United States

Massachusetts: Out-of-State Taxpayer Was a Manufacturer Required to Use Single-Sales Factor Apportionment

Jul 02, 2018
From KPMG TaxWatch

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The Appellate Tax Board recently held that a taxpayer was a “manufacturing corporation” required to use single-sales factor apportionment for the tax years at issue. Under Massachusetts law, manufacturing corporations use a single-sales factor apportionment formula, while all other corporations use a three-factor formula. To be engaged in manufacturing, a corporation must be engaged, in substantial part, in transforming raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature, and adapted to a new use. At issue in the case was whether the taxpayer, a California-based company that created, drafted, planned, and designed blueprints for footwear products that were sent offshore to third parties for production, qualified as a manufacturer. The taxpayer did not own any manufacturing facilities, handled all aspects of the footwear design process. It provided its contract manufacturers with so-called “tech packs,” which contained detailed information about each footwear item, including drawings, materials, precise measurements of the features, and colors. The taxpayer had a China-based subsidiary that acted as the liaison between the U.S. based design team and the third party factories that produced the footwear products. However, the taxpayer’s U.S. based employees were heavily involved in the entire process.

The Board ruled that the taxpayer was engaged in manufacturing because its activities throughout the process of design to ultimate production of footwear constituted transformation of raw materials into a new product. Furthermore, the company’s employees physically interacted with the footwear products throughout the production process and their feedback resulted in substantial modifications to the products. The Board noted that in earlier cases, processes which themselves do not yield a finished product have nonetheless been found to constitute manufacturing, so long as “‘they constitute an essential and integral part of a total manufacturing process.” The taxpayer attempted to distinguish its activities from those of the taxpayers in these  cases by asserting that it created nothing that was either physically useful in the ultimate manufacture of footwear or that had a tangible application in the manufacturing process. The Board, rejecting this argument, found that the taxpayer’s design drawings, spec sheets, and tech packs were physically useful in the manufacturing the footwear. Although the Board ruled in favor of the Department of Revenue, it also determined that the taxpayer had reasonable cause and acted in good faith in filing its tax returns as a non-manufacturing corporation for the tax years at issue. As such, the Department’s assessment of substantial understatement penalties was improper. Please contact Nikhil Sequeira at 617-988-1787 with questions on Decker’s Outdoor Corp. v. Commissioner of Revenue.


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.