Introduction

This guide was created to help manufacturing businesses understand their tax reporting responsibilities and the various tax incentives available to them. The guide includes general tax reporting information and tax incentives for manufacturers

This guide is intended to provide general tax information only. For more information or to get answers to specific questions, please contact us.

Table of Contents

Chapter 1

General Manufacturing Activities / Operations

Manufacturing Business and Occupation (B&O) Tax

Persons who manufacture products in this state are subject to the manufacturing business and occupation (B&O) tax upon the value of the products, including by-products, unless the activity qualifies for one of the special manufacturing B&O tax rates discussed later in the chapter. 

Retailing and Wholesaling B&O tax

Manufacturers who sell their products at retail or wholesale in this state are also subject to either the retailing or wholesaling B&O tax, as the case may be. In such cases, the manufacturer must report under both the "production" (manufacturing) and "selling" (wholesaling or retailing) classifications of the B&O tax.

Multiple Activities Tax Credit (MATC)

Manufacturers and extractors, who report B&O tax on multiple activities in Washington, may qualify for the multiple activities tax credit (MATC). The MATC is a B&O tax credit that is available to certain manufacturers, extractors, and sellers doing business in Washington. Businesses are eligible for this credit against the state B&O tax for gross receipts taxes paid in another jurisdiction or for taxes paid on multiple activities within Washington. The business must complete the Multiple Activities Tax Credit (Schedule C) each time the credit is claimed and attach it to their excise tax return. See WAC 458-20-19301 for a more detailed explanation of the MATC reporting requirements.  

Definitions for B&O tax purposes

"Manufacturer" means every person who, either directly or by contracting with others for the necessary labor or mechanical services, manufactures for sale or for commercial or industrial use from his or her own materials or ingredients any articles, substances or commodities. (RCW 82.04.110)

Manufacturer does not include:

• producers of aluminum master alloys, regardless of the portion of the aluminum provided by that person's customer.
• non-residents of Washington that own materials that are being processed instate. 
• owners of materials from which nuclear fuel assembly is made for it by a processor for hire.    

"To manufacture" embraces all activities of a commercial or industrial nature where labor or skill is applied, by hand or machinery, to materials so that as a result thereof a new, different or useful substance or article of tangible personal property is produced for sale or commercial or industrial use, and shall include: 

The production or fabrication of special made or custom made articles;

• The production or fabrication of dental appliances, devices, restorations, substitutes, or other dental laboratory products by a dental laboratory or dental technician; 
• Cutting, delimbing, and measuring of felled, cut, or taken trees; 
• Crushing and/or blending of rock, sand, stone, gravel, or ore; and
• Cleaning (removal of the head, fins, or viscera) of fish. 
  • A manufacturing B&O tax exemption is available for the cleaning of fish, if the cleaning activities are limited to the removal of the head, fins, or viscera from fresh fish without further processing other than freezing. (RCW 82.04.2403) 
    
    Processors for hire performing these cleaning activities remain subject to the processing for hire B&O tax.

"To manufacture" shall not include: 

• Conditioning of seed for use in planting;
• Cubing hay or alfalfa; 
• Activities which consist of cutting, grading, or ice glazing seafood which has been cooked, frozen, or canned outside this state;
• The growing, harvesting, or producing of agricultural products; 
• Packing of agricultural products, including sorting, washing, rinsing, grading, waxing, treating with fungicide, packaging, chilling, or placing in controlled atmospheric storage.

Manufacturing B&O tax classifications

• Manufacturing – "Catch All" classification if manufacturing activity is not provided a special B&O tax rate
• Commercial Aircraft Manufacturing – Effective October 1, 2005
• Wood Biomass Fuel Manufacturing  
• Manufacturing wheat into flour, barley into pearl barley, soybeans into soybean oil, or sunflower seeds into sunflower oil
• Splitting or processing dried peas 
• Manufacturing seafood products that remain in a raw, raw frozen, or raw salted state 
  • Effective July 1, 2006, B&O tax exemption on manufacturing activity. Also applies to wholesale sales by manufacturer when product transported outside the state by the purchaser. Expires July 1, 2015. 
• Manufacturing dairy products
  • Effective July 1, 2006, B&O tax exemption on manufacturing activity. Also applies to wholesale sales by manufacturer when product transported outside the state by the purchaser. Exemption expires July 1, 2015, then activities will be subject to reduced B&O tax rate.
• Manufacturing fresh fruits and vegetables by canning, preserving, freezing, processing, or dehydrating
  • Effective July 1, 2005, B&O tax exemption on manufacturing activity. Also applies to wholesale sales by manufacturer when product transported outside the state by the purchasers. Exemption expires July 1, 2015, then activities will be subject to reduced B&O tax rate.
• Slaughtering, breaking and/or processing perishable meat products and/or selling the same at wholesale - combines manufacturing and non-manufacturing activities into a single taxable business activity.  Includes meat processing that results in a non- perishable product (canned foods). Excise Tax Advisory (ETA) 3112 (2011)
• Manufacturing Timber or Wood Products
• Manufacturing Semiconductor Materials
• Manufacturing Solar Energy Systems and Components of Solar Energy Systems
• Processing for hire 
• Printing and Publishing 

