The Appellate Tax Board (“ATB” or “Board”) has recently promulgated several decisions clarifying the activities which constitute manufacturing under Massachusetts law. Entities that are “engaged in manufacturing” are entitled to certain tax benefits in the Commonwealth. The Department of Revenue (“DOR”) has recently responded to the ATB’s opinions in Technical Information Release 08-2 (“TIR 08-2”) and has accepted the refinements made to the group of activities that are to be considered “manufacturing.”
The Supreme Judicial Court’s historically expansive view as to what constitutes manufacturing activity has been confirmed and expanded in recent case law, which reinforces that the broad purpose of the statute is the “promotion of the general welfare by inducing new industries to locate in Massachusetts and by fostering expansion and development of our own industries.” Joseph T. Rossi Corp. v. State Tax Commission, 369 Mass. 178, 181 (1975).
Manufacturing Classification vs. Manufacturing Status
A corporation can apply to the Commissioner of Revenue to be formally classified as a manufacturing corporation pursuant to M.G.L. c. 58 § 2. Such formal classification, when granted by the Commissioner of Revenue, entitles a corporation to tax benefits including: 1) the availability of an investment tax credit (M.G.L. ch. 63 § 31A); 2) sales and use tax exemptions for certain sales related to manufacturing (M.G.L. ch. 64H §§ 6(r) and (s)); and 3) the ability to apportion multi-state income using single factor sales as opposed to the normal apportionment method in which sales are double weighted against property and payroll (M.G.L. ch. 63 § 38(l)).
A corporation that does not formally apply for manufacturing corporation classification but that is engaged in manufacturing may be treated as having manufacturing corporation “status.” A corporation with manufacturing corporation status is entitled to most state tax benefits, but may not claim available local property tax benefits based on their status as manufacturer. It is identifying which activities entitle corporations to this status, thereby conferring on them the tax benefits mentioned above, that the Appellate Tax Board most recently addressed. Courts have historically held that even those processes which do not result in a finished products may constitute manufacturing for purposes of conferring tax benefits where the activities in question constitute “an essential and integral part of a total manufacturing process.” Joseph T. Rossi Corp. 369 Mass. at 181-182.
Engaged in Manufacturing
Historic Holdings regarding Manufacturing Status
The standard articulated in William F. Sullivan & Co., Inc. v. Commissioner of Revenue has been relied on for many years. The Court in William F. Sullivan confirmed the definition of manufacturing as “[C]hange wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use.” Id. at 579. In more recent years, where there was no tangible or final product for sale by the taxpayer, the Houghton Mifflin case has been used as a guideline by the DOR and taxpayers alike. In that case, the Supreme Judicial Court held that the taxpayer’s activities, which included producing, editing and layout of the text in an electronic form, was considered manufacturing despite the fact that the tangible products, the books, came into physical existence, or were printed, by an unrelated third party hired by the taxpayer. In its decision, the Court refined the definition of what constitutes being “engaged in manufacturing” to include where the taxpayer “transforms ideas, art, information, and photographs, by application of human knowledge, intelligence, and skill, into computer disks, ready for use by independent printers, containing an immense amount of information in a highly organized form.” Houghton Mifflin Co. v. State Tax Commission, 423 Mass 42 (1996). The ATB, in its most recent rulings discussed below, remain consistent with the concept set out in Houghton Mifflin and allow taxpayers manufacturing status even when there is no tangible product that contains the highly organized information or specifications for manufacture of the end product.
The First Years, Inc v. Commissioner of Revenue, Appellate Tax Board No. C267626
Promulgated: September 17, 2007
Where The First Years’ products were mass-manufactured by unrelated third parties overseas, the ATB held that The First Years qualified as a domestic manufacturing corporation under M.G.L. c. § 38C. The First Years activities included research, design and safety testing of prototypes, development of new products and improvements to existing products for sale. The Board considered the level of involvement of employees located in Massachusetts to the overall manufacturing process, and in coming to understand that ideas, refinements to products, and approval to manufacture came from employees in the Commonwealth, determined that the activities of The First Years were integral and essential to the overall manufacturing process. In making its determination, the Board also cited that quality and safety testing was conducted by employees of The First Years, and that tooling and molds used to manufacture were owned by The First Years. In its opinion, the Board relied heavily on the Supreme Judicial Court’s opinion in the 1996 Houghton Mifflin case, mentioned above.
Duracell, Inc. v. Commissioner of Revenue, Appellate Tax Board No. C266416
Promulgated: August 28, 2007
The ATB found that Duracell’s R&D facility in Needham, which was used exclusively to develop, produce and design improvements to existing products and new products, was an essential and integral part of Duracell’s manufacturing operations. During the tax periods at issue, Duracell had only one facility in Massachusetts, and that facility was devoted to development, improvement and enhancement of battery products or battery manufacturing technologies. While substantially all of Duracell’s receipts were derived from the sale of batteries, none of product that came from the Massachusetts facility was sold at retail. The board concluded that because Duracell generated a large number of their products which were sent to customers for trial in their products, and because those products were substantially similar to those products that were found in stores, the taxpayer transcended the prototype stage and therefore qualified as a manufacturer. Generally, the research, design and creation of a prototype in and of itself is not considered manufacturing. In TIR 08-2, the Department stated that it concurred with the findings of the board and would not seek judicial review with regard to the manufacturing status of the taxpayer. It is important to note that the other issue in this appeal related to receipts related to research and development activities. During the tax periods at issue in the Duracell case a certain amount of receipts from research and development were needed to qualify as a research and development corporation and, as a result, be eligible for additional sales and use tax exemptions. The Commissioner accepted the ruling regarding Duracell’s manufacturing status.
Onex Communications Corp. v. Commissioner of Revenue, Appellate Tax Board No. C271834
Promulgated: September 11, 2007
In this case, the ATB found that Onex was entitled to an abatement of use tax on purchases of certain materials based on its qualification as a foreign manufacturing corporation as defined in M.G.L. c. 63 § 42B. The activities of Onex included working with an abstract concept to eventually produce a piece of technology that was ready for market. Though Onex was responsible for bringing the concept of this technology to a specific blue print, it never had the capacity to manufacture any tangible prototypes or products for commercial sale. Instead, Onex entered into an agreement with an unrelated third party to produce the technology and refined the production blue prints as prototypes were returned to Onex and examined. The third party manufacturer had no discretion or control to exercise in the production or design of the product. The Board held that Onex carried out steps that were “essential and integral” steps in the manufacturing of the product, and that, akin to the Houghton Mifflin case, a transformative change occurred which produced a commodity (the blueprint and manufacturing specifications) that had never existed before. The fact that the taxpayer itself did not produce a tangible product was irrelevant.
Manufacturing Moving Forward
Both the Appellate Tax Board and the Commissioner of Revenue have demonstrated, by way of these recent rulings and associated TIR 08-2 that the expansive view of the legislature and the Supreme Judicial Court will continue to be read broadly. As the Commonwealth continues to adjust its definition of manufacturing with the technological capabilities of clients as well as increasing globalization an environment that is increasingly palatable for foreign corporations is created.