SALES AND USE TAX -- INDUSTRIAL PROCESSING

RAB-2000 - 4. This Revenue Administrative Bulletin (RAB) describes the industrial processing exemption allowed under the Sales and Use Tax Acts. This RAB replaces RAB 1988-14 for periods after March 30, 1999. RAB 1988-14 remains in effect for periods prior to March 31, 1999.

1999 PA 116 and 1999 PA 117 ("the Acts") clarified and expanded the industrial processing exemptions in Michigan's sales and use tax acts. The Acts were based on Michigan Administrative Code Specific Sales and Use Tax Rule 40 (1979 AC, R 205.90) and significantly expanded the exemption. This RAB discusses industrial processing activities and describes the tangible personal property that is exempt when used or consumed in industrial processing.

The Acts expanded and clarified the industrial processing exemption on a prospective basis beginning March 31, 1999. However, the Acts statutorily implemented apportionment effective for all periods beginning March 31, 1995 and all tax years that are open under the statute of limitations. This statutory change does not affect taxpayer liability for persons claiming an industrial processing exemption for previous tax years, as the industrial processing exemption had been apportioned pursuant to Rule 40 for prior periods.

For periods prior to March 31, 1999, refer to RAB 1988-14, Rule 40 (1979 AC, R 205.90), MCL 205.54y; MSA 7.525(25) (Sales Tax Act), and MCL 205.94r; MSA 7.555(4r) (Use Tax Act). For questions related to this RAB or periods prior to March 31, 1999, please call the Sales, Use and Withholding Taxes Division at (517) 373-3190 or write to them at Treasury Building, Lansing, Michigan 48922.

ISSUES

1. What is industrial processing and who qualifies as an industrial processor?
   
   
2. If property is used in both an exempt industrial processing function and also in a taxable manner, is the exemption prorated?
   
   
3. What activities constitute industrial processing?
   
   
4. What activities do not constitute industrial processing?
   
   
5. What property is eligible for an industrial processing exemption?
   
   
6. What property is not eligible for an industrial processing exemption?
   
   
7. Can sales of tangible personal property to persons other than industrial processors qualify for an industrial processing exemption?

CONCLUSIONS

1. Industrial processing "[M]eans the activity of converting or conditioning tangible personal property by changing the form, composition, quality, combination, or character of the property for ultimate sale at retail or for use in the manufacturing of a product to be ultimately sold at retail. Industrial processing begins when tangible personal property begins movement from raw materials storage to begin industrial processing and ends when finished goods first come to rest in finished goods inventory storage." [MCL 205.54t(7)(a); MSA 7.525(20)(7)(a) and MCL 205.94o(7)(a); MSA 7.555(4o)(7)(a)].

An industrial processor "[M]eans a person who performs the activity of converting or conditioning tangible personal property for ultimate sale at retail or use in the manufacturing of a product to be ultimately sold at retail." [MCL 205.54t(7)(b); MSA 7.525(20)(7)(b) and MCL 205.94o(7)(b); MSA 7.555(4o)(7)(b)].

A person is defined in the General Sales Tax Act [MCL 205.51(1)(a); MSA 7.521] and the Use Tax Act [MCL 205.92(a); MSA 7.555(2)] as:

[A]n individual, firm, partnership, joint venture, association, social club, fraternal organization, municipal or private corporation whether organized for profit or not, company, estate, trust, receiver, trustee, syndicate, the United States, this state, county, or any other group or combination acting as a unit, and includes the plural as well as the singular number, unless the intention to give a more limited meaning is disclosed by the context.

2. For all property, the industrial processing exemption is limited to the percentage of exempt use to total use determined by a reasonable formula or method approved by the Department. This RAB discusses numerous instances in which property is used in industrial processing and the property qualifies for an industrial processing exemption. Although the property qualifies for an industrial processing exemption, the exemption is limited to the percentage of exempt use to total use. The formula or method used in determining the industrial processing exemption does not have to be pre-approved by the Department. However, the formula or method used does have to reasonably reflect the percentage of exempt use to total use. The following examples demonstrate exempt use based upon time used in an exempt activity; other methods which would reasonably reflect the exempt activity are also allowable.