Other activities subject to manufacturing B&O tax classification:

Logging

Extracting: The felling, cutting (severing), or taking of trees is an extracting activity. The extracting B&O tax applies to the value of the products, which is the value of the severed trees prior to any cutting, delimbing, or other manufacturing activity. RCW 82.04.100

Manufacturing: The cutting, delimbing, and measuring of felled, cut, or taken trees is a manufacturing activity. The manufacturing B&O tax applies to the value of the products, which is generally the gross proceeds of sale, whether the manufactured product is sold at retail or wholesale. RCW 82.04.120

Mining & Quarrying

Extracting: Mining and quarrying operations are extracting activities, and generally include the screening, sorting, and piling, of rock, sand, stone, gravel, or ore.  For example, an operation that extracts rock, then screens, sorts, and with no further processing places the rock into piles for sale, is an extracting operation.

Manufacturing: The crushing and/or blending of rock, sand, stone, gravel, or ore are manufacturing activities.  These are manufacturing activities whether or not the materials were previously screened or sorted. 

Screening, sorting, piling, or washing of the material, when the activity takes place in conjunction with crushing or blending at the site where the materials are taken or produced, is considered a part of the manufacturing activity if it takes place after the first screen.  If there is no separate first screen, only those activities subsequent to the materials being deposited into the screen are considered manufacturing activities. 

However, rock crushing performed by the same business that is hired to perform road building (public roads or logging roads) is not an activity that qualifies for the manufacturer’s tax exemption since the product (the crushed rock) is not sold as tangible personal property but is instead applied to the road being built.  

Laws and Rules

• RCW 82.04.110
• RCW 82.04.120
• WAC 458-20-135
• WAC 458-20-136

Manufacturers and Reseller Permits

Use your reseller permit only when purchasing ingredients or components which physically enter into and become a physical part of the new article or substance produced for sale. Do not use your reseller permit when purchasing tools, machinery and equipment, or articles that are consumed in the manufacturing process (e.g., fuel used for heating purposes, oil for machinery, sandpaper, etc.).

Note: Manufacturers may purchase certain machinery and equipment used directly in the manufacturing operation without paying sales tax. Such purchases must meet specific criteria and qualifying manufacturers must present a Manufacturer's Sales and Use Tax Exemption Certificate For Manufacturing Machinery and Equipment to the seller at the time of purchase.

Chapter 2

Manufacturer’s Sales/Use Tax Exemption For Machinery and Equipment (M&E)

Generally, a business must report under one or more of the manufacturing B&O tax classifications to be eligible for the manufacturer’s sales and use tax exemption.  Other requirements apply.

M&E Exemption

The Manufacturers' Sales and Use Tax Exemption (M&E) provides a retail sales and use tax exemption for machinery and equipment used directly in a manufacturing operation or research and development operation. Sales of or charges made for labor and services rendered in respect to installing, repairing, cleaning, altering, or improving qualifying machinery and equipment are also exempt from sales tax.  In addition, the exemption may be taken for qualifying machinery and equipment used directly in a testing operation by a person engaged in testing for a manufacturer or processor for hire.

To qualify for the M&E sales and use tax exemption:

• The property must meet the definition of "machinery and equipment" as a:
  • Device,
  • Industrial fixture,
  • Support facility, or
  • Tangible personal property that becomes an ingredient or component of any of the above, including repair and replacement parts, lubricants, etc., with a useful life of one year or more.
• The purchase or use must be by a manufacturer or processor for hire or person engaged in testing for a manufacturer or processor for hire,
• The machinery and equipment must be used directly in a manufacturing operation, research and development by a manufacturer, or testing operation,
• The machinery or equipment must have a useful life of one year or more, and 
• The machinery and equipment must be used more than 50% of the time on an eligible activity (majority use threshold).

The purchase or use must be by a manufacturer or processor for hire or person engaged in testing for a manufacturer or processor for hire.  

"Manufacturing operation" means the manufacturing of articles, substances, or commodities for sale as tangible personal property. 

A manufacturing operation begins at the point where the raw materials enter the manufacturing site and ends at the point where the processed material leaves the manufacturing site. The operation includes storage of:

• raw materials at the site, 
• in-process materials at the site, and
• the processed material at the site.

