Avoid Potential B&O Tax Exposure in Washington State

Business people negotiating a contract.

By Besty Tuck, SALT Mangaer at Aprio

At a glance:

  • The Main Takeaway: The rules for determining business & occupation (B&O) tax classification are not always clear and require considerable thought to navigate appropriately, which was illustrated in a recent case out of Washington.
  • Impact on Your Business: Selecting the wrong classification can cause you to use an incorrect rate for gross receipts, resulting in a potential tax exposure for your business.
  • Next Steps: Evaluate the latest tax legislation including the recent “Washington Decision” to structure your B&O tax liability strategy.

Need help preparing and planning for your company’s B&O strategy? Schedule a meeting with Aprio’s expert State and Local Tax (SALT) team today.

The full story:

The Washington business & occupation (B&O) tax is a gross receipts-based tax, and the tax rate is based upon the business activity and tax classification of the taxpayer. Each tax classification has its own tax rate. While some businesses may fit nicely into a set tax classification, other businesses may conduct activities for which the appropriate tax classification is open to interpretation, as exemplified by a recent Washington State Court of Appeals decision.[1]

A closer look at the Washington decision

In this case, the taxpayer contracted with material recovery facilities (MRFs) to enable employees and management to work in the facilities. The MRFs collect recyclable materials from homes or commercial sites, sort and process the material, and bundle together like materials for future sale to manufacturers.

In 2009, the taxpayer requested and received a tax ruling from the Department of Revenue (DOR), concluding that the taxpayer’s activity should be classified as a “processor for hire,” which means they perform manufacturing activities on materials that belong to someone else so that a new, different or useful good is produced for sale or commercial/industrial use.[1] Despite this ruling, the DOR later audited the taxpayer for the periods of January 2011 to December 2014 and decided that their activities were inconsistent with those described in the ruling. The DOR determined that the taxpayer should instead be classified under the “service and other activities” tax classification and subject to a higher tax rate.[2]

Essentially, the DOR did not agree that the taxpayer’s activities at the MRFs constituted manufacturing, and therefore the taxpayer could not be a processor for hire. This determination was based on the DOR’s position that the work performed by the taxpayer’s employees on the recycled material did not create a “new, different or useful product,” but that in the end, it was still just recyclable material.

The court applied tests from previous case law that identified several factors used to determine whether the taxpayer’s activities created a new, different or useful product, including the following:

  • Changes in form, quality or properties (such changes may be chemical, physical and or/functional in nature);
  • Enhancement in value;
  • The extent and kind of processing involved; and
  • Differences in demand.

Ultimately, the court ruled in favor of the taxpayer and agreed that it should be classified as a processor for hire. Some of the determining factors were that the recycled product could not be sold to manufacturers in its original state, as there were too many waste products mixed into it. The activity involved in creating the product, such as the discarding of contaminants and sorting and bundling like materials together into compressed bales, made the material saleable to manufacturers for use in their own processes. The value of the materials always increased after they were processed by the taxpayer.

The bottom line

The rules for determining the appropriate B&O tax classification are not always clear and are open to interpretation. However, choosing the wrong classification can result in applying an incorrect rate to gross receipts, resulting in a potential tax exposure.

Aprio’s SALT team has experience navigating the B&O tax and can analyze available guidance to assist businesses with choosing an appropriate tax classification, thereby minimizing potential tax liabilities and penalties.

We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Betsy Tuck, SALT Manager at betsy.tuck@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the April 2021 SALT Newsletter.

[1] Wash. Admin. Code 458-20-136(3)(a). In other words, “a processor for hire is any person who would be a manufacturer if that person were performing the labor and mechanical services upon his or her own materials.”

[2] During the audit period, the processor for hire tax rate was 0.484% and the services and other activities tax rate ranged from 1.5%-1.8%.

[1] FPR II, LLC, v. State of Washington, Department of Revenue, No. 53266-2-II (Wash. Ct. App. Div. II, March 9, 2021).

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

X