Like many sales tax practitioners, I do a considerable amount of work assisting manufacturers with identifying where they have had paid too much tax on their purchases. Most states, including New York, offer a production exemption for machinery, equipment, parts, tools, supplies, utilities and fuel used or consumed in the production of tangible personal property for sale. While most manufacturers take advantage of this substantial exemption, unfortunately more often than not, I see them missing out on claiming this exemption for electricity, natural gas and other energy sources used in production. Considering that energy can be very costly and is often a large percentage of operating costs, this can result in a significant amount of sales tax dollars being left on the table for manufacturers.
New York addresses this sales tax exemption in Reg. §§ 528.13 and 528.22 and provides further guidance about utilities used in production in Publication 852 and Tax Bulletin ST-917. Like most matters related to sales tax, there are some conditions that manufacturers should consider before claiming the exemption.
The exemption does not apply to all utilities used by the manufacturer. Only those utilities used directly and exclusively in the production process are exempt from sales tax. This means that the utilities must be used directly to:
- Operate exempt production machinery or equipment;
- Create conditions necessary for production; or
- Perform an actual part of the production process.
The utilities must also be used exclusively or 100% in these production activities. Utilities used for administrative or distribution activities do not qualify for the exemption. In other words, energy used to provide lighting or heating and cooling throughout the facility or to operate non-production equipment (i.e., computers, servers, copiers and appliances) are typically subject to tax. This creates a big problem for the manufacturer, because utilities are typically purchased in bulk or in a continuous flow, and if the manufacturer does not have separate meters or lines providing energy to just their production machinery and equipment, then an allocation needs to be performed to determine the exempt use.
To determine exempt use when separate meters are not available, the manufacturer needs to perform a utility study, energy assessment or employ some other acceptable formula to calculate the amount of energy used or consumed by production machinery and equipment. This can often complicated, and the manufacturer may want to seek assistance from consultants familiar with both sales tax and engineering concepts. Simply estimating or scratching out a percentage on a piece of paper is typically not enough, as one of the first things many auditors will ask for when commencing an audit of a manufacturer is documentation on their exempt energy use. Even if a manufacturer had a utility study performed years ago, changes in the production process, in machinery and equipment and in types of products being manufactured over the years, coupled with the introduction of more energy efficient lighting, HVAC and other equipment, may render that old study obsolete. Manufacturers should consider refreshing their utility study every few years to account for these changes.
Once the manufacturer establishes their exempt use percentage, they can continue to pay sales tax on their utilities at the time of purchase and subsequently claim a refund or credit using Form AU-11, Application for Credit or Refund of Sales or Use Tax within three years of the date of purchase of the utilities. The manufacturer can also elect to provide their energy suppliers with Form ST-121, Exempt Use Certificate and not pay sales tax at the time of purchase. However, your utility supplier will not be able to charge you tax on just the taxable percentage of energy used for non-production purposes. Therefore, the manufacturer will need to remit use tax directly to New York State on any taxable use or consumption. The manufacturer should weigh these options carefully in order to avoid potential exposure if audited.
There are also other issues the manufacturer should consider, including utilities used for research and development purposes, which are also exempt pursuant to Reg. § 528.11 and further discussed in Tax Bulletin ST-773. Another issue that is always a point of contention is when heating and cooling equipment is used to create conditions necessary for production (i.e., specific temperatures, humidity levels, etc.) because it must be shown that this equipment is being used exclusively for production purposes. If the equipment is used for dual purposes – for production and to maintain temperature or humidity for purposes of employee comfort, then the utilities used to operate this equipment will not qualify for the exemption.
Finally, one note to manufacturers who use motor fuel or enhanced diesel motor fuel in their production process, to operate material handling equipment or for other purposes. These types of motor fuel cannot be purchased tax exempt. However, the manufacturer can still file a refund claim using Form FT-500, Application for Refund of Sales Tax Paid on Automotive Fuels to recover the tax paid on these purchases. I have seen many instances where significant sales tax refund opportunities are missed because the manufacturer does not realize this motor fuel is exempt from sales tax when used for production purposes. Otherwise, unenhanced diesel motor fuel and residual petroleum products such as lubricants can be purchased exempt from sales tax.
Other recent “New York (NY)” posts by Tom Mazurek, CPA:
- The Holidays - A Taxing Time for New Yorkers
- New York Manufacturers: Remember Sales Tax Break for Utilities!
- New York: Celebrate Manufacturing Day with Sales Tax Exemptions!
- New York Nexus: For Out-of-State Sellers, No News is Good News
- New York: New Law to Close Loopholes for Related Parties