SALES AND USE TAX

FOR MANUFACTURERS

Oct. 3, 2013

1

TWO TRUTHS AND A LIE

Bakeries are manufacturers

Restaurants are

manufacturers

Cheese cutting plants

are manufacturers

2

TWO TRUTHS AND A LIE

Plastic wrap to keep packages

on a pallet is taxable

Plastic wrap around dry cleaning is

taxable

Plastic wrap to protect contents

delivered to customers is

taxable

3

TWO TRUTHS AND A LIE

Quality control of raw

materials is taxable

Quality control of work in process is

taxable

Quality control of finished products is

taxable

4

TWO TRUTHS AND A LIE

The safety guard on a lathe is

exempt

The screw driver to assemble the lathe is exempt

The screw driver to assemble the manufactured

product is exempt

5

WHY WE’RE HERE

• Wisconsin sales tax collections were

roughly $4.3 billion in 2012

• Wisconsin has 340 field and office auditors

• Wisconsin auditors assessed $295 million

in 2011

• For every $1 spent on audit, $11 in

additional revenue is generated

6

WHAT IS SUBJECT TO TAX?

• All tangible personal property, unless an

exemption applies

• Listed services, including repair and

maintenance, processing of tangible

personal property, and

telecommunications.

7

WHEN I’M PURCHASING . . .

• What if my vendor doesn’t charge me tax?

• Not a freebie! Use tax applies

• Use tax is due on the storage, use, or

consumption of tangible personal property

in Wisconsin

• Why might this happen?

8

VENDORS DON’T CHARGE TAX

BECAUSE . . .

• Out of state vendor

• Vendor not aware of sales tax obligations

• You’ve given the vendor an exemption

certificate

• Items were removed from inventory for

internal use, including displays,

samples, or giveaways

9

WHAT DOES THIS MEAN

FOR ME?

• Potentially significant tax liability, penalties

and interest

• For manufacturers, state will typically

spend most their time auditing purchases

rather than sales

10

WHAT SHOULD I DO?

• Best practice: consistent review process

for each vendor invoice.

• Where sales tax has not been charged but

should have been, record use tax.

• Pay use tax with sales/use tax returns.

• Keep good workpapers for audit trail.

11

EXEMPTIONS

• Exemptions in Wisconsin are narrowly construed. The burden of proving an exemption applies is on the taxpayer.

• If your facts don’t meet the requirements for an exemption, it doesn’t apply.

• This requires diligence on your part to make sure an exemption applies as intended.

• Requires communication between production and accounting to determine whether an exemption applies.

12

EXEMPTIONS FOR

MANUFACTURERS

• Equipment and machinery

• Inputs or consumables

• Fuel and electricity

• Containers and shipping materials

• Waste reduction/recycling

• Qualified research

13

WHAT IS MANUFACTURING?

• The production by machinery

• Of a new article of tangible personal

property

• With a different form, use, and name from

existing materials

• By a process popularly regarded as

manufacturing

14

SCOPE OF MANUFACTURING

• Manufacturing begins when raw materials

begin to be changed.

• Manufacturing ends when the finished

product reaches its first point of storage.

• Items used either before manufacturing

begins or after it ends are not exempt,

even when used by a manufacturer.

15

INCLUDED IN MANUFACTURING

• Conveying work in process directly from one manufacturing process to another in the same plant;

• Testing or inspecting throughout the manufacturing process the product that is being manufactured;

• Storing work in process in the same plant where the manufacturing occurs.

16

INCLUDED IN MANUFACTURING

• Assembling finished units in the same

plant by the manufacturer of those units.

• Packaging units in the same plant by the

manufacturer of those units.

17

MEANING OF “PLANT”

• A parcel of property or adjoining parcels of property and the buildings, machinery, and equipment that are located on the parcel.

• The activity at each plant must meet the manufacturing requirements.

• If a second plant is not separately manufacturing, none of its equipment will be exempt.

• Equipment, machinery, containers and other materials used to ship goods between plants are not exempt.

18

NOT INCLUDED IN

MANUFACTURING

• Testing of raw materials

• Storage of raw materials

• Storage of unfinished goods if removed

from the manufacturing process

• Storage of finished goods in inventory

• Internally repairing or maintaining

equipment

19

NOT INCLUDED IN

MANUFACTURING

• Processing or fabricating that does not

meet all the criteria of manufacturing

• Storage or transportation of work in

process between two plants

• Creation or duplication of digital goods

20

FABRICATION VS.

MANUFACTURING

• Manufacturing requires a “new article” with

a different form, use and name.

