California law now provides for a partial exemption from state sales and use tax for equipment purchased for manufacturing, research and development by certain qualified purchasers and certain lessees, as of July 1, 2014. This partial exemption applies only to state sales and use tax and does not affect city, county, or district sales taxes.
The partial exemption reduces the state sales and use tax for qualified property purchases by 4.1875 percent from July 1, 2014 to Dec. 31, 2016, and by 3.5625 percent from Jan. 1, 2017 to June 30, 2022. Currently, the California sales and use tax rate is 7.5 percent, which means that purchases qualifying for this partial exemption will be taxed at a sales and use tax rate of 3.3125 percent from now through Dec. 31, 2016. Through Dec. 31, 2016, this reduced rate will yield a savings of $41.88 for every $1,000 in purchases of qualified property. However, each qualified person or combined reporting unit cannot claim partial exemptions for more than $200 million in qualified purchases in any given calendar year.
Overview of qualification requirements
In order to be eligible for the sales and use partial tax exemption, the taxpayer must be a qualified person purchasing qualified property for a qualified use. The partial exemption applies to qualified persons which are businesses that include, in reference to the 2012 North American Industry Classification System, code 3111-3399 (manufacturing), 541711 (biotech research and development), and 541712 (physical, engineering, and life sciences research and development).
The California law provides that qualified property subject to the partial tax exemption includes (but is not limited to):
- Machinery and equipment;
- Certain equipment or devices used or required to operate, control, regulate, or maintain the machinery;
- Certain tangible personal property used in pollution control; and
- Certain special purpose buildings and foundations used as an integral part of the manufacturing, processing, refining, fabricating, or recycling process, or that constitute a research or storage facility used during those processes.
However, qualified property does not include any consumables with a useful life of less than one year; furniture and equipment used to store products completed once the manufacturing process has completed; and property used primarily in administration, general management, or marketing. Furthermore, qualified property which would otherwise fall within the partial tax exemption will not be eligible if the purchaser intends to lease the property in substantially the same form as it was acquired.
In addition, qualified property must be used 50 percent or more in one of these activities:
- Manufacturing, processing, refining, fabricating, or recycling tangible personal property;
- Researching and developing;
- Maintaining, repairing, measuring, or testing any qualified property; or
- Uses by a contractor purchasing property for use in the performance of a construction contract for a qualified person, provided that the qualified person will use the resulting improvement to real property as an integral part of the manufacturing, processing, refining, fabricating, or recycling process or as a research of storage facility for use in connection with those processes.
If within one year from the date of the purchase of the property, the taxpayer uses the property in a manner that does not qualify for the exemption, converts its use of the property from an exempt use to some other use not qualifying for the exemption, or removes it from the state of California, the exemption will no longer apply and the taxpayer will be required to pay the full sales and use tax.
Partial exemption procedure
If a purchaser believes that they may be eligible for this partial exemption, they can take advantage of the lower tax rate by using an exemption certificate. Exemption certificates are available through the California Board of Equalization. Exemption certificates must be presented to the seller of the property in a timely manner around the time of the purchase. A timely presentation of the exemption certificate includes:
- Before the retailer bills the purchaser for the qualified property;
- Within the retailer’s normal billing or payment cycle;
- At or prior to delivery of the qualified property to the purchaser or purchaser’s representative; or
- No later than 15 days after the date of purchase.
The retailer is then required to retain the exemption certificate for 4 years after the partial tax exemption is claimed. The Board of Equalization currently has example exemption certificates here and here.
A company that thinks it may be eligible for the partial sales and use tax exemption should evaluate its business and purchases to ascertain if they are in line with the guidelines provided above and should consider taking the necessary steps in order to claim this partial exemption from California sales and use tax.