The manufacturing operation is defined in terms of a process occurring at a location. To be eligible as a qualifying use of M&E, the use must take place within the manufacturing operation, unless specifically exempted by law. Storage of raw material or other tangible personal property, packaging of tangible personal property, and other activities that potentially qualify under the "used directly" criteria, and that do not constitute manufacturing in and of themselves, are not within the scope of the exemption unless they take place at a manufacturing site. 

Note: The statute specifically allows testing to occur away from the site.

“Testing” means activities performed to establish or determine the properties, qualities, and limitations of tangible personal property.

"Testing operation" means the testing of tangible personal property for a manufacturer or processor for hire.  

A testing operation begins at the point where the tangible personal property enters the testing site and ends at the point where the tangible personal property leaves the testing site. The term also includes that portion of a cogeneration project that is used to generate power for consumption within the site of which the cogeneration project is an integral part.

The testing operation is defined in terms of a process occurring at a location. To be eligible as a qualifying use of M&E, the use must take place within the testing operation, unless specifically exempted by law.

“Research and development operation” means engaging in research and development as defined in RCW 82.63.010 by a manufacturer or processor for hire. 

RCW 82.63.010 defines "research and development" to mean: Activities performed to discover technological information, and technical and nonroutine activities concerned with translating technological information into new or improved products, processes, techniques, formulas, inventions, or software. The term includes exploration of a new use for an existing drug, device, or biological product if the new use requires separate licensing by the Federal Food and Drug Administration under chapter 21, C.F.R., as amended. The term does not include adaptation or duplication of existing products where the products are not substantially improved by application of the technology, nor does the term include surveys and studies, social science and humanities research, market research or testing, quality control, sale promotion and service, computer software developed for internal use, and research in areas such as improved style, taste, and seasonal design.

Manufacturing Sites

Temporary Manufacturing Sites
A manufacturing operation can exists where the manufacturing site is temporary and where the manufacturing equipment is mobile.  For example, operations using portable saw mills or rock crushing equipment are considered "manufacturing operations" if the activity in which the person is engaged is manufacturing.  

• Rock crushing equipment that deposits material onto a roadway is not used in a manufacturing operation because this is a part of the constructing activity, not a manufacturing activity.  
• Likewise, a portable cement mixer at a construction site is not used in a manufacturing operation because the activity is constructing, not manufacturing.  
• Other portable equipment used in non-manufacturing activities, such as continuous gutter trucks or trucks designed to deliver and combine aggregate, or specialized carpentry tools, do not qualify for the same reasons.

Excise Tax Advisory (ETA) 3123 

Multiple Manufacturing Sites
Manufacturing tangible personal property for sale can occur in stages.  Each stage can take place at different manufacturing sites.  For example, if a taxpayer processes pulp from wood at one site, and transfers the resulting pulp to another site that further manufactures the product into paper; two separate qualifying manufacturing operations exist if the end product is sold as tangible personal property.  

At the Site or Away from the Site
Questions have been raised regarding whether, and to what extent, the M&E exemption includes a requirement that qualifying activity take place at a manufacturing site. The M&E statute provides an exemption from tax for machinery and equipment “used directly in the manufacturing operation.” The phrase “manufacturing operation” is defined as “the manufacturing of articles, substances, and commodities for sale as tangible personal property.” The M&E statute also describes the manufacturing operation in terms of a process, with a beginning and an end, taking place at a location. The statutory definition of “manufacturing operation” provides in part, “a manufacturing operation begins at the point where the raw materials enter the manufacturing site and ends at the point where the processed material leaves the manufacturing site.” The definition of “testing operation” has similar language. The definition of “research and development operation” does not have any language regarding site.

Machinery and Equipment (M&E) defined

"Machinery and equipment" means:

• Industrial fixtures
  • "Industrial fixture" means an item attached to a building or to land. Fixtures become part of the real estate to which they are attached and upon attachment are classified as real property, not personal property. Examples of "industrial fixtures" are fuel oil lines, boilers, craneways, and certain concrete slabs.
• Devices
  • “Device” is an item that is not attached to the building or site. Examples of devices are: Forklifts, chainsaws, air compressors, clamps, free standing shelving, software, ladders, wheelbarrows, and pulleys.
• Support facilities, and
  • "Support facility" means a part of a building, or a structure or improvement, used to contain or steady an industrial fixture or device. A support facility must be specially designed and necessary for the proper functioning of the industrial fixture or device and must perform a function beyond being a building or a structure or an improvement. It must have a function relative to an industrial fixture or a device. To determine if some portion of a building is a support facility, the parts of the building are examined. For example, a highly specialized structure, like a vibration reduction slab under a microchip clean room, is a support facility. Without the slab, the delicate instruments in the clean room would not function properly. The ceiling and walls of the clean room are not support facilities if they only serve to define the space and do not have a function relative to an industrial fixture or a device.
• Tangible personal property that becomes an ingredient or component of any of the above, including repair parts and replacement parts. 