• The application of labor to an article is not

manufacturing unless the finished article is

“clearly and distinctively new and

different.”

21

SERVICES FOR

MANUFACTURERS

• A company that is not a manufacturer

that performs a test or other service

for a manufacturer may not claim

manufacturing exemptions.

• Repackaging or reassembling

products on behalf of a manufacturer

for reshipping is not manufacturing.

22

EXAMPLES OF

MANUFACTURERS

• Bakeries

• Breweries

• Creameries

• Cheese slicing and packaging plants

• Meat packers

• Food processing plants

• Snowmaking for ski hills

• Printers

23

NOT MANUFACTURERS

• Contractors

• Farmers

• Research and development firms

• Mining companies

• Recycling companies

• Photographers

• Restaurants

24

EXEMPTIONS FOR

MANUFACTURERS

• “Machines and specific processing

equipment and repair parts exclusively

and directly used by a manufacturer in

manufacturing tangible personal property.”

25

WHAT IS A “MACHINE”?

• An item that is “principally and primarily a

significantly contributive factor in the

actual manufacture or production of the

product.”

• This is known as the “use and function”

test.

• Requires “activity” on the part of the

machinery or equipment.

26

“MACHINES AND SPECIFIC

PROCESSING EQUIPMENT”

• Includes small hand tools

• Includes repair and replacement parts

(augers, bits, dies, wheels, jigs, drills, tool

holders, cutters, saw blades)

27

SAFETY ATTACHMENTS

• Exemption applies to safety attachments for exempt machines.

• Safety attachments may protect the operator, the machine or the product being manufactured.

• Safety attachments do not have to be original with the machine, but

• Must be physically attached to the machine.

28

WHAT IS “EXCLUSIVE USE”?

• “Exclusive” means that the machines and

specific processing equipment are used by

a manufacturer in manufacturing to the

exclusion of all other uses, except for

occasional and sporadic use.

• “Occasional” use is generally defined

as 5% or less.

29

EXAMPLES OF

“EXCLUSIVE” USE

• Equipment used exclusively in testing

products through the manufacturing

process is exempt. If the same equipment

is used more than 5% of the time to test

raw materials before the manufacturing

process begins, or to test finished

product after the first point of storage,

the equipment will not qualify for the

exemption.

30

EXAMPLES OF

“EXCLUSIVE” USE

• Cranes, pallet jacks, fork lifts and conveyor belts used exclusively within the manufacturing process to lift and move product are exempt.

• If that same equipment is used more than 5% of the time to move product before or after manufacturing begins, or is used to move manufacturing equipment, tools, or other plant equipment, it will not qualify for the exemption.

31

BEST PRACTICE TO MEET

“EXCLUSIVE” TEST

• Assign specific equipment to testing

versus manufacturing areas;

• Use different fork lifts, pallet jacks and

other conveyance equipment for the

warehouse than used on the

manufacturing floor.

32

WHAT IS “DIRECT” USE?

• Machines or equipment must physically

impact the manufacturing process.

• Machines or equipment that are passive

or that act on something other than the

product being manufactured are not

exempt, even if the machines or

equipment are necessary or required

for the manufacturing process.

33

EXAMPLES OF ITEMS THAT ARE

NOT USED “DIRECTLY”

• Tables and stands used to hold manufacturing equipment are not used “directly” in manufacturing and are not exempt unless the stand is purchased from the seller of the machine as an original component part of the machine.

• Items used for waste disposal, air circulation, communication, lighting, fire suppression, and maintenance are not used “directly” in manufacturing even though they may be required for the manufacturing process to occur.

34

EXAMPLES OF ITEMS THAT ARE

NOT USED “DIRECTLY”

• Tools used to repair manufacturing

machines

• Water softening equipment

• Refrigerated storage facilities, even if the

refrigeration occurs during the

manufacturing process

35

STORAGE TANKS

• Tanks used within the scope of the

manufacturing process may be taxable

or exempt, depending on their features.

• Tanks that are passive receptacles of

product are taxable.

• Tanks that cool or heat, agitate, change

or mix raw materials are used “directly”

in manufacturing and are exempt.

36

WHAT IS “TANGIBLE PERSONAL

PROPERTY”?

• Personal property that can be seen,

weighed, measured, felt or touched, or

that is in any other manner perceptible to

the senses, and includes electricity, gas,

steam, [and] water . . .”

37

EXEMPTION FOR INGREDIENTS

AND CONSUMABLES

• Different from the machinery exemption

• Must still be used in the scope of

manufacturing

• Must still be used by a manufacturer

• Additional requirement: must be used in

manufacturing items that are destined

for sale as tangible personal property

38

“DESTINED FOR SALE”

REQUIREMENT

• Excludes inputs for items that will be used

internally or given away.

