The Massachusetts Department of Revenue (“Department”) recently promulgated a proposed amended regulation governing the classification of corporations as “manufacturing corporations” for corporate excise tax purposes (the “Proposed Regulation”). The Proposed Regulation follows an emergency regulation that was promulgated on September 11, 2018. Collectively, the emergency regulation and Proposed Regulation clarify Massachusetts’ manufacturing classification rules in light of recently enacted federal tax reform provisions, as well as change the appeals process for corporations that are denied manufacturing classification.
Massachusetts Tax Treatment of Manufacturing Corporations
Under current law, a corporation is classified as a “manufacturing corporation” for corporate excise tax purposes if it is engaged in “manufacturing” in Massachusetts and those manufacturing activities are substantial. “Manufacturing” is defined as “the process of substantially transforming raw or finished materials by hand or machinery, and through human skill and knowledge, into a product possessing a new name, nature, and adapted to a new use.” This is a fact-intensive inquiry that carefully examines the circumstances of each case.
Manufacturing activities will be considered substantial if any one of several tests is met including examining the percentage of a corporation’s gross receipts arising from manufacturing activities (the “gross receipts factor”), the percentage of payroll paid to employees engaged in manufacturing activities, and the percentage of property owned and used in manufacturing activities.
It is important to note that the Proposed Regulation addresses situations in which a corporation has filed an application with the Department requesting that it be classified as a manufacturing corporation. The determination of whether a corporation so qualifies under the Proposed Regulation depends upon whether the manufacturing activities take place in Massachusetts, and whether those Massachusetts manufacturing activities are substantial. A corporation that is classified by the Department as a “manufacturing corporation” under the Proposed Regulation is required to use a single sales factor for apportionment purposes, and is also entitled to several tax benefits, including a property tax exemption, an investment tax credit, and sales and use tax exemptions for machinery used in manufacturing or research and development.
However, for Massachusetts apportionment purposes, an out-of-state corporation could be deemed by the Department to be a manufacturer even if it is not classified by the Department as a “manufacturing corporation” under the Proposed Regulation. For apportionment purposes, the same tests from the Proposed Regulation are used to determine whether manufacturing activities are substantial, except that gross receipts from manufacturing and business activities everywhere – not just in Massachusetts – are taken into account. A corporation deemed to be a manufacturer for apportionment purposes is also required to use single sales factor apportionment, which is generally more beneficial to an in-state than out-of-state corporation. Moreover, an out-of-state corporation that is not classified as a “manufacturing corporation” under the Proposed Regulation because it does not have Massachusetts manufacturing activities will not be entitled to investment tax credits, or property or sales tax exemptions, even if it is deemed to be a manufacturer for apportionment purposes.
Amendments to the Existing Regulation
Amendments Related to Federal Tax Reform
To determine whether manufacturing activities are substantial under the Proposed Regulation, the gross receipts factor is calculated by dividing a corporation’s gross receipts from manufacturing activities in Massachusetts by the corporation’s total gross receipts from all business activities in Massachusetts, plus the sum of all gross interest, dividends, and capital gains.
The Proposed Regulation clarifies that for purposes of the gross receipts fraction, the term “dividend” does not include amounts deemed to have been repatriated under amended Internal Revenue Code Section 965, or GILTI under new Internal Revenue Code Section 951A.
Amendments Related to the Appeals Process
Under the existing regulation, a corporation denied manufacturing classification is entitled to request an internal hearing with the Department within 30 days of the denial, and may appeal an adverse decision of the Department to the Appellate Tax Board. A corporation may also appeal directly to the Appellate Tax Board under the current regulation.
The Proposed Regulation eliminates the internal appeal process at the Department and allows only for a manufacturing classification appeal directly to the Appellate Tax Board.
A public hearing on the proposed amendments is scheduled for November 1, 2018. The exclusion from the gross receipts factor of any deemed repatriated income or GILTI under Internal Revenue Code Sections 951A and 965 may increase the likelihood that a company’s manufacturing activities will be considered “substantial” for Massachusetts tax purposes, causing that company to be classified as a manufacturer. Any company engaged in manufacturing activities outside of Massachusetts, in particular, should be aware of the impact of the Proposed Regulation’s changes, as they also impact whether a corporation could be deemed to be a manufacturer for apportionment purposes.