"Machinery and equipment" includes pollution control equipment installed and used in a qualifying operation to prevent air pollution, water pollution, or contamination that might otherwise result from the operation.  

The machinery & equipment must be “used directly in a manufacturing operation, testing operation, or research and development operation.” 

Items that are not used directly in a qualifying operation are not eligible for the exemption.  RCW 82.08.02565 provides eight descriptions of the phrase "used directly."  The manner in which a person uses an item of machinery and equipment must match one of these descriptions.  If machinery and equipment is not "used directly" it is not eligible for the exemption. 

Machinery and equipment is "used directly" in a manufacturing operation, testing operation, or research and development operation, if the machinery and equipment meets any one of the following criteria:

1. Acts upon or interacts with an item of tangible personal property.   Examples of this are drill presses, cement mixers (agitators), ready-mix concrete trucks, hot steel rolling machines, rock crushers, and band saws.  Also included is machinery and equipment used to repair, maintain, or install tangible personal property.  Computers qualify under this criteria if:
   1. They direct or control machinery or equipment that acts upon or interacts with tangible personal property; or  
   2. If they act upon or interact with an item of tangible personal property.
2. Conveys, transports, handles, or temporarily stores an item of tangible personal property at the manufacturing site or the testing site.   Examples of this are wheelbarrows, handcarts, storage racks, forklifts, tanks, vats, robotic arms, piping, and concrete storage pads.  Floor space in buildings does not qualify. 
   

   Items that are used to ship the product or in which the product is packaged are not eligible under this criterion. This includes materials used to brace or support an item during transport.
   
   Storage of raw material or other tangible personal property, packaging of tangible personal property, and other activities that potentially qualify under the "used directly" criteria, and that do not constitute manufacturing in and of themselves, must take place at the manufacturing site to qualify for the exemption.
   

3. Controls, guides, measures, verifies, aligns, regulates, or tests tangible personal property at the site or away from the site.   Examples of "away from the site" are road testing of trucks, air testing of planes, or water testing of boats, with the machinery and equipment used off site in the testing eligible under this criteria.  Machinery and equipment used to take readings or measurements is eligible under this criterion.
4. Provides physical support for or access to tangible personal property.  Examples of this are catwalks adjacent to production equipment, scaffolding around tanks, braces under vats, and ladders near controls.  Machinery and equipment used for access to the building or to provide a work space for people or a space for tangible personal property or machinery and equipment, such as stairways or doors, is not eligible.
5. Produces power for or lubricates machinery and equipment.  A generator providing power to a sander is an example of machinery and equipment that produces power for machinery and equipment.  An electrical generating plant that provides power for a building is not eligible.  Lubricating devices, such as hoses, oil guns, pumps, and meters, whether or not attached to machinery and equipment, are eligible.
6. Produces another item of tangible personal property for use in the manufacturing operation, testing operation, or research and development operation.  Machinery and equipment that makes dies, jigs, or molds, and printers that produce camera-ready images.
7. Places tangible personal property in the container, package, or wrapping in which the tangible personal property is normally sold or transported.
8. Is integral to research and development as defined in RCW 82.63.010.
   "Integral" means the machinery and equipment is necessary for research and development.
   
   For example, an electrical apparatus used directly in a research and development operation need only be “integral” to the research and development operation to be entitled to the M&E exemption. There is no requirement that it act upon or interact with an item of tangible personal property or produce power for machinery and equipment

    

Examples of items that are not used directly in a qualifying operation:

• Cafeteria furniture
• Safety equipment not part of qualifying M&E
• Packaging materials
• Shipping materials 
• Administrative or office equipment

What is eligible for the exemption?

A manufacturer/processor for hire is exempt from sales and use tax on: 

• Purchases of machinery and equipment.
• Purchases of tools for repairing qualifying machinery and equipment.
• Charges for hiring someone to repair machinery and equipment.
• Renting equipment (with or without operator) to repair or install machinery and equipment.

Repair services and parts
Because the exemption is limited to items with a useful life of one year or more, some charges for repair, labor, services, and replacement parts may not be eligible for the exemption.  

In the case of labor and service charges that cover both qualifying and non-qualifying repair and replacement parts, the labor and services charges are presumed to be exempt.  If all of the parts are non-qualifying, the labor and service charge is not exempt.

