Massachusetts Classifies Biotech Company as Manufacturer Requiring Single Sales Factor Apportionment

February 27, 2017

State income apportionment methods sometimes vary by industry, and a recent case highlights the importance of industry classification.

By Tina Chunn, SALT senior manager

In the last several years, many states have enacted legislation to change the method used in apportioning income to their state for income tax purposes. Specifically, these states are moving away from the historical model of three factor apportionment, based on sales, property and payroll factors, to a single factor method represented solely by the sales activity within their state. However, in some states, this change in the apportionment method does not apply to all companies and may be limited to specific industries.

Massachusetts provides for the use of three factor apportionment using a double-weighted sales factor. [1] In 1996, the statutory formula was modified to require manufacturing companies to use the single sales factor apportionment method. [2] Thus, the issue of whether or not a company is a manufacturer must be analyzed in order to determine whether or not the single sales factor apportionment method is required. This was the issue in a recent Massachusetts Supreme Court decision in which it determined that a biotechnology company was a manufacturer, thus requiring the company to file using the single sales factor apportionment method.

Genentech is a biotechnology company, with its principal business operations in California, that develops drugs from proteins produced by living cells. Employees use a four-step process to modify the genetic code of living cells to produce proteins that will have desired pharmacologic effects, thereby transforming these living cells into insulin, human growth compounds and drugs used for cancer treatments. For several years, Genentech filed its Massachusetts corporate income tax returns using the three factor method for apportionment purposes. The Department of Revenue (“DOR”) issued assessments re-computing Genentech’s tax liability using the single sales factor apportionment method. [3]

In order to be classified as a “manufacturing corporation,” a company “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.” [4] Genentech claimed first that their operations are not manufacturing in nature, and second, even if their operations are manufacturing, they are not substantially engaged in such activity. Specifically with regard to the first claim, Genentech argued that the process is more identical to mining, whereby a product is extracted, rather than the creation of a new product. However, the court determined that the cells are genetically modified and different from the original cells. Genentech then extracts the “protein of interest” from these modified cells, and that protein serves as the source of each drug that markets and sells. Therefore, the court concluded that Genentech was engaged in manufacturing.

As to the second claim by Genentech regarding substantiality, the court noted that the statute provides alternative tests for measuring whether a taxpayer’s manufacturing operation is substantial, including if 25 percent or more of the company’s gross receipts are derived from the sale of goods that it manufactures. [5] Genentech argued that the return of capital on investment operations performed by two to seven employees in its treasury department to invest excess cash in short-term securities on a daily basis should be included in the analysis to determine if gross revenues from manufacturing exceed this required 25 percent threshold. [6]

However, the court ruled that the gross receipts from the daily redemption and reinvestment of these short-term securities should not be included in this analysis as these transactions are merely a return of capital, noting that such amounts are excluded from the sales factor under the three factor apportionment method. In addition, these transactions did not generate capital gains or losses during the tax years in question, and these proceeds were not included in the computation of gross receipts for federal income tax purposes.

The Aprio SALT team is experienced at reviewing these special apportionment rules and can assist your company in properly applying these rules to your business operations. We can also assist in preparing an analysis of the income tax impact to your business as you continue to grow your operations into additional states or if you are looking to relocate significant operations to a different state. We constantly strive to keep our clients advised of important SALT issues in order to help them address their specific tax situations. We will continue to monitor these and other significant tax developments, and we will include any updates in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the February 2017 SALT Newsletter. To view the entire newsletter, click here.

[1] Mass. G. L. c. 63, §38(c).

[2] Mass. G. L. c. 63, §38(l)(2). This provided an incentive for manufacturing companies to remain in or move to Massachusetts since the presence of property and payroll in the state would not increase their income taxes. Of course, manufacturers based outside the state will likely find that the three factor method is more favorable.

[3] Two points are worth noting. First, since Genentech was based in California, it preferred to use the three factor formula in Massachusetts because its Massachusetts property and payroll factors were lower than its sales factor, thereby lowering its overall apportionment percentage. Second, in the final year at issue in the case, Genentech actually switched to single sales factor on its original return and then sought a refund claiming that it should have used the three factor formula. This caused the DOR to assess prior years as well, so be sure to carefully consider changes in tax reporting methodologies. It is possible that if Genentech had not changed its apportionment method in the first place, these assessments would not have been issued.

[4] Mass. G. L. c. 63, §38(l)(1).

[5] Mass. G. L. c. 63, §38(l)(1)1.

[6] By including these amounts in the gross receipts analysis, Genentech’s manufacturing receipts would have been well below the 25 percent threshold.

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.

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About the Author

Tina Chunn

Tina is a senior manager with Aprio’s State & Local Tax group. She has over 24 years of experience assisting companies and their owners to minimize their tax liability and maximize their profitability. Some of the industries Tina serves include professional services, manufacturing, warehousing and distribution, telecommunications, real estate, retailers and wholesalers. Tina has extensive experience dealing with corporate tax issues, including state and local tax returns; state and federal tax credits; state and local sales; and use, income, escheat, business licenses and property tax issues.