Example 1

An industrial processor uses a forklift truck 60% of the time in its plant moving in-process parts from one press to another press; this usage is exempt under industrial processing. The forklift truck is used the remaining 40% of the time in taxable activities such as shipping and receiving. The forklift truck would qualify for a 60% industrial processing exemption on the cost of the truck.

Example 2

An industrial processor makes castings of steel bolts at one of its plant sites. These bolts are taken by a forklift truck to another building at its plant site for hardening. In this example, if the forklift truck was used 30% of the time in moving bolts from one building to another building, and 70% of the time in non-industrial processing activities, the forklift truck would qualify for a 30% industrial processing exemption.

3. Industrial processing includes the following activities:
   
   
   1. Production or assembly.
      
      
   2. Research or experimental activities. Any person may qualify for an exemption under industrial processing for research or experimental activities if specific criteria are met. The General Sales Tax Act [MCL 205.54t(7)(e); MSA 7.525(20)(7)(e)] and the Use Tax Act [205.94o(7)(e); MSA 7.555 (4o)(7)(e)] define research or experimental activity:

[A]ctivity incident to the development, discovery, or modification of a product or a product related process. Research or experimental activity also includes activity necessary for a product to satisfy a government standard or to receive government approval. Research or experimental activity does not include the following:

1. Ordinary testing or inspection of materials or products for quality control purposes.
   
   
2. Efficiency surveys.
   
   
3. Management surveys.
   
   
4. Market or consumer surveys.
   
   
5. Advertising or promotions.
   
   
6. Research in connection with literacy, historical, or similar projects.

As used under "research and experimental activity", the General Sales Tax Act [MCL 205.54t(7)(c); MSA 7.525(20)(7)(c)] and the Use Tax Act [MCL 205.94o(7)(c); MSA 7.555 (4o)(7)(c)] define product as:

[I]ncludes but is not limited to a prototype, pilot model, process, formula, invention, technique, patent, or similar property, whether intended to be used in a trade or business or to be sold, transferred, leased, or licensed.

Example 3

The research division of an automobile manufacturer designs a new prototype of an engine. The equipment and supplies consumed in the development of the prototype would qualify under research and development. The manufacturer qualifies for an industrial processing exemption because the "tangible personal property is used by that person to perform an industrial processing activity." [MCL 205.54t(1)(c); MSA 7.525(20)(1)(c) and MCL 205.94o(1)(c); MSA 7.555(4o)(1)(c)].

Example 4

A manufacturer of plastics develops several new plastics. The manufacturer then hires an independent research company to test the fire retardant capabilities of the new plastics. The independent research company also conducts its own private research of the tensile strength of several new steel alloys. The research company does not manufacture any product nor does it actually sell the steel alloys. Instead, the research company is seeking to develop a new patent on the steel alloys and sell or license the patent. Approximately 20% of the research company's equipment and supplies are consumed in the research that it conducts for the plastics manufacturer with the remaining 80% of the equipment and supplies being consumed in its own private research of the tensile strength of the new steel alloys.

Even though the research company is not an industrial processor, the research company would qualify for a 20% industrial processing exemption because the "tangible personal property is used by that person to perform an industrial processing activity for or on behalf of an industrial processor." [MCL 205.54t(1)(c); MSA 7.525(20)(1)(c) and MCL 205.94o(1)(c); MSA 7.555(4o)(1)(c)]. However, the research company would not qualify for an industrial processing exemption on the remaining 80% of the equipment and supplies because the research company is not an industrial processor nor is it consuming "tangible personal property [which] is used by that person to perform an industrial processing activity for or on behalf of an industrial processor." The research company does not meet the definition of an industrial processor which means "[A] person who performs the activity of converting or conditioning tangible personal property for ultimate sale at retail or use in the manufacturing of a product to be ultimately sold at retail." [MCL 205.54t(7)(b); MSA 7.525(20)(7)(b) and MCL 205.94o(7)(b); MSA 7.555(4o)].

3. Engineering related to industrial processing.
   
   
4. Inspection, quality control, or testing to determine whether particular units of materials or products or processes conform to specified parameters at any time before materials or products first come to rest in finished goods inventory storage.

Example 5

An industrial processor performs tests on its raw materials. The equipment and supplies used or consumed by an industrial processor in this testing and quality control function are exempt.