Renting or Leasing of Tangible Personal Property

Bare Rentals
The “renting or leasing of tangible personal property,” sometimes referred to as a bare rental or true lease, is eligible for the M&E exemption if all other conditions of the exemption are satisfied. For example, the rental of a crane on a bare rental basis to a manufacturer, whose employee operates the crane to move equipment to the top of a building, may be eligible for the M&E exemption.

Rental of Equipment with an Operator  
The “rental of equipment with an operator” is a separate and distinct activity from the “renting or leasing of tangible personal property.”  The “rental of equipment with an operator” is a sale of a service and not a sale of tangible personal property. While the seller is providing equipment along with the equipment operator, the customer is purchasing the knowledge, skills, and expertise of an operator needed to operate the equipment at the customer’s direction. Because the “rental of equipment with an operator” is not a sale of tangible personal property, it is not eligible for the M&E exemption. 

For example, manufacturer hires a company to provide a crane with operator to move equipment to the top of a building. While the company’s employee operates the crane, the equipment is actually installed by manufacturer’s employees. The purchase of the crane with operator service is not eligible for the M&E exemption.

The tax application of any scenario depends on the facts and circumstances of the particular situation. For example, consider the situation where a manufacturer hires a company to provide a crane with operator to move equipment to the top of a building and the personnel to install the equipment. In this case, the purchased services may be eligible for the M&E exemption because the company hired by the manufacturer is responsible for installing the equipment.

Refer to WAC 458-20-211 for additional guidance for distinguishing when a person is renting or leasing tangible personal property, providing a rental of equipment with an operator, or is performing construction or installation services. ETA 3118

Electrical Apparatus - Manufacturing Operations and Testing Operations
Electrical apparatus such as motor control centers, starters, switches, regulators, and exciters “act upon or interact with” tangible personal property, often in a sequential manner. The motor control center, for example, produces an action that results in a reaction by the motor. Switches and exciters work in much the same way. Similarly, circuit breakers and comparable equipment react to an event in another item, and this cause and effect behavior falls under the “acts upon or interacts with” criteria. Thus, these items are eligible for the M&E exemption, subject to meeting the other requirements of the exemption. Converters, transformers, and other equipment on site, that alter the characteristics of the electricity “produce power” for machinery and equipment, and qualify for the M&E exemption, subject to meeting the other requirements of the exemption. Apparatus that are part of a utility system used for qualifying and non- qualifying purposes should be examined using the allocation standard set forth below. Transmission and distribution systems located off site do not qualify for the M&E exemption. ETA 3120

Utility Systems used for Qualifying and Nonqualifying Purposes – Allocation
The M&E exemption defines “machinery and equipment” to, in part, exclude building fixtures that are not integral to the manufacturing operation, testing operation, or research and development operation that are permanently affixed to and become a physical part of the building, such as utility systems for heating, ventilation, air conditioning, communications, plumbing, or electrical.

Conversely, building fixtures are eligible if they are integral to the manufacturing operation, testing operation, or research and development operation, and meet the other requirements of the exemption, such as the “used directly” test. Thus, while the M&E exemption contemplates that these utility systems are to be separately considered as potentially eligible industrial fixtures and not a part of a “building” for purposes of exemption, not all such systems are eligible for the exemption. Utility systems that serve a building purpose, as opposed to a manufacturing purpose, do not qualify. ETA 3120

For example, a utility system used to perform a general building purpose, such as a HVAC system controlling the air temperature or air quality in general, is not eligible for the M&E exemption. If a utility system is used for both qualifying and non-qualifying purposes, the system should be allocated so that only the qualifying portion of the system receives the exemption, and the building portion does not receive an exemption.  One way of allocating a utility system is by applying the ratio of the qualifying use made of the system to the total use of the system. This ratio must be established and substantiated by sufficient documentation, such as, but not limited to, engineering analyses and power bills. Thus, if the taxpayer can document that 30 percent of a system is used for the manufacturing activity (e.g., 30 percent of the system is dedicated to manufacturing frozen raspberries vs. 70 percent dedicated to cold storage) then this 30 percent qualifies for the exemption.

The concept of allocating portions of a utility system as qualifying or non-qualifying for purposes of the M&E exemption is limited to utility system machinery and equipment considered a building fixture, when used to support both manufacturing machinery and equipment and the building systems. Allocation is not applicable to any other situation. In other areas dealing with dual use of machinery and equipment (dual use meaning property is used in both qualifying and non-qualifying activities) the majority use threshold is applicable. Rule 13601(10) sets forth the criteria used in applying the majority use test.