• Excludes inputs used by a manufacturer

that manufactures and installs real

property improvements.

• Examples: cement, countertops,

cabinetry, ductwork, prefabricated

buildings.

39

WHAT THE EXEMPTION

APPLIES TO

• Product must be become “an ingredient or

component part of the article of tangible

personal property . . .” or

• Become “consumed or destroyed or lose

its identity in manufacturing . . .”

40

EXAMPLES OF CONSUMABLES

• Gases

• Lubricants

• Filtering clay

• Foundry sand

• Lapping and grinding compounds

• Cleaning agents and solvents for maintaining

manufacturing machinery

• Safety supplies used to maintain the purity

of the product being manufactured (gowns, gloves,

shoe covers) 41

EXAMPLES OF ITEMS THAT ARE

NOT EXEMPT

• Safety glasses, clothing, shoe covers, and gloves used to protect the workers from the product or the process

• Cleaning supplies used to maintain the facility, even in a clean room

• Cardboard used to contain or absorb liquids or waste products

• Shop towels, even if used to maintain manufacturing equipment

42

USING PERCENTAGES

• To avoid having to track how individual

supplies are used, calculate a reasonable

percentage of exempt versus taxable use,

and apply that percentage to your ongoing

purchases. Update periodically.

• Examples: cardboard, wrap, gloves,

cleaning supplies.

43

FUEL AND ELECTRICITY

• Fuel and electricity consumed in manufacturing tangible personal property is exempt.

• Fuel can include oxygen, acetylene, and other gases used to produce heat or power.

• Must be used directly in manufacturing, not for plant heating or cooling, lighting, receiving, storage, shipping or office.

44

FUEL USED IN

MANUFACTURING

• Calculations of the percentage of fuel

exemption claimed are subject to audit.

• Percentages may be calculated through

third party utility studies, but may also be

calculated by other methods.

45

CALCULATING PERCENTAGE OF

EXEMPT FUEL

• Study must be reasonable and documented.

• May consist of a list of machines, energy consumption per machine, how many hours each machine operates per day compared to total plant energy usage.

• Must be adjusted as circumstances change (machinery added or removed, shifts added or ended).

46

CONTAINERS

• Containers and packaging materials are

exempt when used to transfer

merchandise “destined for sale” to

customers.

• Does not apply to containers used to

transport products for further

processing or products that are not

“destined for sale”

47

CONTAINERS THAT QUALIFY

• Boxes, product and shipping labels, wrapping paper, tape, barrels, bottles, sacks, cans, drums, and packaging materials used to keep the product safe in shipping

• Packaging materials include items inside a package that preserve, stabilize, or protect the contents

• It does not matter what the container is made of

• It does not matter whether the container is returnable

48

ITEMS THAT

DON’T QUALIFY

• Advertising flyers, packing slips, coupons

and other items included in the package

• Lumber or other material used for

bracing, blocking, or shoring items in

shipping

• Cardboard, paper and wrap that are used

to protect products during shipping but

are not transferred with the product to the

customer.

49

WASTE

REDUCTION/RECYCLING

• Exemption applies to machinery and

equipment used exclusively and directly

for waste reduction or recycling activities

that reduce the amount of solid waste

generated, reuse solid waste, recycle solid

waste, compost solid waste or recover

energy from solid waste.

50

DEFINITIONS

• Solid waste means garbage, refuse,

sludge or other materials or articles,

including solids, semisolids, liquids, and

contained gases.

51

EXAMPLES OF EXEMPT

RECYCLING EQUIPMENT

• Machinery used to produce fuel cubes by

shredding paper and other waste

products; refrigerant recovery systems

where the refrigerant is recycled back into

the cooling unit; equipment used to

remove impurities from lubricants in

manufacturing machines so the

lubricants can be reused; and a system

for burning used oil to provide heat.

52

QUALIFIED RESEARCH

• Exemption became effective as of 1/1/12

• Applies to those who are “primarily

engaged in manufacturing or

biotechnology”

• Applies to items used exclusively and

directly in qualified research

53

PRIMARILY ENGAGED IN

MANUFACTURING

• “Primarily engaged” means more than 50% of the company’s activities must be manufacturing.

• Primary activity is determined by a reasonable measure of all activities conducted in Wisconsin. A reasonable measure of activity may use sales revenue, costs and expenses, or investment in plant, machinery and equipment.

