Manufacturer's sales/use tax exemption for machinery and equipment (M&E)

• Basic overview
• What qualifies?
• Definitions
• What doesn’t qualify?
• Determining “used directly”
• Determining useful life
• Determining majority use
• Manufacturing sites
• Research and development operations
• Design and product development
• Electrical apparatus and utility systems
• Renting or leasing tangible personal property
• Prototypes
• Reporting/documentation
• Additional resources
• References

Basic overview

The Manufacturers' Sales and Use Tax Exemption for Machinery and Equipment (M&E exemption) provides a retail sales and use tax exemption for:

• Machinery and equipment used directly in a manufacturing operation or research and development operation by a manufacturer or processor for hire.
• Sales of, or charges made for, labor and services rendered in respect to installing, repairing, cleaning, altering, or improving qualifying machinery and equipment.
• Machinery and equipment used directly in a testing operation by a person engaged in testing for a manufacturer or processor for hire.

Generally, to be eligible for the M&E exemption, a business must report under one or more of the manufacturing business and occupation (B&O) tax classifications. This is because they are manufacturing items for commercial or industrial use (research & development or manufacturing), or they are manufacturing items for sale. Both activities result in a B&O tax liability. However, other requirements apply.

Cannabis processors: Cannabis processors must pay retail sales tax or use tax on all purchases of machinery and equipment used in the manufacturing, research and development, or testing of cannabis, useable cannabis, or cannabis-infused products, including cannabis concentrates. Cannabis businesses that perform these activities are not eligible for the M&E exemption.

What qualifies?

A manufacturer/processor for hire is exempt from sales and use tax on:

• Purchases of machinery and equipment.
• Purchases of machinery and equipment for repairing machinery and equipment.
• Charges for hiring someone to repair machinery and equipment.
• Renting equipment (with or without an operator) to repair or install machinery and equipment.

To qualify for the M&E sales and use tax exemption:

• The property must meet the definition of "machinery and equipment" as one of the following:
  • Device. o Industrial fixture.
  • Support facility.
  • Tangible personal property that becomes an ingredient or component of any of the above, including repair and replacement parts, lubricants, etc., with a useful life of one year or more.
• The purchase or use must be by a manufacturer or processor for hire or a person engaged in testing for a manufacturer or processor for hire.
• The machinery and equipment must be used directly in a manufacturing operation, research and development by a manufacturer, or testing operation,
• The machinery or equipment must have a useful life of one year or more.
• The machinery and equipment must be used more than 50% of the time on an eligible activity (majority use threshold).

Repair services and parts: Because the exemption is limited to items with a useful life of one year or more, some charges for repair, labor, services, and replacement parts may not be eligible for the exemption. In the case of labor and service charges that cover both qualifying and non-qualifying repair and replacement parts, the labor and services charges are considered exempt. If all of the parts are non-qualifying, the labor and service charge is not exempt.

Computers: Computers may qualify for the M&E exemption if they meet either of the following criteria:

• They direct or control machinery or equipment that acts upon or interacts with tangible personal property.
• If they act upon or interact with an item of tangible personal property.

Software: Computer software satisfies the definition of device because it performs a task and is not attached to a building or site. Consequently, software can qualify for the M&E exemption if it meets a used directly test. For example, a software program that controls equipment operation that cuts logs into lumber qualifies for the M&E exemption. It performs a task, the control of a piece of eligible machinery, and is used directly in the manufacturing operation. However, a CD-ROM of a repair manual for this equipment does not qualify for the M&E exemption because the software does not perform a task in the manufacturing operation.

Definitions

Machinery and equipment (M&E) means industrial fixtures, devices, support facilities, and tangible personal property that becomes an ingredient or component thereof, including repair parts. M&E also includes pollution control equipment installed and used in a qualifying operation to prevent air pollution, water pollution, or contamination that might otherwise result from the operation.

Device means an item that is not attached to the building or site.

Industrial fixture means an item attached to a building or to land. Fixtures become part of the real estate to which they are attached and, upon attachment, are classified as real property, not personal property.

A support facility is a part of a building, structure, or improvement used to contain or steady an industrial fixture or device. It must be specially designed and necessary for the proper functioning of the industrial fixture or device and must perform a function beyond being a building, structure, or improvement. It must have a function relative to an industrial fixture or device.