Devices
Device is defined as “an item that is not attached to the building or site.” Examples include “forklifts, chainsaws, air compressors, clamps, free standing shelving, software, ladders, wheelbarrows, and pulleys.” These examples fit within the common dictionary definition of “machinery and equipment” and “device.” ETA 3121

Books
In order to be eligible for the M&E as a device the property has to perform a task and do work. Books are used for reference and to assist in or guide or control decision making but are not used by a person in the same manner as machinery and equipment, which have an applied function. Therefore, books do not qualify for the M&E.

Software
Computer software satisfies the definition of device because it performs a task and is also not attached to a building or site. Consequently, software can qualify for the M&E exemption if it meets a used directly test. The issue is whether the software performs a task in relation to the qualifying operation.

For example, a software program that controls the operation of equipment that cuts logs into lumber qualifies for the M&E exemption. It performs a task, the control of a piece of eligible machinery, and is used directly in the manufacturing operation. On the other hand, a CD-ROM of a repair manual for this equipment does not qualify for the M&E exemption because the software does not perform a task in the manufacturing operation.

“Computer software" means a set of coded instructions designed to cause a computer or automatic data processing equipment to perform a task. All software is classified as either prewritten or custom. Consistent with this definition "computer software" includes only those sets of coded instructions intended for use by an end user and specifically excludes retained rights in software and master copies of software. (RCW 82.04.215)

Design and Product Development

The Department makes a distinction between activities that take place within the manufacturing operation and activities that either precede or follow the manufacturing operation. For example, creation and design of information, such as writing text for a newspaper, is an activity that takes place before the manufacturing operation begins. However, the preparation of this information for use in a manufactured product, is an activity that generally occurs in the manufacturing operation. Composition of a book or the writing of a newspaper article are activities that are considered product development and outside of the manufacturing operation, and thus are not considered to be within the scope of the M&E exemption.

Similarly, design of an automobile, or engineering of a piston are considered product development and outside of the manufacturing operation. However, taking a completed manuscript and preparing it for printing could be part of the manufacturing operation, as could be the layout and pagination of a newspaper. Other products that have information content, such as compact discs and music are subject to the same tax application. Essentially, the creation of the information is not manufacturing and is not part of the manufacturing operation. Property that is used both in product development and in manufacturing of tangible personal property may be eligible for the M&E exemption, if all other requirements of the exemption are met. 

The Department will presume that design activity is not part of the manufacturing operation and machinery and equipment used in design is not eligible for the M&E exemption. Equipment used in redesign or refinement of a product after manufacturing has begun is not eligible for the M&E exemption. This presumption can be overcome by showing that the design decisions and the application of labor and skills to the raw materials are the same activity. ETA 3122

Machinery and equipment used in research and development

The M&E exemption applies to sales of machinery and equipment used directly in an R&D operation by a manufacturer or processor for hire. Machinery and equipment is used directly in an R&D operation if it is integral to R&D as defined in RCW 82.63.010.

Examples of machinery and equipment include computer hardware, software, data processing equipment, and laboratory equipment. Machinery and equipment does not include property with a useful life of less than one year. ETA 3127

Integral to research and development operation
Machinery and equipment is integral to an R&D operation if R&D cannot be accomplished without such machinery and equipment. For example, a laboratory table is integral to an R&D operation. Likewise, telephones, computer hardware (e.g., cables, scanners, printers, etc.), and computer software (e.g., Word, Excel, Windows, Adobe, etc.) used in a typical workstation for an R&D personnel are integral to an R&D operation. Also, a chair used in a laboratory workstation is integral to an R&D operation. A chair used in a lobby area, however, is not integral to an R&D operation. Similarly, decorative artwork is not integral to an R&D operation.

Research and development operation
"R&D operation" means engaging in R&D by a manufacturer or processor for hire. R&D can be performed away from a manufacturing site, and the machinery and equipment used to perform such R&D may still qualify for the M&E exemption. 

R&D includes the following activities:

• Activities performed to discover technological information,
• Technical and non-routine activities concerned with translating technological   information into new or improved products, processes, techniques, formulas, inventions, or software, and
• Exploration of a new use for an existing drug, device, or biological product, if the new use requires separate licensing by the federal food and drug administration under chapter 21, C.F.R., as amended.

R&D does not include the following activities:

• Adaptation or duplication of existing products without substantial improvement by application of the technology,
• Surveys and studies,
• Social science and humanities research,
• Market research or testing,
• Quality control,
• Sale promotion and service,
• Computer software developed for internal use, and
• Research to improve style, taste, or seasonal design.

Refer to WAC 458- 20-24003 for additional information on what constitutes R&D.

