Washington Manufacturer Owes Sales Tax on Equipment Used at Separate Packaging Facility

By Jess Johannesen, SALT Director

At a glance 

• The main takeaway: A manufacturer based in Washington was denied an exemption for packaging machinery and equipment purchased after the business relocated its packaging activity from the manufacturing facility to a separate location.  
• Assess the impact: It’s important for manufacturers to understand the scope of the manufacturing machinery and equipment exemption in the state where they operate, as applications and interpretations vary state-by-state.
• Take the next step: Aprio’s State and Local Tax (SALT) team can help manufacturers structure their operations to maximize eligibility for these exemptions and assist with identifying new opportunities for refunds. 

Schedule a free consultation today to learn more!

The full story

Most states provide manufacturers with sales tax exemptions that can apply to the equipment and machinery purchased and used in the manufacturing process. However, the application of these exemptions differs from state-to-state due to varying statutory language and related interpretations. For example, states can differ on what activities constitute manufacturing, and this distinction can impact whether the purchase of a particular piece of equipment or machinery is taxable or exempt. 

A recent Washington Department of Revenue administrative decision highlights that the scope of a “manufacturing operation” is site-specific, and ultimately the taxpayer’s purchase of certain machinery and equipment at a separate warehouse was subject to sales tax since the activities at the warehouse were outside the scope of the state’s exemption.

A closer look at the case

The taxpayer at issue manufactured and sold vitamins, and used to manufacture, package, and distribute the vitamins from a single facility. However, due to demand for increased production capacity, the taxpayer invested in additional space and equipment to open a separate warehouse that would focus solely on the packaging and distribution functions.

For the period under audit, the taxpayer manufactured the vitamins at one facility which were then packaged into large transport bags and sent to the taxpayer’s warehouse. At the warehouse, the taxpayer removed the vitamins from the transport bags, inspected the vitamins, and then fed the vitamins into equipment that ultimately packaged and labeled the bottles to be ready for sale. The prominent issue of the case is whether the taxpayer’s machinery and equipment used at the warehouse is exempt from sales tax.

The ruling explained 

Under Washington law, sales tax “does not apply to sales to a manufacturer or processor for hire of machinery and equipment used directly in a manufacturing operation.” The law states that “a manufacturing operation begins at the point where raw materials enter the manufacturing site and ends at the point where the processed materials leave the manufacturing site.” However, administrative regulations clarify these activities are site-specific, and that the activities of storing and packaging tangible goods “that do not constitute manufacturing in and of themselves, are not within the scope of the exemption unless they take place at the manufacturing site.”

With the scope of a manufacturing operation being site-specific, the taxpayer argued that the transformation of the bulk packaged vitamins to commercially saleable vitamins qualified as creating a new or different product and should be considered its own manufacturing activity. The state disagreed and noted that such activities must occur at the same site as the manufacturing operation.

The taxpayer then argued that its facts were analogous to prior court cases which held that 

1. The transformation of whole fish into individual filets for freezing and subsequent sale constituted manufacturing, and 
2. The preparation and processing of whole peas into split peas constituted manufacturing.  

However, the state disagreed and distinguished the cases from the taxpayer’s vitamin packaging activities in the warehouse since the taxpayer’s activities do not change the form, quality, or properties of the vitamins. Instead, the vitamins exit the facility with the same properties and characteristics that they entered with, “merely in smaller containers.”

Accordingly, Washington held that the activities at the warehouse did not constitute a qualifying manufacturing operation, and the machinery and equipment used in the warehouse was not eligible for the sales tax exemption.

The bottom line

As a manufacturer, it is important to understand the scope of the manufacturing machinery and equipment exemption in the state where you operate. In this case, perhaps the taxpayer would not have restructured its operations as it did if it knew that its packaging machinery would no longer qualify for a sales tax exemption.

Aprio’s SALT team has experience with state manufacturing exemptions, and we can help you structure your manufacturing operation to maximize your eligibility for these exemptions. We can also assist with identifying exemptions that your business may have missed and pursue refunds of sales tax paid on manufacturing equipment and other inputs. 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.

1. Washington Det. No. 21-0152, 43 WTD 25 (September 9, 2024)
2.  RCW § 82.08.02565(1)(a).
3.  RCW § 82.08.02565(2)(f).
4.  WA Admin. Code §458-20-13601(2)(i)
5.  Another area where states differ as to the scope of the manufacturing exemption is the extent to which machinery or equipment is used in the manufacturing process.