Manufacturing operation means the manufacturing of articles, substances, or commodities for sale as tangible personal property. It begins when the raw materials enter the manufacturing site and ends when the processed material leaves the manufacturing site. The operation includes storage of raw, in-process, and processed materials at the site. The term also includes that portion of a cogeneration project that is used to generate power for consumption within the site of which the cogeneration project is an integral part.

The manufacturing operation is defined in terms of a process occurring at a location. To be eligible as a qualifying use of M&E, the use must take place within the manufacturing operation, unless specifically exempted by law. The statute specifically allows testing to occur away from the site.

Research and development operation means engaging in research and development as defined in RCW 82.63.010 by a manufacturer or processor for hire.

Testing means activities performed to establish or determine the properties, qualities, and limitations of tangible personal property.

Testing operation means the testing of tangible personal property for a manufacturer or processor for hire. It starts when the tangible personal property enters the testing site and ends when the tangible personal property leaves the testing site. The term also includes that portion of a cogeneration project that generates power for use within the site. The testing operation is defined in terms of a process occurring at a location. To be eligible as a qualifying use of M&E, the use must take place within the testing operation, unless specifically exempted by law.

What doesn’t qualify?

In addition to items that are not eligible because they do not meet the used directly test or fail to overcome the majority use threshold, there are four categories of items that are excluded from eligibility by statute. The following property is not eligible for the M&E exemption:

1. Hand-powered tools. Screwdrivers, hammers, clamps, tape measures, and wrenches are examples of hand-powered tools. Electric-powered, including cordless tools, are not hand-powered tools, nor are calipers, plugs used in measuring, or calculators.
2. Property with a useful life of less than one year. All eligible machinery and equipment must satisfy the useful life criteria, including repair and replacement parts. For example, items such as blades and bits are generally not eligible for the exemption because, while they may become component parts of eligible machinery and equipment, they generally have a useful life of less than one year. Blades generally having a useful life of one year or more, such as certain sawmill blades, are eligible. (See subsection on thresholds to determine useful life.)
3. Buildings, other than machinery and equipment that is permanently affixed to or becomes a physical part of a building. Buildings provide workspace for people, shelter machinery and equipment, or tangible personal property. The building itself, and some of its components, such as walls, partitions, floors, ceilings, windows, and doors, are not eligible for the exemption. The industrial fixtures and support facilities that become affixed to or part of the building might be eligible. The subsequent real property status of industrial fixtures and support facilities does not affect eligibility for the exemption.
4. Building fixtures that are not integral to the manufacturing operation, testing operation, or research and development operation that are permanently affixed to and become a physical part of a building, such as utility systems for heating, ventilation, air conditioning, communications, plumbing, or electrical. Examples of nonqualifying fixtures are: Fire sprinklers, building electrical systems, or washroom fixtures. Fixtures that are integral to the manufacturing operation might be eligible, depending on whether the item meets the other requirements for eligibility, such as the used directly test.

Books: To be eligible for the M&E exemption as a device, the property must perform a task and do work. Books are used for reference and to assist in, guide, or control decision-making, but they are not used by a person in the same manner as machinery and equipment, which have an applied function. Therefore, books do not qualify for the M&E exemption.

Determining “used directly”

The machinery & equipment must be used directly in a manufacturing operation, testing operation, or research and development operation.

The law provides eight descriptions of the phrase used directly. The way a person uses an item of machinery and equipment must match one of these descriptions. If machinery and equipment is not used directly it is not eligible for the exemption.

Machinery and equipment is used directly in a manufacturing operation, testing operation, or research and development operation if the machinery and equipment meet any one of the following criteria:

1. Acts upon or interacts with an item of tangible personal property. Examples of this are drill presses, cement mixers (agitators), ready-mix concrete trucks, hot steel rolling machines, rock crushers, and band saws. Machinery and equipment used to repair, maintain, or install tangible personal property are also included.
2. Conveys, transports, handles, or temporarily stores an item of tangible personal property at the manufacturing site or the testing site. Examples of this are wheelbarrows, handcarts, storage racks, forklifts, tanks, vats, robotic arms, piping, and concrete storage pads. Floor space in buildings does not qualify.
3. Controls, guides, measures, verifies, aligns, regulates, or tests tangible personal property at the site or away from the site. Examples of "away from the site" are road testing of trucks, air testing of planes, or water testing of boats, with the machinery and equipment used off-site in the testing eligible under this criteria. Machinery and equipment used to take readings or measurements is eligible under this criterion.
4. Provides physical support for or access to tangible personal property. Examples of this are catwalks adjacent to production equipment, scaffolding around tanks, braces under vats, and ladders near controls. Machinery and equipment used for access to the building or to provide a workspace for people or a space for tangible personal property or machinery and equipment, such as stairways or doors, is not eligible.
5. Produces power for or lubricates machinery and equipment. An example of this is a generator providing power to a sander. Lubricating devices, such as hoses, oil guns, pumps, and meters, are eligible even if they are not attached to machinery and equipment. An electrical generating plant that provides power for a building is not eligible.
6. Produces another item of tangible personal property for use in the manufacturing operation, testing operation, or research and development operation. Examples include machinery and equipment that makes dies, jigs, or molds, and printers that produce camera-ready images.
7. Places tangible personal property in the container, package, or wrapping in which the tangible personal property is normally sold or transported.
8. Is integral to research and development. Integral means the machinery and equipment is necessary for research and development. Example: An electrical apparatus used directly in a research and development operation need only be “integral” to the research and development operation to be entitled to the M&E exemption. There is no requirement that it act upon or interact with an item of tangible personal property or produce power for machinery and equipment.

Examples of items that are not used directly in a qualifying operation include, but are not limited to:

• Cafeteria furniture.
• Safety equipment not part of qualifying M&E.
• Packaging materials.
• Shipping materials.
• Administrative or office equipment.

Determining useful life

Property with a useful life of less than one year is not eligible for the M&E exemption. The useful life threshold identifies items that do not qualify for the exemption, such as supplies, consumables, and other classes of items that are not expected or intended to last a year or more.

For example, tangible personal property that is acquired for a one-time use and is discarded upon use, such as a mold or a form, has a useful life of less than one year and is not eligible.

If it is clear from taxpayer records or practice that an item is not used for at least one year, the item is not eligible, regardless of the answers to the four threshold questions.

Generally, if the machinery and equipment meet all of the other M&E exemption requirements, useful life can be determined by answering the following questions for an individual piece of machinery and equipment:

1. Is the machinery and equipment capitalized for either federal tax purposes or accounting purposes?
   • If the answer is "yes," it qualifies for the exemption.
   • If the answer is "no," go to the next question.
2. Is the machinery and equipment warranted by the manufacturer to last at least one year?
   • If the answer is "yes," it qualifies for the exemption.
   • If the answer is "no," go to the next question.
3. Is the machinery and equipment normally replaced at intervals of one year or more, as established by industry or business practice? (This is commonly based on the actual experience of the person claiming the exemption.)
   • If the answer is "yes," it qualifies for the exemption.
   • If the answer is "no," go to the next question.
4. Is the machinery and equipment expected at the time of purchase to last at least one year, as established by industry or business practice? (This is commonly based on the actual experience of the person claiming the exemption.)
   • If the answer is "yes," it qualifies for the exemption.
   • If the answer is "no," it does not qualify for the exemption.

Determining majority use

Machinery and equipment both used directly in a qualifying operation and used in a non-qualifying manner is eligible for the exemption only if the qualifying use satisfies the majority use requirement. Examples of situations in which an item of machinery and equipment is used for qualifying and non-qualifying purposes include:

• The use of machinery and equipment in manufacturing and repair activities, such as using a power saw to make cabinets in a shop versus using it to make cabinets at a customer location.
• The use of machinery and equipment in manufacturing and constructing activities, such as using a forklift to move finished sheet rock at the manufacturing site versus using it to unload sheet rock at a customer location.
• The use of machinery and equipment in manufacturing and transportation activities, such as using a mixer truck to make concrete at a manufacturing site versus using it to deliver concrete to a customer.