Majority use requirement for machinery and equipment used in research and development
Machinery and equipment used in R&D operation must satisfy the majority use threshold in order to qualify for the M&E exemption. Machinery and equipment that does not satisfy the majority use threshold is subject to use tax at the time the majority use threshold is no longer met. For example, a laboratory table used solely for qualifying R&D purposes and then converted solely to non-qualifying uses is subject to use tax at the time of conversion. 

What is not eligible for the exemption?

In addition to items that are not eligible because they do not meet the used directly test or fail to overcome the majority use threshold, there are four categories of items that are statutorily excluded from eligibility.  The following property is not eligible for the M&E exemption:

1. Hand-powered tools.  Screw drivers, hammers, clamps, tape measures, and wrenches are examples of hand-powered tools.  Electric powered, including cordless tools, are not hand-powered tools, nor are calipers, plugs used in measuring, or calculators.
2. Property with a useful life of less than one year.  All eligible machinery and equipment must satisfy the useful life criteria, including repair parts and replacement parts.  For example, items such as blades and bits are generally not eligible for the exemption because, while they may become component parts of eligible machinery and equipment, they generally have a useful life of less than one year.   Blades generally having a useful life of one year or more, such as certain sawmill blades, are eligible.  (See subsection on thresholds to determine useful life.)
3. Buildings, other than machinery and equipment that is permanently affixed to or becomes a physical part of a building.   Buildings provide work space for people or shelter machinery and equipment or tangible personal property.  The building itself, and some of its components, such as walls, partitions, floors, ceilings, windows, and doors, are not eligible for the exemption.  The industrial fixtures and support facilities that become affixed to or part of the building might be eligible.  The subsequent real property status of industrial fixtures and support facilities does not affect eligibility for the exemption.
4. Building fixtures that are not integral to the manufacturing operation, testing operation, or research and development operation that are permanently affixed to and become a physical part of a building, such as utility systems for heating, ventilation, air conditioning, communications, plumbing, or electrical.  Examples of nonqualifying fixtures are:  Fire sprinklers, building electrical systems, or washroom fixtures.  Fixtures that are integral to the manufacturing operation might be eligible, depending on whether the item meets the other requirements for eligibility, such as the used directly test.

Useful Life

Property with a useful life of less than one year is not eligible for the M&E exemption.  The useful life threshold identifies items that do not qualify for the exemption, such as supplies, consumables, and other classes of items that are not expected or intended to last a year or more.   

For example, tangible personal property that is acquired for a one-time use and is discarded upon use, such as a mold or a form, has a useful life of less than one year and is not eligible. 

If it is clear from taxpayer records or practice that an item is not used for at least one year, the item is not eligible, regardless of the answers to the four threshold questions. 

Determining useful life
Assuming the machinery and equipment meets all of the other M&E requirements and does not have a single one-time or is not discarded during the first year, useful life can be determined by answering the following questions for an individual piece of machinery and equipment:

1. Is the machinery and equipment capitalized for either federal tax purposes or accounting purposes?  
   - If the answer is "yes," it qualifies for the exemption.
   - If the answer is "no," go to the next question.
2. Is the machinery and equipment warranted by the manufacturer to last at least one year?  
   - If the answer is "yes," it qualifies for the exemption.
   - If the answer is "no," go to the next question.
3. Is the machinery and equipment normally replaced at intervals of one year or more, as established by industry or business practice? (This is commonly based on the actual experience of the person claiming the exemption.)  
   - If the answer is "yes," it qualifies for the exemption.
   - If the answer is "no," go to the next question.
4. Is the machinery and equipment expected at the time of purchase to last at least one year, as established by industry or business practice?  (This is commonly based on the actual experience of the person claiming the exemption.)  
   - If the answer is "yes," it qualifies for the exemption.  
   - If the answer is "no," it does not qualify for the exemption.

The majority use threshold

Machinery and equipment both used directly in a qualifying operation and used in a non- qualifying manner is eligible for the exemption only if the qualifying use satisfies the majority use requirement.  Examples of situations in which an item of machinery and equipment is used for qualifying and non-qualifying purposes include:  

• The use of machinery and equipment in manufacturing and repair activities, such as using a power saw to make cabinets in a shop versus using it to make cabinets at a customer location; 
• The use of machinery and equipment in manufacturing and constructing activities, such as using a forklift to move finished sheet rock at the manufacturing site versus using it to unload sheet rock at a customer location; and 
• The use of machinery and equipment in manufacturing and transportation activities, such as using a mixer truck to make concrete at a manufacturing site versus using it to deliver concrete to a customer.  

