Since 2014, California has allowed certain businesses engaged in manufacturing and research and development (R&D) activities to pay a substantially lower sales tax rate when they purchase or lease qualifying equipment. Specifically, eligible businesses are only required to pay state sales and use tax at 3.3125 percent, as opposed to the regular rate of 7.25 percent. This partial exemption was enacted with the goal of bolstering the state’s economy by attracting business and creating high-skilled manufacturing and R&D jobs. However, in light of recent reports indicating that the exemption is underutilized, the California Legislature is considering bills that would expand the measure.
Currently, businesses must meet three requirements in order to claim the exemption. They must:
- Be a “qualified person” engaged in certain types of business—primarily manufacturing or R&D.
- Purchase or lease “qualified property,” which is defined to include equipment used in manufacturing or R&D that has a useful life of one or more years, or machinery, fixtures, or other materials used in buildings that are constructed for manufacturing or R&D purposes.
- Use the qualified property for permitted purposes more than 50 percent of the time. Permitted purposes include manufacturing, processing, refining, fabricating, or research and development in the physical or life sciences, engineering, or biotechnology.
Eligible businesses may claim the exemption for qualifying purchases of up to $200 million per year. While they are still required to pay local sales and use taxes, the exemption could save a business millions of dollars.
Concerns have recently been raised that the exemption is not fulfilling its intended purpose of attracting jobs and investment to California. The 2015 Reshoring Initiative Data Report stated that out of 130,000 manufacturing jobs that were brought back to the U.S. between 2010 and 2015, only 1,479 were reshored in California. Additionally, according to a report that the State Board of Equalization (BOE) delivered to the Legislature on March 1, 2017, businesses claimed approximately $165 million under the exemption in 2016—which is only one-third of the amount that was predicted when the exemption was enacted.
In order to expand use of the partial sales tax exemption and advance the goal of stimulating the state economy, legislators have introduced AB 600 and SB 600. These bills propose several changes to the exemption, including:
- Raising the $200 million annual limit
- Extending the exemption to agricultural processors and businesses that produce electric power from alternative sources
- Adopting a broader definition of “useful life”
- Extending the current sunset date of July 1, 2022
As the California Legislature considers whether to expand the partial exemption, businesses that conduct manufacturing and R&D activities should consult with tax professionals to determine how they can maximize savings on state sales and use taxes. The team at Capital Review Group (CRG) offers expertise on California tax law, as well as tax issues related to manufacturing and R&D. Contact CRG to learn more or schedule a pro bono analysis!
(Sources: http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180SB600, https://www.boe.ca.gov/sutax/manufacturing_exemptions.htm, http://www.boe.ca.gov/pdf/pub541.pdf, http://www.cpapracticeadvisor.com/news/12325326/california-issues-update-on-sales-tax-exemption-for-manufacturing-and-research-and-development-equipment).