Think You’re Not a Manufacturing Company? Think Again!
Deadline Approaching for 2018 Retroactive Classification in Massachusetts
Like many states, Massachusetts offers significant tax benefits to corporations engaged in manufacturing. But, what is “manufacturing?” In the words of a former U.S. president, “it depends on what the meaning of the word ‘is’ is.” Or, in this case, the meaning of “manufacturing.”
The window will soon close for classification as a manufacturing corporation for the 2018 calendar year. Now is the time to consider whether your company may qualify for classification, and the following is intended to help in making that determination.
Tax benefits available for manufacturing corporations
A corporation engaged in manufacturing in the commonwealth may be entitled to beneficial income, sales/use and property tax treatment. Available benefits include:
- The 3% investment tax credit,
- Single sales factor apportionment,
- An exemption from the 6.25% sales tax for equipment and supplies used in manufacturing or research and development, and
- A full exemption from the up to 4% personal property tax.
“GAGNONtax has secured classification for numerous clients where other providers had advised that classification was not possible. We have likewise obtained approval in cases where applications, whether prepared by other providers or internally by the client, were denied by the Department.”
What kind of activity qualifies as manufacturing?
While historically these tax benefits were generally limited to traditional manufacturers of tangible personal property, the legal meaning of “manufacturing” has progressively expanded over time. Further, it is not necessary that all, or even most, of the activity in question occurs in the commonwealth—or even in the U.S.
For example, a corporation engaged in SaaS software development and sales in Massachusetts is engaged in manufacturing. A pharmaceutical corporation that has no approved drugs in the marketplace may qualify, or a corporation engaged solely in research and development if it is producing limited runs of product for testing. Even the production of intangibles such as electronic design files, if integral to the manufacturing process, can qualify. These are just a few examples. The Appellate Tax Board and the courts have proven to be very taxpayer-friendly in related rulings.
There are two levels of manufacturing corporations. A “classified” manufacturing corporation is awarded classification upon approval of a substantive application to the Department of Revenue. Alternatively, a corporation may be regarded as having the “status” of a manufacturing corporation by claiming such status on its tax return and meeting certain requirements.
Once classified, a corporation secures all of the tax benefits described above until it ceases to engage in manufacturing. A corporation claiming manufacturing status receives all of the benefits except the exemption from personal property tax. Classification is preferable, not only for property tax savings, but also because is secures entitlement to the other tax benefits.
In contrast, manufacturing status is merely the adoption of a return position that is subject to review on audit. While a classified manufacturing corporation is not immune from review on audit, it is awkward for the Department to claim the taxpayer is not engaged in manufacturing when it has reviewed and approved a substantive application, especially if such approval occurred fairly recently. In fact, classification can even bootstrap a claim in an audit of historical years (or in a refund claim) that single sales factor apportionment (or any of the other tax benefits) should have been claimed.
Generally, a new application for classification as a manufacturing corporation must be filed by January 31 of the calendar year for which classification is sought. However, an infrequently utilized method statutorily extends the filing deadline by several months and gives retroactive classification to the beginning of the year. A taxpayer that did not meet the general deadline for the 2018 year may still apply if it takes appropriate action by a date that will soon be specified. That date will be 30 days following the release by the department of its annually published “Corporations Book.” In recent years, the 30-day deadline has fallen during June or July.
How much work is an application for classification?
The application requires detailed narrative descriptions of the taxpayer and its activities, both in and outside the commonwealth, as well as calculation of several financial thresholds. For a traditional manufacturer of tangible personal property, the application can be fairly straightforward. For a company that does not fit squarely in that industry, equal parts science and art may be required.
GAGNONtax has secured classification for numerous clients where other providers had advised that classification was not possible. We have likewise obtained approval in cases where applications, whether prepared by other providers or internally by the client, were denied by the Department.
Safe harbor requirements
A corporation is engaged in manufacturing if its business activities involve manufacturing, and if those activities are substantive. This deceptively simple statement is the subject of a regulation and dozens of administrative decisions and court rulings. There are four instances—I like to refer to them as “safe harbors”—where business activity should be regarded as substantial manufacturing:
- 25% of a corporation’s gross receipts are derived from manufacturing activity carried out in the commonwealth. This should not be confused with Massachusetts sales apportionment, as the sales can be made anywhere in the world, and the denominator is limited to receipts attributable to other activities carried on in the commonwealth, or
- 25% of a corporation’s payroll comprises payroll paid to employees in Massachusetts who are engaged in manufacturing activity. Similarly to gross receipts, the payroll denominator is limited to Massachusetts employees, or
- 25% of tangible property in the commonwealth is utilized in manufacturing activity, and 15% of gross receipts are derived from manufacturing activity, or
- 35% of tangible property in the commonwealth is utilized in manufacturing activity.
In making the above determinations, headquarters activity in Massachusetts is excluded entirely. Note that even with failure to meet one of the safe harbors, all is not lost. A corporation may nonetheless be classified if its manufacturing activities are otherwise substantive.
Many corporations with business activity that may not seem like manufacturing nonetheless qualify for tax benefits available for manufacturing in Massachusetts. Although the normal deadline for an application for classification as a manufacturing corporation in 2018 has passed, a statutory quirk allows for a late application and retroactive classification. Now is the time to explore whether your company may qualify for these benefits for the 2018 year before the second deadline passes.
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