Taxation of Manufacturing Companies
Manufacturing: Manufacturers are involved in the creation of tangible products which may go through various steps of processing before they are ultimately sold to a retailer. In many instances, the product will be manufactured in one jurisdiction and sold in another. Here are some scenarios that manufacturers may encounter and the potential tax consequences for each of them in the California:
Purchases: Manufacturing companies must be aware that the taxability of any purchase that they make will depend upon the use of that item. In general, if a product is being purchased as raw material that will be used for the creation of a product, those raw materials will not be taxable. (Business Taxes Law Guide-Revision 2020, Article 3, Regulation 1525(b)). On the other hand, other materials purchased that will be used for purposes other than as raw material will generally be taxable.
Alterations: Whether or not taxes may be paid for the alteration of a product will depend in part on whether the alterations are being done for a consumer who has already purchased and used the item or whether they are being done for an entirely new item. While alterations for used items are not subject to taxation, alterations of new items are. (Business Taxes Law Guide-Revision 2020, Article 3, Regulation 1524(b)).
Resale Certificates Seller’s Permits: Resale certificates are used for businesses who plan on purchasing any taxable items for resale to avoid double taxation on that item. Seller’s permits are necessary for businesses selling or leasing taxable, tangible personal property.
Their applicability to manufacturers will depend on what types of products are being created and what they are used for when sold. For example, some manufacturers may not sell finished products that are ready to be sold to consumers at retail stores.
Rather, such manufacturers may be in the business of selling components of products to other manufacturers who eventually piece the finished product together.
If your business provides manufacturing services of this variety, it most likely will not need to obtain a seller’s permit. On the other hand, if you are selling manufactured items directly to retailers, a seller’s permit will be necessary. In situations where a retailer is purchasing from a manufacturer, the manufacturer can collect a certificate of resale from the retailer.
By doing so, the manufacturer seller will not owe taxes on the sale and instead, the sales tax will be properly collected by the retailer when the item is sold to a consumer.
Exemption for Manufacturing and Research and Development Equipment
In California, manufacturers may take advantage of partial use and sales tax exemptions on certain qualifying tangible personal property used within their business.
Although the exemption has various criteria for qualification, machinery and various devices used to control machinery may qualify for the exemption.
The current exemption percentage is 3.9375 percent. To learn more about which entities and items qualify for the exemption, closely review the guidelines provided by the CDTFA .
Taxation of Service Companies in California
For out-of-state services companies, the answer to the question of whether their work will be considered taxable will be entirely dependent on the jurisdiction in question, as certain jurisdictions will tax some types of services while not taxing others.
In general, California limits the imposition of sales and use taxes to transactions that involve the use or sale of tangible personal property. Furthermore, whether you will owe taxes on services can depend on whether you are purely providing a service or if you are providing a service that is incidental to a tangible good you are selling.
California will impose taxes on on-of-state service providers, even when none of the services were performed from within the state or were accompanied by the sale of tangible property.
The law also addresses various other scenarios to determine whether a corporation, profession, business, sole proprietorship or other entity owes California taxes.
If your services business is conducted in any manner within the state or with a California entity, you will need to work with an attorney to determine the applicability of the law to your specific scenario.
With or without exchanging a tangible item with another person or entity in California, if you derive income from within the state, you can expect that California may have a law in the books to allow for the taxation of that income. (18 CCR § 17951-4(c)).
Services Accompanied by the Use or Sale of Tangible Property
Sometimes, services are provided in conjunction with the sale of a tangible product. For example, an office desk may be sold and assembled for the customer for an additional fee. The “true object” test is one of a few tests commonly applied across various jurisdictions to determine whether a service can be divorced from the tangible property by which it is accompanied.
The “true object” test aims to answer the question as to whether the service is incidental to the receipt of the tangible property or otherwise. The CDTFA defines the “true object” test to be an inquiry as to whether the purpose of the transaction is to receive the service or a tangible item produced by the service with which it is accompanied. (Business Taxes Law Guide, Annotation 515.0020).
Why Are Out-of-State Companies Taxed in California?
California loves to collect sales and use taxes and manufacturers, contractors and service businesses are not wholly exempt. However, some circumstances may qualify a business for tax exemption, for instance, if the materials or production are being used for R&D purposes.
Further complicating the tax issues is if personnel or raw materials come from out-of-state. In those cases, the seller may be subject to sales and use tax. Another variable is at what point in the supply chain that the title passes from the manufacturer or contractor to the consumer.
The same out-of-state tax rules apply to service businesses. Taxation depends on where the service was performed and whether or not it was in conjunction with the purchase of a product.
As you can see, taxation on these industries is complicated. That is why it is important to have an experienced attorney review any contracts you plan to sign. I can help you figure out whether or not the transactions are subject to sales and use tax and at what percentage.