54

EXCLUSIVELY AND DIRECTLY

• Exclusive use means at least 95% of the

total use must be in qualified research

• If other requirements are met, is mixed

use between manufacturing and qualified

research allowed? Yes.

55

QUALIFIED RESEARCH

• Must be undertaken for the purpose of discovering information which is technological in nature,

• The application of which is intended to be useful in the development of a new or improved business component, and

• Substantially all of the activities of which constitute elements of a process of experimentation relating to a new or improved function, performance, reliability or quality.

56

QUALIFIED RESEARCH

• Burden of proof is on the taxpayer

claiming the exemption

• All of the requirements listed above must

be met

• Tests must be applied separately to each

project, product or process

57

NOT QUALIFIED RESEARCH

• Research that relates to style, taste,

cosmetic or seasonal design factors

• Research after commercial production

• Duplication of an existing business

component

• Marketing studies

• Routine data collection

58

DOCUMENTATION

• Same as required for an R&D study

• Project scope (including uncertainty as

to scope)

• Research and testing activities

performed

• Results of the research

• The specific activities and manner in

which the exempt items are used

59

SALES BY MANUFACTURERS

• All sales of tangible personal property are presumed to be taxable unless an exception or exemption applies

• The burden of proving a sale is not taxable is on both the seller and the buyer (not the state)

• Manufacturers that sell both wholesale and retail in Wisconsin are required to have a seller’s permit

• Sales of business assets are taxable

60

DOCUMENTING EXEMPT SALES

• Where sales are made out of state,

document out of state ship to address on

invoice

• Where sales are wholesale, manufacturer

must obtain valid exemption certificates

61

EXEMPTION CERTIFICATE

REQUIREMENTS

• Name and address of buyer

• Name of seller

• Description of property

• Reason for exemption

• Must be signed by buyer

• Must be dated

• If the buyer is from out of state (but sale occurs in Wisconsin), must also obtain buyer’s state tax identification number.

62

ACCEPTING CERTIFICATES

• The seller must not have a reason to

know of false or misleading information

on the certificate

• The seller is presumed to know if an

exemption could apply to the purchase

• The seller may be held liable for

soliciting invalid exemption certificates.

63

AUDIT FLAGS

• Failure to report any use tax

• A vendor is audited

• A customer is audited

• Industry initiatives

• Recent press

• Building permits

• Claims for refund

• Prior audit with poor results

64

DEFENDING AN AUDIT – USE

• Institute consistent practice of reviewing all

vendor invoices and credit card charges

• Document reasons for exemptions

• Document percentage allocations

• Keep use tax calculation workpapers

• Reconcile and document credit memos

and adjustments

• Be careful with exemption certificates!

65

DEFENDING AN AUDIT - SALES

• Invoice all sales of used assets and

charge tax where appropriate

• Document where sales occur

• Obtain exemption certificates, even if the

exemption seems obvious

• Check exemption certificates for

accuracy

66

MULTISTATE ISSUES

• Where does a sale occur? Where

possession of the goods transfers.

• When shipped by common carrier or

delivery service, possession transfers

when the goods reach their destination.

Does not matter who chose or paid the

shipper.

67

SALES OUTSIDE WISCONSIN

• Not subject to Wisconsin sales tax

• Will be subject to the destination state’s

rules

• You may (or may not) be required to

collect the other state’s tax

• Will depend on whether you have

nexus

68

WHAT IS NEXUS?

• Nexus is the threshold that must be met in

order for a state to require an out of state

business to collect sales tax.

• For sales tax, a business must have

physical presence in a state in order to

create nexus.

• Without physical presence, the state

cannot require the business to collect tax

on sales made to customers in that state.

69

PHYSICAL PRESENCE

• Salespeople, but doesn’t matter if they’re

employees or independent contractors

• Employees working from home

• Third party installers and repair people

• Trade shows (in most states)

• Delivery in a company vehicle

• No physical presence = no sales tax

obligation – or does it?

70

MARKETPLACE FAIRNESS ACT

• Has passed the Senate; currently in the House

• Would impose sales tax collection and remittance requirements on out of state businesses despite lack of physical presence

• Would apply to sellers with more than $1 mm in out of state sales

• Is not limited to “on-line” sales

71

PREPARING FOR “FAIRNESS”

• Start collecting exemption certificates from

every customer wherever located

• Expect many more nexus questionnaires

• Track sales by state

• Become knowledgeable about states’

responses to the law change

• Implement systems to record, collect

and remit tax where appropriate

72

QUESTIONS?

Julie Bogle, JD

julie.bogle@sgcpa.com

828-3119

Peter Soman, CPA

peter.soman@sgcpa.com

828-3174

73