We’ve previously discussed the general rule that Texas sales and use tax are imposed on sales of “tangible personal property” or “taxable services,” [1] and that the Texas Tax Code and Comptroller’s Rules set out exemptions for these items. A discussion of one of these exemptions, the “sale-for-resale” exemption, can be found here. Another common exemption is the “manufacturing exemption,” which applies to the purchase of certain items by a “manufacturer.” Similar to the sale-for-resale exemption, the concept is that because the manufacturer is not the end-consumer of the items being purchased, they should not be responsible for paying tax on the purchase, and instead the burden of paying tax on the final product is shifted downstream to the ultimate consumer.
The Manufacturing Exemption
Texas Tax Code § 151.318(a) provides an exemption from Texas sales and use tax for listed items that are sold, leased, rented to, or stored, used, or consumed by a “manufacturer.” [2] As such, in order to qualify for the exemption, the following must be satisfied: (i) the purchasing party must be a “manufacturer,” and (ii) the item at issue must be one of the items listed in Texas Tax Code § 151.318.
- “Manufacturer”
The term “manufacturer” is not defined by Texas Tax Code § 151.318, which can create some confusion for taxpayers. [3] The Comptroller’s definition is also somewhat unhelpful – Rule 3.300(a)(8) defines a manufacturer as “[a] person who is engaged in manufacturing.” [4] “Manufacturing,” in turn, is defined to mean “[e]ach operation beginning with the first stage in the production of tangible personal property and ending with the completion of tangible personal property.” [5] The term is also defined to include “processing” and “fabrication,” [6] which are defined as follows:
- Processing – The physical application of the materials and labor necessary to modify or to change the characteristics of tangible personal property. [7]
- Fabrication – To make, build, create, produce, or assemble components of tangible personal property, or to make tangible personal property work in a new or different manner. [8]
As these definitions make clear, the term “manufacturer” can be incredibly broad, but generally applies to someone engaged in the creation, or transformation, of tangible personal property.
- Potentially Exempt Items
Texas Tax Code § 151.318 contains a list of items that may be exempt under the manufacturing exemption. These include, among others [9]:
- Tangible personal property that will become an ingredient or component part of tangible personal property manufactured, processed, or fabricated for ultimate sale;
- Tangible personal property directly used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale if the use or consumption of the property is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a chemical or physical change to:
- The product being manufactured, processed, or fabricated for ultimate sale; or
- Any intermediate or preliminary product that will become an ingredient or component part of the product being manufactured, processed, or fabricated for ultimate sale; and
- Services performed directly on the product being manufactured prior to its distribution for sale and for the purpose of making the product more marketable.
Items that fall under one of these categories, or any of the other categories listed in Texas Tax Code § 151.318(a), will potentially be exempt if sold, leased, or rented to, or stored, used, or consumed by a manufacturer.
Potential Issues
Although the application of this exemption may appear straightforward, there are questions that can cause issues for taxpayers. For example, the Comptroller has taken the position that the manufacturing exemption does not apply to “contractors,” [10] which I discussed in a separate post here. However, certain taxpayers are engaged in activities that include elements of both manufacturing and construction, which raises the question – in what contexts should a taxpayer be considered a “contractor” vs. a “manufacturer”? Additionally, taxpayers engaged in manufacturing often purchase materials in bulk, and may not use all of those materials for manufacturing purposes. How should the purchase of those items be treated for purposes of the exemption?
[1] Tex. Tax Code § 151.051(a), 151.010.
[2] Tex. Tax Code § 151.318(a).
[3] See Tex. Tax Code § 151.318.
[4] Tex. Tax Code § 151.318(d); 34 Tex. Admin. Code § 3.300(a)(8).
[5] 34 Tex. Admin. Code § 3.300(a)(9).
[6] 34 Tex. Admin. Code § 3.300(a)(9)(B).
[7] 34 Tex. Admin. Code § 3.300(a)(10).
[8] 34 Tex. Admin. Code § 3.300(a)(5).
[9] Tex. Tax Code §§ 151.318(a)(1)-(3).
[10] 34 Tex. Admin. Code § 3.300(i).
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