Majority use can be expressed as a percentage, with the minimum required amount of qualifying use being greater than 50% compared to overall use. To determine whether the majority use requirement has been satisfied, the person claiming the exemption must retain records documenting the measurement used to substantiate a claim for exemption. Majority use is measured by looking at the use of an item during a calendar year using any of the following:

1. Time. Time is measured using hours, days, or another unit of time, with qualifying use of the M&E the numerator, and total time used the denominator. Suitable records for time measurement include employee time sheets or equipment time use logs.
2. Value. Value means the value to the person, measured by revenue if the qualifying and non-qualifying uses both produce revenue. Value is measured using gross revenue, with revenue from qualifying use of the M&E the numerator, and total revenue from use of the M&E the denominator. If there is no revenue associated with the use of the M&E, such as in-house accounting use of a computer system, the value basis may not be used. Suitable records for value measurement include taxpayer sales journals, ledgers, account books, invoices, and other summary records.
3. Volume. Volume is measured using amount of product, with volume from qualifying use of the M&E the numerator and total volume from use of the M&E the denominator. Suitable records for volume measurement include production numbers, tonnage, and dimensions.
4. Other comparable measurement for comparison. The department may agree to allow a taxpayer to use another measure for comparison, provided that the method results in a comparison between qualifying and non-qualifying uses. For example, if work patterns or routines demonstrate typical behavior, the taxpayer can satisfy the majority use test using work site surveys as proof.

Each piece of M&E does not require a separate record if the taxpayer can establish that it is reasonable to bundle M&E into classes. Classes may be created only from similar pieces of machinery and equipment and only if the uses of the pieces are the same.

For example, forklifts of various sizes and models can be bundled together if the forklifts are doing the same work, such as moving wrapped product from the assembly line to a storage area. An example of when not to bundle classes of M&E for purposes of the majority use threshold is the use of a computer that controls a machine through numerical control versus use of a computer that creates a camera-ready page for printing.

Generally, whether the majority use threshold is met is decided on a case-by-case basis, looking at the specific manufacturing operation in which the item is being used. However, for purposes of applying the majority use threshold, the department may develop industry-wide standards.

For example, the aggregate industry uses concrete mixer trucks in a consistent manner across the industry. Based on a comparison of selling prices and delivery prices the department has determined that concrete trucks generally overcome the majority use threshold and can qualify for the M&E exemption. Only in those limited instances where it is apparent that the use of the concrete truck is atypical for the industry would the taxpayer be required to provide recordkeeping on the use of the truck to support the exemption.

Manufacturing sites

What is a site?

A site is one or more immediately adjacent parcels of real property. The property's ownership status is irrelevant – a parcel can be owned, rented, or leased by the manufacturer or processor for hire. Adjacent parcels of real property separated only by a public road comprise a single “site.” The public road dividing the site is an incidental separation of what would otherwise be one site.

Temporary manufacturing sites

A manufacturing operation can exist where the manufacturing site is temporary and where the manufacturing equipment is mobile. For example, operations using portable sawmills or rock-crushing equipment are considered "manufacturing operations" if the activity in which the person is engaged is manufacturing.

• Rock-crushing equipment that deposits material onto a roadway is not used in a manufacturing operation because this is a part of the constructing activity, not a manufacturing activity.
• A portable cement mixer at a construction site is not used in a manufacturing operation because the activity is constructing, not manufacturing.
• Other portable equipment used in non-manufacturing activities, such as continuous gutter trucks or trucks designed to deliver and combine aggregate or specialized carpentry tools, do not qualify for the same reasons.

Multiple manufacturing sites

Manufacturing tangible personal property for sale can occur in stages. Each stage can take place at different manufacturing sites. For example, if a taxpayer processes pulp from wood at one site and transfers the resulting pulp to another site that further manufactures the product into paper, two separate qualifying manufacturing operations exist if the end product is sold as tangible personal property.

At the site or away from the site

Generally, machinery and equipment must be used at the manufacturing site to qualify for the M&E exemption.

However, machinery and equipment that meets the used directly test for “controls, guides, measures, verifies, aligns, regulates, or tests tangible personal property at the site or away from the site” is the exception. This exception commonly applies to M&E used at a testing operation or an R&D operation.

Research & development operations

The M&E exemption applies to sales of machinery and equipment used directly in an R&D operation by a manufacturer or processor for hire. Machinery and equipment is used directly in an R&D operation if it is integral to R&D.

Examples of machinery and equipment used in R&D operations that may qualify for the exemption if all other requirements are met include:

• Computer hardware and software.
• Data processing equipment.
• Laboratory equipment.

