The state of Pennsylvania exempts sales tax on the purchase of materials, equipment or services that are used directly in the manufacturing process according to state law. This manufacturing exemption sounds simple on the surface; however, it can be tricky and time consuming to determine the taxability of certain items. If an item is purchased under the exemption but falls outside of the state’s definition and scope of manufacturing, then the business may owe consumer use tax. Consumer use tax is complimentary to sales tax and is due when sales tax is owed but not paid at the time of purchase. It is the business’s responsibility to ensure they are paying the appropriate amount of use tax. If they do not self-assess and remit the appropriate amount of use tax, they may be subject to a significant tax liability during an audit.
The list below summarizes the top five things to consider when reviewing purchases for use tax accrual for locations in Pennsylvania.
- What is Inside the Scope of the Manufacturing Process in Pennsylvania?
The state of Pennsylvania defines the manufacturing process as starting with the first production operation. In other words, the first change to the raw material. It ends when the product is packaged for the ultimate consumer. This includes internal packing materials and reusable containers.
The following processes are also considered to fall under the scope of manufacturing:
- Repair and maintenance of machinery and equipment used directly in the manufacturing process.
- Pollution control devices – Equipment and supplies used to prevent air, water or noise pollution generated during the manufacturing process.
- Quality control – Equipment used to test and inspect products.
- Research and development – provided that the object of research is to improve or develop a manufactured product.
- Personal protective equipment – Face masks, gloves, goggles, and other items worn by production personnel to provide protection during the manufacturing process are exempt. It should be noted that items used by employees for personal comfort or convenience are not tax exempt.
- What is Direct Use?
Direct use refers to the purpose of the equipment or service. If the physical proximity of the item being used is within and has a direct impact on the production process, it is considered to be used directly in the manufacturing process and exempt from tax.
For example, if a business purchases a tool that is used on the production line during the manufacturing process to modify a product, then the tool is considered direct use and would be exempt from tax under the manufacturing exemption. However, if a tool was purchased and used to repair miscellaneous items in the building, such as the ventilation system, then it would not be considered tax exempt under the manufacturing exemption.
- What is Predominant Use?
When equipment is used for more than one purpose, it must be used predominantly in the manufacturing process to be exempt from tax. To qualify for predominant use, it must be used in the manufacturing process more than 50% of the time.
For example, if a business purchases a forklift, they must determine the forklift’s predominant use to decide if the item falls under the manufacturing exemption or if tax is owed and use tax should be accrued. If the forklift will be used to unload deliveries of raw materials on the receiving dock more than 50% of the time, it is subject to tax. On the other hand, if the forklift will be used to move parts on the production line more than 50% of the time, it will be exempt.
A partial exemption or sales tax refund for predominant use is also possible for manufacturing operations in Pennsylvania. Official predominant use studies can be conducted on utilities to determine the percentage of utility use attributable to production processes and non-production processes.
- What is Outside the Scope of the Manufacturing Process in Pennsylvania?
The following items fall outside of the direct use manufacturing guidelines and therefore are not exempt from tax under the manufacturing exemption. It should be noted that some of the items below may fall under another exemption.
- Preproduction activities – Receiving and storing of raw material.
- Postproduction activities – This includes equipment that loads packaged products into cases or cartons and equipment used to transport, handle or store packaged products.
- Safety and fire prevention equipment, supplies, or programs.
- Real estate – The construction, maintenance, or improvement of buildings.
- Ventilation, heating, cooling, and lighting equipment – This includes the fuel or power used to ventilate, heat, cool, or light a building. If, however, it can be established that equipment has a direct use in the manufacturing process, then it will be exempt.
- What Type of Documentation is Required?
When a business uses the manufacturing exemption, they must provide a properly executed Pennsylvania Exemption Certificate within 60 days of the sale. The Pennsylvania Exemption Certificates does not expire. For more information regarding sales tax exemption certificates by state, click here.
Tips for the Taxpayer
It is in a company’s best interest to make themselves aware of tax exemptions and understand how the exemptions affect their use tax accruals. Without an understanding of the exemptions, there is more potential for incorrect reporting which can lead to a tax liability and potential audits in the future. A business should have a system in place to ensure they are in compliance with state rules and regulations.
Have a question? Contact Jordan Perri, Allyn International.
Contributor: Shannon McCormick-Grubbs
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