Your manufacturing business is essential for the innovation of goods that contribute to the growth and well-being of consumers in California. However, your work likely involves complex processes that carry equally complex sales tax applications under CDTFA regulations. Without a clear understanding of your California sales tax obligations as a manufacturer, you increase your risk for audit, financial penalty, and other punishment that may come with inaccurate reporting. Here, we will introduce you to the fundamentals of California sales tax as a manufacturer, highlight specially regulated manufacturing industries, and discuss some available exemptions.
When Manufacturers Pay California Sales Tax on Their Purchases
Manufacturers use their skills, knowledge, and tools to create new items through the processing or other alteration of raw materials and personal property. As a result, manufacturers participate in multiple transactions where sales tax could apply. On the front end, you will likely pay sales tax on the materials, tools, aids, and other items you purchase to help you manufacture a finished product. However, you will not usually pay sales tax for the raw materials or property that become a part of the manufactured product. As an example, you would pay sales tax on the hammer bought to build a bench, but you would not pay sales tax on the purchased lumber or nails that ultimately become the bench.
Sales Tax for By-Products and Joint Products Created from Manufacturing Processes
As explained above, manufacturing often involves two types of personal property. The property you use or consume in the manufacturing process and the property you eventually resale as a finished product (i.e., combined raw materials). Depending on the manufacturing process, you may also have raw materials that become separately identifiable by-products (e.g., the pulp from a fruit juice processor).
The CDTFA requires payment of use tax on the by-products you consume during the manufacturing process unless you can show that you combined the by-product with the purchased property beforehand. Manufacturers that consume by-products in their operations should develop a method of cost allocation for consumed materials to properly report use tax liability. The CDTFA typically allows manufacturers to use any method of their choosing so long as it conforms with generally accepted accounting principles and the taxpayer consistently applies the method. Taxpayers can also obtain approval from the CDTFA prior to adopting an accounting method to ensure compliance.
California’s Partial Exemption for Certain Manufacturing or R&D Equipment
California offers a partial exemption on certain manufacturing and research equipment purchases that would otherwise be subject to sales tax based on the retail price. Until June 30, 2030, qualified taxpayers only pay a 3.3125 rate (plus any applicable district tax rates) on qualified purchases or leases for a limit of up to $200 million per calendar year. To receive the benefit of the partial exemption your business and the related equipment purchase must meet certain criteria:
- You must be primarily engaged in a qualifying industry under the NAICS (i.e., derive 50% or more of revenue from industry-related activity).
- The purchase must have a useful life of a year or greater (generally determined through depreciation or capitalization treatment on state income or franchise tax returns).
- You must primarily use the purchased equipment for qualifying manufacturing or R&D purpose (i.e., more than 50% of its use).
- https://www.cdtfa.ca.gov/formspubs/cdtfa230m.pdf (partial exemption certificate)
- https://www.cdtfa.ca.gov/formspubs/cdtfa230mc.pdf (partial exemption certificate - construction contracts)
- https://www.cdtfa.ca.gov/formspubs/pub541.pdf (partial exemption tax guide)
When Must Manufacturers Collect Sales Tax from Customers?
As a manufacturer, you will collect applicable state and local sales tax on the gross receipt of your sales to consumers unless an exemption or other standard applies (e.g., use of a resale certificate). You can review California’s district sales tax rate to see if additional tax applies beyond the state’s rate. The CDTFA regulations also specifically distinguish the sales tax application or limitation for certain goods and business activities that relate to manufacturing and producing:
- The alteration of new versus used items (e.g., clothing, fabrics, etc.)
- Painting or finishing of personal property versus real property
- The processing of property a consumer provides (no sales tax applies to mere repair or reconditioning of property)
- Sound recording
- Photographs, photo and film processing, and photocopying
- Motion pictures and related production services
- Teleproduction and postproduction service equipment
- Partial sales tax on the purchase of coke to foundries in manufacturing castings via cupola process
- Fur dressers and dyers
- Liquefied petroleum gas
- Farm equipment and machinery (including the use of diesel fuel)
- Timber harvesting equipment
- Racehorse breeding stock
Handling an Audit or Other Sales Tax Issue as a Manufacturer
Audits and other interactions with the CDTFA can be challenging for businesses focused on the result of their efforts and who may not have time to fully consider the California sales or use tax of their manufacturing operations. The risk of audit and subsequent CDTFA determinations especially increases when you fail to properly classify your equipment, manufacturing aids, raw materials, and by-products. A lack of detailed receipts or use can lead to the imposition of additional taxes that may result in an overpayment. With questions about your sales tax reporting or a related audit, consider a consultation with our sales tax professionals.
Contact us to schedule a free consultation for the sales tax reporting or audit defense of your manufacturing business.