Massachusetts retailer and consumer products company tax benefits
INSIGHT ARTICLE |
Whether your organization is a brick and mortar or ecommerce retail business, or other consumer products business that outsources its manufacturing, it may be missing out on favorable Massachusetts tax benefits. Many retailers selling private-label products and consumer products companies are unaware that they may be classified as manufacturers for Massachusetts tax purposes, even if the production of all of their products is outsourced to third parties for manufacture. The primary factors in determining classification is the business’ level of involvement in and control over the production process and the percentage of sales that the business derives from these items. If the classification applies, a business may be entitled to apportion its taxable income in Massachusetts based solely on the percentage of sales made into the state. In addition, if the company is a C or S corporation it may be eligible for the Massachusetts Investment Tax credit, as well as local property tax benefits.
A business is considered a manufacturer in Massachusetts if it is substantially “engaged in manufacturing.” While it may seem counterintuitive for a retailer to consider itself as engaged in manufacturing, Massachusetts has consistently held that such definition is to be broadly construed. As the industry evolves, it is increasingly common for retailers to sell their own store-brand goods, known as private-label products. According to industry publications, there were over $128 billion in private-label product sales in the United States in 2019. The manufacturing classification could apply to such retailers, even in cases where production is entirely completed through outsourcing arrangements, if the retailer’s design and control of the creation of the product is essential and integral to producing and bringing the products to market. Therefore, Massachusetts-based retailers selling private label products should be particularly interested in these potential Massachusetts tax benefits.
Similarly, other consumer product companies that outsource manufacturing may likewise qualify for the classification. The Massachusetts Appellate Tax Board (ATB) has determined that companies are “engaged in manufacturing” if they perform activities that are “essential and integral” to the manufacturing process. Essential and integral activities are not limited to the actual manufacture and production of products, having been interpreted to include more oversight activities, such as creating drafts, planning, designing, testing, and inspecting the goods. Therefore, if a business contracts with a third-party producer, the business may still be classified as a manufacturer if it has a significant amount of control over the production of the products. This model is prevalent for consumer products companies that are sellers of shoes, apparel, food, and personal technology products, and in many other industry lines.
Most recently, the ATB has reiterated this broad construction in 2018, with its Deckers Outdoor Corporation v. Commissioner of Revenue decision. The taxpayer, a footwear company headquartered in California, creates, designs, tests and inspects footwear, but contracts with third-party producers overseas to complete the actual production of the footwear. The taxpayer did not have a manufacturing floor and exclusively engaged third-party factories to produce its footwear products. The ATB held that the extensive hands-on planning, design and testing completed throughout the entire production process constitutes an essential and integral part of the total manufacturing process, thus classifying the taxpayer as a manufacturer.
A retailer or consumer products company that is engaging in manufacturing activities will be classified as a manufacturer if such manufacturing activities are substantial, which is determined by meeting any one of five statutory tests. Of these five tests, the gross receipts test is likely the most applicable when determining manufacturing status. Under this test, a business’ manufacturing is deemed substantial if it derives 25% or more of its gross receipts from the sale of goods it manufactures.
Impacts of manufacturing classification
Once a business has determined that it should be classified as a manufacturer in Massachusetts, it is required to apportion its net income using a single-sales factor apportionment formula. By applying the single-sales factor apportionment, a business can exclude property and payroll from its apportionment calculation. Massachusetts-based businesses that have sales outside of Massachusetts could see favorable apportionment adjustments through classification as a manufacturer. Note, out-of-state businesses that fall under the manufacturer classification may incur an increased tax burden under the single sales apportionment methodology, as they will no longer be able to dilute their apportionment factor by using the property and payroll in other states.
Corporations that qualify as manufacturers in Massachusetts can also qualify for the Investment Tax Credit (ITC) and earn a credit for the purchase or lease of ‘qualifying tangible properties.’ The credit could be as much as 3% of the value of the property purchased or leased. Such properties include tangible personal property, as well as buildings and structural components of buildings acquired by purchase. The credit may be used against the corporate excise tax of C and S corporations and generally can be carried forward for a period of three tax years.
Finally, corporations that are classified as manufacturers may benefit from local personal property tax exemptions. Corporate manufacturers are entitled to an exemption of all machinery from local property tax, even if the machinery is not used directly in manufacturing. To qualify for this benefit, the corporation must request and be granted classification as a manufacturer from the Massachusetts Department of Revenue by submitting an application by January 31st of the calendar year for which the corporation is first seeking classification. The corporation would then need to reaffirm its status with the department on an annual basis to continue its exempt status.
These classifications can be complex. Retailers and consumer products companies doing business in Massachusetts that may qualify for the manufacturing classification should reach out to your RSM consumer products team, or State and Local Tax specialists with questions.
 Note, there is a separate determination process whereby a company may be deemed a manufacturer under M.G.L. ch. 63 section 38. Designation as a “section 38 manufacturer” provides more limited benefits, primarily the ability to apply single sales factor apportionment.
 The five tests are: the corporation’s percentage of gross receipts, payroll, or tangible property related to manufacturing or the manufactured goods must exceed any one of the following:
- 25% or more of gross receipts are from the sale of manufactured goods it manufactures;
- 25% or more of payroll is paid to employees working in the manufacturing operation, and 15% or more of gross receipts are from the sale of manufactured goods it manufactures;
- 25% or more of tangible property is used in its manufacturing operations, and 15% or more of gross receipts are from the sale of manufactured goods it manufactures;
- 35% or more of its tangible property is used in its manufacturing operations;
- The manufacturing activities are otherwise deemed substantial by regulation