Craft breweries are opening up all over Texas and Texas craft beer consumers couldn’t be happier. According to the Texas Craft Brewers Guild, almost 1.2 million barrels are produced each year just in Texas. While I love craft beer, I also love educating Texas taxpayers and assisting them with compliance. Unfortunately, the brewing industry in Texas has a tax issue of which most breweries are not aware and without legislative intervention or education or both, could prove detrimental to a breweries ability to stay in business. It’s called the “returnable containers issue”.
Texas Tax Rule 3.300 Manufacturing:
Texas Tax Rule 3.300 defines a manufacturer as a person engaged in manufacturing to include processors, fabricators and custom manufacturers. A very simplistic way to explain manufacturing is any activity that causes a chemical or physical change.
Also, per Texas Tax Rule 3.300 manufacturing is defined as each operation beginning with the first stage in the production of tangible personal property and ending with the completion of tangible personal property having the physical properties (including packaging, if any) that it has when transferred by the manufacturer to another.
Exemptions afforded to Manufacturers by the Texas Tax Code in the process of Manufacturing are:
- Ingredients or component parts of the product that is manufactured, processed, or fabricated for ultimate sale.
- Tangible personal property that is directly used or consumed in or during the manufacturing process (e.g. equipment).
- Services performed directly on the product being manufactured.
- Equipment used to power, supply, support, or control exempt manufacturing equipment.
- Tangible personal property essential to pollution control.
- Lubricants, chemicals, gases, etc. necessary and essential for prevent the decline, failure, lapse, or deterioration of exempt equipment.
- Tangible personal property essential to a quality control process.
- Safety apparel – if required by the government or if the manufacturing process would not be possible without the use of the apparel.
- Gas and electricity when used directly in manufacturing.
- Wrapping and packaging supplies that are used to further the sale of a product.
- Piping or conveyor systems that are a component part of a single item of exempt manufacturing equipment.
Kegs – Wrapping and Packaging:
As mentioned above, per Texas Tax Rule 3.300(d)(13) – wrapping, packing, and packaging supplies that are used to further the sale of a product are exempt. In addition, per Texas Tax Rule 3.314(b)(1) – sales or use tax is not due on containers or packaging supplies purchased by manufacturers for use as a part of the completion of the manufacturing process. The manufacturing process is complete when the product being produced has been packaged by the manufacturer as it will be sold.
In reading these sections of the tax code, one would rightly interpret that kegs would qualify as exempt wrapping and packaging purchases by a brewery. The brewing process is complete when the beer is packaged in bottles, cans or kegs, loaded onto pallets and wrapped for shipment and delivery. However, there is another section of the tax code that directly contradicts this conclusion. Section (g)(3) of Rule 3.314 states “sales or use tax is not due on returnable containers when sold with the contents in connection with the retail sale of the contents or when resold for refilling. The SELLER must pay sales or use tax on the container at the time of purchase”.
The "Returnable Containers” Issue:
So this is what is known in among tax professionals as the “returnable containers” issue - and it has been argued and challenged many times in Texas Administrative Court. Many industries that have returnable containers (bottled water processors, oxygen and other gas distributors, etc.) have challenged the issue arguing the returnable containers qualify for the wrapping and packaging exemption per Rule 3.300, while others have argued that the returnable containers qualify as a purchase for resale (furthering the sale of their product).
The prevailing decision in all of the attempts to argue for the exemption is two-fold. The first rests on Comptroller’s Rule 1.40, entitled Burden of Proof which states that in a contested case, the burden of proof is on the taxpayer, by clear and convincing evidence that a transaction is exempt from taxation. Exemptions from taxation are subject to strict construction since they are the antithesis of equality and uniformity and because they place a greater burden on other taxpaying businesses and individuals. An exemption cannot be raised by implication but must affirmatively appear, and all doubts resolved in favor of the taxing authority and against the taxpayer. In other words, in a contested case in which there are two or more competing rules, the State must prevail. Secondly, supporting the State’s argument and subsequent decision in these cases is Section 151.322 of the Texas Tax Code which recognizes that the container exemption statute is a specific exemption that provides an exception to the general rule of the manufacturing or sale for resale exemption.
What Can Be Done?
The returnable containers law was enacted in 1984 as a result of the East Texas Oxygen Co. v. State case. There have however been rulings by the Texas Supreme Court since then that lead some tax attorneys to believe that the East Texas Oxygen ruling can and should be overturned and the law changed. The challenge is that changing legislation is an expensive undertaking. Equally as important, it would seem that most breweries are unaware of the tax law surrounding returnable containers and are in a way “sitting ducks” for the Texas Comptroller to audit and assess tax, interest and penalty for the purchase of kegs. Conversation needs to begin to determine the best approach to protect the breweries in the State of Texas whether that be through advocating and lobbying the Texas legislature for the brewing industry and / or litigation that may or may not result in changing the law. At a bare minimum, education surrounding this issue for breweries should begin immediately.
Want to do your part to bring tax equality to the brewing industry? Drop me a line...
Brown Goertz & Co believes that the 1984 East Texas Oxygen Co ruling is wrong and should be overturned. We are partnering with other sales and use tax professionals in Texas to start the conversation about important next steps. If you are interested in this issue - you may reach me directly at 469.352.9620 (office) or 469.742.1159 (cell) - and my email address is firstname.lastname@example.org (or simply click this Susan Goertz link to send a direct message). You may also submit a message to me using the orange “Request a Consultation” link on my Firm Profile page.
Other recent “Texas (TX)” posts by Susan Goertz:
- Taxing Texas Brewers - Overturn Returnable Containers Law!
- BIG Sales & Use Tax Savings – Found in SMALL Town Wisdom
- Detrimental Reliance & Texas Sales-Use Tax: 4 Key Considerations
- Texas Construction Taxation: Sales & Use Tax Explained