Published: January 11, 2024

Navigating Sales Tax Exemptions in Manufacturing

Navigating Sales Tax Exemptions in Manufacturing

In the manufacturing industry, numerous states provide opportunities for companies to leverage sales tax exemptions. These exemptions often cover items crucial to the manufacturing process, such as raw materials, machinery, and equipment, as well as consumable supplies. However, it’s essential to note that just because an item is necessary for manufacturing doesn’t guarantee its qualification for exemption.

Understanding Taxability Theories

Manufacturers must grasp that states generally follow one of two theories – “direct use” or “integrated plant” – to determine the taxability of items in the manufacturing process. Let’s explore these theories and how states apply them.

  1. Integrated Plant Theory: The integrated plant theory posits that machinery and equipment integral to the manufacturing process will generally be exempt from sales and use tax. This model encompasses a broader subset of exemptions.
  2. Direct Use Standard: The direct use standard stipulates that only machinery and equipment directly involved in changing the product being manufactured will be exempt from sales tax. Notably, more states tend to follow this model than the integrated plant theory.

State-Specific Nuances

Companies with manufacturing plants in multiple states face the daunting challenge of staying abreast of the models embraced by each state and the specific nuances within them. As expected, this often leads to confusion and perplexing answers. For instance, consider a 2021 private letter ruling issued by the North Carolina Department of Revenue1. The taxpayer in this ruling was a yarn manufacturer that had purchased and installed fire detection and suppression systems attached to the actual production equipment.

North Carolina, being a direct-use state, generally considers attachments to actual production equipment as exempt. Its Sales & Use Tax Technical Bulletin 57-2 explicitly states that “sales of mill machinery or mill machinery parts or accessories to be used in the production process…to [a manufacturing industry or plant] are exempt from sales and use tax.” In this case, there is a significant fire risk for the yarn, prompting the installation of fire detection and suppression systems on several actual production machines. However, the Department of Revenue ruled that even though the systems were physically attached to the production machinery, they did not qualify for the state’s exemption because the systems themselves weren’t directly used in producing the yarn.

Seeking Expert Guidance

To navigate the diverse landscape of manufacturing-related exemptions offered by states, it’s advisable to consult with experts. Reach out to Clarus Partners for expert advice. We can help your company navigate the diverse landscape of manufacturing-related exemptions offered by states.

  1.  SUPLR 2021-0012, North Carolina Department of Revenue (March 1, 2021).