Integral to research and development operation

Machinery and equipment must be integral to the R&D operation to qualify for the M&E exemption. This means the R&D cannot be accomplished without such machinery and equipment.

Examples of machinery and equipment that are integral to an R&D operation include:

• A laboratory table in a lab.
• A chair used in a laboratory workstation.
• Telephones, computer hardware (e.g., cables, scanners, printers, etc.), and computer software (e.g., Word, Excel, Windows, Adobe, etc.) used in a typical workstation for an R&D personnel.

Examples of items that are not integral to an R&D operation include:

• Decorative artwork.
• A chair in a lobby area or conference room. 
• Computer hardware and software used by the accounting department.

Research and development activities Machinery and equipment used by a manufacturer or processor for hire to perform R&D may still qualify for the M&E exemption when R&D is performed away from a manufacturing site. R&D includes the following activities:

• Activities performed to discover technological information.
• Technical and non-routine activities concerned with translating technological information into new or improved products, processes, techniques, formulas, inventions, or software.
• Exploration of a new use for an existing drug, device, or biological product if the new use requires separate licensing by the Federal Food and Drug Administration under Chapter 21, C.F.R., as amended.

R&D does not include the following activities:

• Adaptation or duplication of existing products without substantial improvement by application of the technology.
• Surveys and studies.
• Social science and humanities research.
• Market research or testing.
• Quality control.
• Sale promotion and service.
• Computer software developed for internal use.
• Research to improve style, taste, or seasonal design.

Majority use requirement for machinery and equipment used in research and development

Machinery and equipment used in a R&D operation must satisfy the majority use threshold to qualify for the M&E exemption. Machinery and equipment that does not satisfy the majority use threshold is subject to use tax at the time the majority use threshold is no longer met. For example, a laboratory table used solely for qualifying R&D purposes and then converted solely to non-qualifying uses is subject to use tax at the time of conversion.

Design and product development

The department distinguishes between activities that take place within the manufacturing operation and activities that happen before or after the manufacturing operation. The M&E exemption does not apply to machinery and equipment exclusively used in design and product development because those activities take place before the manufacturing operation. However, property that is used both in product development and in manufacturing of tangible personal property may be eligible for the M&E exemption if all other requirements of the exemption are met.

Examples of non-qualifying design and product development activities that take place before the manufacturing operation include:

• Composition of a book or the writing of a newspaper article.
• Design of an automobile or engineering of a piston.

Examples of qualifying activities that take place during the manufacturing operation include:

• Taking a completed manuscript and preparing it for printing.
• Layout and pagination of a newspaper.

Essentially, the creation of the information is not manufacturing or part of the manufacturing operation.

The department will presume that design activity is not part of the manufacturing operation, and the machinery and equipment used is not eligible for the M&E exemption.

Equipment used in redesign or refinement of a product after manufacturing has begun is not eligible for the M&E exemption. This presumption can be overcome by showing that the design decisions and the application of labor and skills to the raw materials are the same activity.

Electrical apparatus and utility systems

Electrical apparatus and utility systems are generally considered industrial fixtures or devices. Industrial fixtures and devices may be eligible for the M&E exemption if they meet all of the other requirements. However, some utility systems are building fixtures that only serve a building purpose and as such do not qualify.

Electrical apparatus

Electrical apparatuses such as motor control centers, starters, switches, regulators, and exciters “act upon or interact with” tangible personal property, often in a sequential manner. For example, the motor control center produces an action that results in a reaction by the motor. Switches and exciters work in much the same way. Similarly, circuit breakers and comparable equipment react to an event in another item, and this cause-and-effect behavior falls under the “acts upon or interacts with” criteria.

Converters, transformers, and other equipment on site that alter the characteristics of the electricity “produce power” for machinery and equipment.

Apparatuses that are part of a utility system used for qualifying and non-qualifying purposes should be examined using an appropriate allocation standard. Transmission and distribution systems located off-site do not qualify for the M&E exemption.

Utility systems used for qualifying and nonqualifying purposes

Utility systems that are building fixtures and are integral to the manufacturing operation, testing operation, or research and development operation qualify for the M&E exemption if they meet all of the other requirements.