Example 6

Testing and quality control activities are taxable once finished goods have come to rest and are placed in finished goods inventory storage. An industrial processor manufactures a product and the completed product is placed in finished goods inventory storage. Before shipment of the product to its customers, the industrial processor performs testing and quality control activities on the product to insure that proper standards are being met. Equipment and supplies used or consumed by an industrial processor in a quality control function in testing finished goods which have come to rest are taxable. These testing and quality control activities would not qualify under industrial processing inasmuch as industrial processing ends once the goods have been placed "in finished goods inventory storage."

5. Planning, scheduling, supervision, or control of production or other exempt activities.

Example 7

A computer used by an industrial processor to schedule maintenance on exempt equipment is exempt.

Example 8

A computer used by an industrial processor to schedule employees' overtime equalization in the plant is taxable as an administrative function. The computer is taxable regardless of whether the employees are working with exempt industrial processing equipment or in a taxable administrative function.

6. Design, construction, or maintenance of production or other exempt machinery, equipment, and tooling.

Example 9

An industrial processor uses drafting equipment 40% of the time to draft plans for exempt equipment and 60% of the time for drafting plans for building expansion. The drafting equipment would qualify for a 40% industrial processing exemption.

7. Remanufacturing.

The General Sales Tax Act [MCL 205.54t(7)(d); MSA 7.525(20)(7)(d)] and the Use Tax Act [MCL 205.94o(7)(d); MSA 7.555 (4o)(7)(d)] define remanufacturing as:

[T]he activity of overhauling, retrofitting, fabricating, or repairing a product or its component parts for ultimate sale at retail.

Example 10

A company purchases used carburetors and other parts and refurbishes the carburetors by installing new gaskets on the carburetors. The company then resells the carburetors. The company would qualify for industrial processing on the equipment and supplies used or consumed in restoring the carburetors. Remanufacturing includes the activities of disassembly, sorting, and reassembly of parts when that activity accompanies overhauling.

Example 11

A company purchases used driveshafts to be sold to automobile parts retailers. The company only cleans the driveshafts and then resells the driveshafts to the automobile parts retailers. The equipment and supplies consumed in the cleaning of the driveshafts would not qualify for industrial processing. The activity of merely cleaning the driveshafts would not qualify under remanufacturing and therefore the equipment and supplies would not qualify under industrial processing.

8. Processing of production scrap and waste up to the point it is stored for removal from the plant of origin.

Example 12

A heat treating company uses chemicals in performing its processing functions. These chemicals must be disposed of after being used. The taxpayer purchases equipment and supplies to treat the used chemicals before the chemicals are shipped to a landfill. The equipment and supplies used to treat the chemicals are exempt for industrial processing because they are used to treat production waste up to the point it is stored for removal from the plant of origin.

Example 13

An industrial processor collects its own production waste from several small containers near the industrial processing equipment and stores this waste in a large container for pickup by a waste removal company or a recycler. The waste removal company or recycling company dumps the waste from the large container into its own trucks. The small containers located near the industrial processing equipment are exempt and the large container is taxable.

Example 14

An industrial processor collects its own production waste from several small containers near the industrial processing equipment and stores this waste in a large container. The industrial processor then bales the production waste into bundles and places these bundles in a storage area to be picked up by a recycling company. The equipment and supplies used or consumed in the baling of the production waste qualifies for exemption under industrial processing. As in the prior example, the small containers located near the industrial processing equipment are exempt. In this example however, the large container is also exempt because the scrap has not come to rest until it is placed in bundles and put in a storage area.

9. Recycling of used materials for ultimate sale at retail or reuse.

Example 15

A plastics manufacturing company grinds up production scrap to be reused for two purposes, first as a raw material in its own process, and second, as a raw material to be sold to other industrial processors. The grinding equipment used in these processes would qualify for the industrial processing exemption.

10. Production material handling.

Example 16

An industrial processor manufactures steel bolt castings at one of its plants. These castings are taken by a forklift truck to another building at its plant site for grinding. The forklift truck would be exempt under industrial processing. Production material handling includes in-process movement of production materials and interplant movement of in-process materials within the same legal entity.

Example 17

An industrial processor manufactures steel bolt castings at one of its plants. These castings are taken by a forklift truck to a nearby plant of one of its subsidiary corporations for grinding. The forklift truck would not qualify for industrial processing because the bolts are not shipped within the same legal entity.

