn’t pay taxes on large capital manufacturing purchases like plant machinery and equipment, but they may not know they are exempt from paying for materials used in repairs of this equipment,or potentially consumable supplies like towels, safety equipment, lubricants and even boots. Yet all these things are considered by some jurisdictions to be “necessary and integral” to the manufacturing process.

Here’s a quick snapshot of some exemptions that have changed significantly just in Georgia over the past few years:

1. Raw Materials and Packaging: While this has been in place for a few years now, the exemption has been modified. Manufacturers can exempt certain packaging material, cellophane, dunnage and even pallets used in the packaging process for shipping product to customers.

2. Consumable Items: In 2014, consumable items language was added to the definition of “equipment” as an exemption recognized by the Georgia Department of Revenue for manufacturers. Consumable supplies, or tangible personal property consumed or expended during manufacturing, is now included in the manufacturing exemption.

3. Utility Exemption: Phased-in exemption initiated in 2013 (25%), 50% in 2014, 75% in 2015 and 100% thereafter provides an exemption of sales tax on energy used or consumed in the manufacturing process. This continues to be evaluated and modified for analysis and even inclusion of local option sales tax components which were previously excluded from the utility exemption.

4. Safety Equipment and Uniforms: Items that provide safety to an employee or protect the quality and integrity of the product could be exempt from sales tax.

Are Restaurants Manufacturers? In Some Cases, Yes!

Certain states have provided interpretations that restaurants are to be included in the definition of a manufacturer, and this provides them many of the same exemptions as large manufacturers, and in some cases, even allows for the application of utility exemptions based on their usage within a restaurant location. These exemptions need to be accompanied by a qualified utility study. We can assist you in coordinating these studies and can apply the appropriate percentages and file for refunds related to overpayments of the taxes on these utilities.  

Getting Your House in Order Before Filing a Claim

While these exemptions may sound very enticing and straightforward, we do not recommend that manufacturers rush to file sales tax refund claims. When you file a refund claim, you need to be sure that your sales tax process is clear from any outstanding issues that may arise from the Department of Revenue reviewing your account. If this refund claim potentially triggers an audit, which it can, you must to be prepared to defend an inquiry adequately and accurately.

A professional advisor can help you determine why you overpaid in the first place. You’ll also want to be sure you are charging and collecting tax where appropriate and collecting, remitting and filing returns when necessary.

If everything checks out, it’s straightforward to file a claim for a line item refund. If you bought something that should have been exempt under a manufacturing exemption statute, the team at Synexus can help you file a claim for your refund in many jurisdictions. Most jurisdictions allow for a multiple period lookback for refund analysis and claims with regards to sales tax procedures.

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