Majority use can be expressed as a percentage, with the minimum required amount of qualifying use being greater than fifty percent compared to overall use.  To determine whether the majority use requirement has been satisfied, the person claiming the exemption must retain records documenting the measurement used to substantiate a claim for exemption.  Majority use is measured by looking at the use of an item during a calendar year using any of the following:

1. Time.  Time is measured using hours, days, or other unit of time, with qualifying use of the M&E the numerator, and total time used the denominator.  Suitable records for time measurement include employee time sheets or equipment time use logs.
2. Value.  Value means the value to the person, measured by revenue if the qualifying and non-qualifying uses both produce revenue.  Value is measured using gross revenue, with revenue from qualifying use of the M&E the numerator, and total revenue from use of the M&E the denominator.  If there is no revenue associated with the use of the M&E, such as in-house accounting use of a computer system, the value basis may not be used.  Suitable records for value measurement include taxpayer sales journals, ledgers, account books, invoices, and other summary records.
3. Volume.  Volume is measured using amount of product, with volume from qualifying use of the M&E the numerator and total volume from use of the M&E the denominator.  Suitable records for volume measurement include production numbers, tonnage, and dimensions.
4. Other comparable measurement for comparison.  The department may agree to allow a taxpayer to use another measure for comparison, provided that the method results in a comparison between qualifying and non-qualifying uses.  For example, if work patterns or routines demonstrate typical behavior, the taxpayer can satisfy the majority use test using work site surveys as proof.

Each piece of M&E does not require a separate record if the taxpayer can establish that it is reasonable to bundle M&E into classes.  Classes may be created only from similar pieces of machinery and equipment and only if the uses of the pieces are the same.  For example, forklifts of various sizes and models can be bundled together if the forklifts are doing the same work, as in moving wrapped product from the assembly line to a storage area.  An example of when not to bundle classes of M&E for purposes of the majority use threshold is the use of a computer that controls a machine through numerical control versus use of a computer that creates a camera ready page for printing.

Typically, whether the majority use threshold is met is decided on a case-by-case basis, looking at the specific manufacturing operation in which the item is being used.  However, for purposes of applying the majority use threshold, the department may develop industry-wide standards.  For instance, the aggregate industry uses concrete mixer trucks in a consistent manner across the industry. Based on a comparison of selling prices and delivery prices the department has determined that concrete trucks overcome the majority use threshold.  Only in those limited instances where it is apparent that the use of the concrete truck is atypical for the industry would the taxpayer be required to provide recordkeeping on the use of the truck in order to support the exemption.

Other types of property – Do they qualify for the M&E exemption?

Prototypes
Property that is the object of the manufacturing activity does not itself qualify for the exemption. The thing being made is the object of the activity and as such is not “machinery and equipment” as that phrase is used in the M&E exemption. If a prototype is not used to make, build, or test a different product or used in some supportive capacity (used directly) in stages of the manufacturing operation, its use does not qualify. Any product made by a manufacturer and used in a qualifying manner potentially qualifies for exemption – subject to not being the object of the activity itself. For example, a “prototype” used as a manufacturing mockup to calibrate tools will qualify as machinery and equipment. A prototype used as a test bed will qualify if it can be shown that the information gained from the test will be used for a different product or process, and will not be used to refine or change the product itself. 

The phrase ‘test bed” means that the prototype is used to test other property, and not the prototype itself. A “test bed” typically evaluates how property operates under a range of working conditions. If the prototype is being tested itself, then it is not being used as a “test bed.” ETA 3126

Presumption
In order to determine whether a product made by a manufacturer is eligible for the exemption, an examination of the facts, as supported by documentation or other credible evidence regarding the property’s use, must be undertaken. The Department presumes that a manufacturer of an item that is being developed or manufactured is not using the property in a manner eligible for the M&E exemption. To overcome this presumption, the manufacturer must establish that the item is being used to test something other than itself. This determination will be done on a case by case basis, and will in each case be based on the individual facts and circumstances. For example, in order for a prototype of a fire extinguisher to be eligible for use in an R&D operation, use of the prototype must be part of activities relating to another product and not be in regard to R&D on the fire extinguisher itself.

The Department also presumes that a product and all of its components are the thing being tested. The burden is on the taxpayer to demonstrate, and support by documentation or other credible evidence, that the product is being used as a “test bed.” Documentation will need to reflect the basis for the activity and the intent of the manufacturer.

Reporting/Documentation

Buyers must provide the seller with a properly completed Manufacturer’s Sales and Use Tax Exemption Certificate.

Sellers remain subject to the retailing B&O tax on all sales of machinery and equipment to consumers if delivery is made within the state of Washington. The retail sales tax exemption must be itemized on the Deduction Detail page of the excise tax return under the explanation “Sale of Manufacturing Mach/Equip; Install Labor.”  The seller must retain the certificate in their records.

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