Example 18

An industrial processor manufactures steel bolt castings at its primary plant. These castings are shipped by truck to one of its own divisions located several miles away. The division performs grinding operations on the castings and then returns the castings to the primary plant for further processing. In-process shipping and receiving within the same legal entity is exempt. Therefore, any equipment or supplies consumed by either the primary plant or the division is shipping and receiving of in-process parts and is exempt. The truck would not qualify for an industrial processing exemption, regardless of whether it is owned by the company or a third party, inasmuch as it is a licensed highway vehicle.

11. Storage of in-process materials.

Example 19

An industrial processor manufactures automobiles. One of its divisions manufactures plastic handles which are then shipped to its primary assembly plant. The handles are received at the assembly plant and placed into in-process storage utilizing an automated storage/retrieval system that consists of a computer system, bins, portable storage racks, and material handling equipment. The handles are retrieved as needed and sent to the production line using an automatic guided vehicle system. The computer system, bins, portable storage racks, material handling equipment, and automatic guided vehicle system are exempt.

4. Industrial processing does not include the following activities:

1. Purchasing, receiving, or storage of raw materials.

Example 20

A chrome plating company receives parts from another industrial processor. The chrome plating company applies chrome finish to the industrial processor's parts and then ships the parts back to the industrial processor. The receiving and shipping activities of the chrome plating company are taxable activities inasmuch as the company is receiving raw material.

[Note: The receiving and shipping activities of the industrial processor are also taxable activities because the in-process movement of materials is not within the same legal entity. If the plating company and the industrial processor were separate divisions or plants of the same legal entity, the receiving and shipping activities of the separate divisions or plants would be exempt.]

Sales, distribution, warehousing, shipping, or advertising activities.

Administrative, accounting, or personnel services.

Design, engineering, construction, or maintenance of real property and nonprocessing equipment.

Plant security, fire prevention, or medical or hospital services.

Example 21

An industrial processor has a fire protection sprinkler system installed in the ceiling in their plant. The sprinkler system is excluded from the industrial processing exemption as realty. The fact that the sprinkler system serves to protect the industrial processing area does not exempt the sprinkler system under industrial processing.

Property that is eligible for an industrial processing exemption includes the following:

1. Property that becomes an ingredient or component part of the finished product to be sold ultimately at retail.
   
   
2. Machinery, equipment, tools, dies, patterns, foundations for machinery or equipment, or other processing equipment used in an industrial processing activity and in their repair and maintenance.
   
   
3. Property that is consumed or destroyed or that loses its identity in an industrial processing activity.
   
   

Example 22

An industrial processor uses lubricating oils in the processing equipment. The lubricating oils are exempt under industrial processing.

4. Tangible personal property, not permanently affixed and not becoming a structural part of real estate, that becomes a part of, or is used and consumed in installation and maintenance of, systems used for an industrial processing activity.
   
   
5. Fuel or energy used or consumed for an industrial processing activity. This includes energy such as natural gas, coal, electricity, or fuel oil to operate industrial processing equipment or to heat, cool, and illuminate the industrial processing areas.

Example 23

An industrial processor consumes electricity in its industrial processing activities as well as taxable non-industrial processing activities. The industrial processor is billed a lump sum for the electricity, transmission, and distribution of the electricity. If the industrial processor consumes 30% of the electricity in an industrial processing function, 30% of the total amount for electricity, transmission, and distribution would be exempt for industrial processing.

6. Machinery, equipment, or materials used within a plant site or between plant sites operated by the same person for movement of tangible personal property in the process of production.

Example 24

Portable racks that are used in shipping in-process materials between plant sites operated by the same person are exempt. The racks may be used for shipment of in-process materials and placed on licensed highway vehicles to other plants of the same person; the racks would still be exempt under industrial processing. However, racks that are only used when attached to licensed highway vehicles are taxable because the racks are part of the vehicle and are excluded from the exemption.

7. Office equipment, including data processing equipment, used for an industrial processing activity.

Example 25

An engineer for an industrial processor uses a hand-held calculator in the plant to verify tolerances on in-process parts. The calculator would be exempt under industrial processing.

6. Property that is not eligible for an industrial processing exemption includes the following: