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California Sales Tax for Manufacturers and Producers

You or your client’s manufacturing business is essential for producing goods and innovating industry, both of which contribute to the growth and well-being of consumers in California. However, that 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 the risk of audit, tax 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 industries with special rules, and discuss some available sales tax exemptions to help your business.

When Manufacturers Pay California Sales Tax on Their Purchased Materials

Manufacturers use a combination of tools and raw materials to create new items through various processes that are later resold to customers – whether online or in-person. As a result, manufacturers participate in two sets of transactions that involve sales tax. On the front end, you may need to pay sales tax on the purchased items you use to further your manufacturing business. The CDTFA regulations distinguish purchased items into two categories – the property that you use to process raw materials and the raw materials that you physically incorporate into the final manufactured product. Sales tax applies to the items you use to process the raw materials but exempts from sales tax the purchase of incorporated raw materials. See Regulation 1525.

Sales Tax for the By-Products You Create or Consume During the Manufacturing Processes

Depending on the nature of your 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. See Regulation 1525.5.

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. See CDTFA Publication 541. Until June 30, 2030, qualified taxpayers only pay a 3.9375 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 primarily engage 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 more (generally determined through depreciation or capitalization treatment on state income or franchise tax returns).
  • You must primarily use the purchased equipment for a qualifying manufacturing or R&D purpose (i.e., for more than 50% of its use).

You must document transactions that qualify using the Partial Exemption Certificate for Manufacturing and Research & Development Equipment (CDTFA-230-M).

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., the 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. If you participate in any of the following areas, you will want to consider additional rules that may apply:

  • 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 the 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.

Does Your Manufacturing Business Need Further Sales Tax Help?

Audits and outstanding sales tax notices from the CDTFA can be a burdensome distraction for manufacturing businesses. Unfortunately, such interactions are not uncommon because of the difficulty in classifying property and paying the right sales tax (i.e., machinery and tools vs. incorporated raw materials vs. by-products). Failing to keep detailed and accurate records such as exemption certificates or receipts can also compound those sales tax problems. If you or your client’s business recently received notice from the CDTFA, our sales tax professionals are available to help. We provide a cost-effective alternative for manufacturers who simply need help navigating the administrative hurdles of compliance and want guidance on options to push their business forward.

Check out our California Sales Tax Guide for more information on compliance with the CDTFA.