Massachusetts Rules Taxpayer Outsourcing its Manufacturing Activities Must Still Use Single Factor Apportionment

August 29, 2018

The Massachusetts Appellate Tax Board determined that an out-of-state company was a manufacturer and therefore required to use single sales factor apportionment, even though it outsourced its manufacturing activities to third parties.

When determining the amount of a multi-state business’ income is subject to tax in any particular state, the states are required to fairly apportion the taxpayer’s income to reflect the business conducted within that state. Generally, the states accomplish this by applying total income against a fraction, or apportionment percentage, that is based on a measure of a taxpayer’s property, payroll and/or sales attributable to the state over the taxpayer’s total property, payroll and/or sales. States vary in how much weight is placed on any one factor with many using only a measure of sales.

Massachusetts normally adheres to a three-factor formula taking into account a business’ property, payroll and sales in Massachusetts versus elsewhere, except in certain cases, such as when the corporation is a manufacturer. Corporations engaged in manufacturing are instead required to use single-factor apportionment based on sales alone.  Therefore, whether a taxpayer is engaged in manufacturing has a significant impact on its Massachusetts apportionment percentage.[1]

On June 21, 2018, the Massachusetts Appellate Tax Board (“ATB”) issued a decision in which it determined that a corporation that hired contract manufacturers to produce its products was still a “manufacturing corporation,” despite engaging in no actual fabrication of its products,[2] and thus was required to use single-factor apportionment.

Deckers Outdoor Corporation (“Deckers”), a footwear company based in California, outsourced all physical production activities as well as some design/engineering activities to third-party manufacturers. When filing their Massachusetts corporate excise tax returns,[3] Deckers used the standard three-factor apportionment formula instead of the single sales factor formula required for manufacturing corporations. The Massachusetts Department of Revenue disagreed with this position, classifying Deckers as a manufacturer subject to single sales factor apportionment, and the ATB upheld this decision on appeal.

Under Massachusetts law, to qualify as a “manufacturing corporation,” it 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.[4] Although they did not actually manufacture goods for sale, Deckers performed several related activities: initial product design, review of product samples, creation of detailed product drawings and specifications, and quality control at both the contract manufacturers’ factories and at U.S. distribution centers.  Through these activities, Deckers developed a “Tech Pack,” detailing the technical steps for manufacturing the product, which it sent to all third-party manufacturers.

The ATB determined that Deckers’ actions throughout the manufacturing process, from design through mass-production, amounted to the transformation of physical materials into a new product and thus met the definition of “engaged in manufacturing.” In making this decision, they relied upon several cases where the courts broadly construed manufacturing to include scenarios where a taxpayer created drafts, plans, designs or blueprints for a product and then sent them off for mass production by another party. The ATB reasoned that items created by Deckers, including the Tech Packs, were physically useful in making the products since they contained precise information for every component. Additionally, Deckers employees interacted with the products throughout the production process (through testing and quality control) and their feedback resulted in physical modifications to the products. Based on these activities in their totality, the ATB ruled that Deckers was engaged in manufacturing.

As a result of this determination, Deckers was required to apportion its income to Massachusetts using a single factor based entirely upon sales rather than the standard three-factor formula based on property, payroll and sales. Since Deckers’ physical operations were based outside of Massachusetts, the removal of the property and payroll factors likely resulted in an increase of the overall apportionment percentage, and therefore, its Massachusetts tax liability.

This ruling demonstrates how the subtleties in the state’s interpretation of its tax law and definitions can impact state tax outcomes. Furthermore, it shows how a tax law designed to encourage manufacturing activities in the state can be conversely used to enforce a greater tax obligation on businesses outside the state. Sellers of products who outsource all their actual manufacturing should compare their own facts and circumstances to that of this ruling. If these businesses have enough involvement in the design of their product or monitoring of the contract manufacturing operations, they could very well be considered a manufacturing company and thus subject to single sales factor apportionment in Massachusetts.

Aprio’s SALT practice has experience dealing with multi-state income tax apportionment issues.  We can assist businesses to ensure that they are in compliance with their multi-state income tax obligations as well as look at opportunities to minimize those liabilities. 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 Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the August 2018 SALT Newsletter.

[1] Presumably, Massachusetts requires manufacturers to use a single sales factor apportionment method so that out-of-state manufacturers do not benefit from a lower apportionment percentage based on zero or near-zero property and payroll factors.

[2] Deckers Outdoor Corporation v. Commission of Revenue, Docket Nos. C320020 & C321955 (June 21, 2018).

[3] MA excise tax includes a tax measured by net income.

[4] MA Gen. L. §38(I)(1)

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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