Utility systems that only serve a building purpose do not qualify for the exemption. For example, a utility system used to perform a general building purpose, such as an HVAC system controlling the air temperature or air quality in general, is not eligible for the M&E exemption.

If a utility system is used for both qualifying and non-qualifying purposes, it should be allocated so that only the qualifying portion of the system receives the exemption, and the building portion does not.

Allocating utility systems

One way of allocating a utility system is by applying the ratio of the qualifying use of the system to the total use of the system. The manufacturer must support this ratio with documentation, such as engineering analyses and power bills. This means if the manufacturer can document that 30% of a system is used for the manufacturing activity (e.g., 30% of the system is dedicated to manufacturing frozen raspberries vs. 70% dedicated to cold storage), then this 30% qualifies for the exemption.

Note: The concept of allocating based on qualifying or non-qualifying for purposes of the M&E exemption is limited to utility system machinery and equipment considered a building fixture that is used to support both manufacturing machinery and equipment and the building systems. All other areas dealing with qualifying and non-qualifying use of machinery and equipment must use the majority use threshold.

Renting or leasing tangible personal property

Bare rentals: The “renting or leasing of tangible personal property”, sometimes referred to as a bare rental or true lease, is eligible for the M&E exemption if all other conditions of the exemption are met. For example, the rental of a crane on a bare rental basis to a manufacturer whose employee operates the crane to move equipment to the top of a building may be eligible for the M&E exemption.

Rental of equipment with an operator: The “rental of equipment with an operator” is a separate and distinct activity from the “renting or leasing of tangible personal property.” The “rental of equipment with an operator” is a sale of a service and not a sale of tangible personal property. While the seller is providing equipment along with the equipment operator, the customer is purchasing the knowledge, skills, and expertise of an operator needed to operate the equipment at the customer’s direction. The rental of equipment with an operator may not be eligible for the M&E exemption. The facts and circumstances of each situation must be considered.

For example, a manufacturer hires a company to provide a crane with an operator to move qualifying equipment to the top of a building. While the company’s employee operates the crane, the equipment is actually installed by manufacturer’s employees. The purchase of the crane with an operator service is not eligible for the M&E exemption.

However, if a manufacturer hires a company to provide a crane with an operator to move qualifying equipment to the top of a building and the personnel to install the equipment the purchased service is eligible for the M&E exemption. This is because the company hired by the manufacturer is responsible for installing the equipment.

Prototypes

Property that is the object of the manufacturing activity does not itself qualify for the M&E exemption. The thing being made is the object of the activity and, as such, is not machinery and equipment, as that phrase is used in the M&E exemption. To qualify for the M&E exemption, a prototype must be used in one of the following ways:

• To make, build, or test a different product.
• In some supportive capacity (used directly) in stages of the manufacturing operation.

Any product made by a manufacturer and used in a qualifying manner may qualify for exemption if it is not the object of the activity itself. Examples of products that may qualify for the M&E exemption include:

• A prototype used as a manufacturing mockup to calibrate tools.
• A prototype used as a “test bed”.

The phrase “test bed” means that the prototype is used to test other property and not the prototype itself. A test bed typically evaluates how property operates under a range of working conditions. The manufacturer must be able to show that the information gained from the test bed will be used for a different product or process.

Assumptions

The department assumes both of the following regarding prototypes:

• The product that is being developed or manufactured will not be used in a manner eligible for the M&E exemption.
• The product and all its components are the thing being tested.

To overcome these assumptions, the manufacturer must keep documentation showing that the item is being used to test something other than itself. Such documentation must reflect the basis for the activity and the manufacturer's intent. Eligibility for the M&E exemption will be determined on a case-by-case basis.

Reporting/documentation

Buyers must give the seller a properly completed Manufacturer’s Sales and Use Tax Exemption Certificate.

Sellers must report all sales of machinery and equipment under the Retailing B&O and Retail Sales tax classifications. They may then use one of the following deductions:

• Sales of Manufacturing Machinery/Equipment and Installation Labor from the Retail Sales tax classification for delivery/installation in Washington.
• Interstate and Foreign Sales from both classifications for delivery/installation outside of Washington.

The seller must keep a copy of the Manufacturer’s Sales and Use Tax Exemption certificate or proof of delivery in their records.