Are You Paying Sales Tax on Exempt R&D Transactions?
Massachusetts and many other state and local jurisdictions in the USA provide substantial sales tax exemptions for specific Research and Development (R&D) activities.
Take advantage of the many cost-saving R&D sales tax exemptions before they are lost to the statute of limitations.
Many corporations inadvertently lose valuable capital by paying sales tax on exempt R&D transactions.
Those funds could otherwise be invested into growing their business.
Knowing how to qualify your corporation for R&D sales tax exemptions is step one.
Identifying and utilizing those valuable exemptions for continual savings comes next.
While each jurisdiction has specific sales tax exemptions based on its statutes and regulations, most “generally” offer similar exemptions for Research and Development. Massachusetts Regulation 830 CMR 64H.6.4 provides a comprehensive explanation of the eligibility criteria and application process for these exemptions, serving as a useful example of what to look for.
Be sure to read the examples at the end of this article as they make it easier to understand the legalese. Additionally, a link to TIR 98-5 is provided at the end of the article, offering further details on exemptions for specific sales of power used in manufacturing and Research and Development.
Purpose of the Regulation The primary purpose of 830 CMR 64H.6.4 is to outline the requirements for an entity to qualify for exemption from Massachusetts sales tax under M.G.L. c. 64H, §§ 6(r) and (s). This exemption is specifically for tangible personal property used directly and exclusively in R&D. It applies to both research and development corporations and manufacturing corporations, as defined under M.G.L. c. 63, § 38C or 42B.
Eligibility Criteria To be eligible, a research and development corporation must pass either a receipts or expenditures test. The regulation also clarifies the eligibility of these corporations for certain credits and other exemptions, although it does not cover the Massachusetts research credit provided by M.G.L. c. 63, § 38M.
Key Definitions 830 CMR 64H.6.4 provides definitions for terms such as ‘Code’, ‘Domestic Corporation’, ‘Foreign Corporation’, and ‘Research and Development’. These definitions are essential for understanding the scope of activities that qualify as R&D and the types of corporations that can benefit from the exemption.
General Rule The general rule states that qualifying entities can claim sales tax exemptions on materials, tools, fuel, machinery, and replacement parts used directly and exclusively in R&D. The qualification must be determined annually, and entities may also be eligible for additional credits and exemptions.
Qualification Requirements For a corporation to qualify as a research and development corporation, it must meet four requirements: it must be a domestic or foreign corporation, engaged in R&D in the Commonwealth, with its principal activity in the Commonwealth being R&D, and it must meet the receipts or expenditures test.
Receipts Test and Expenditures Test The receipts test requires that more than two-thirds of a corporation’s Massachusetts receipts come from R&D. The expenditures test involves a corporation’s spending on R&D in the Commonwealth. Both tests have specific definitions and exclusions that must be carefully considered.
Conclusion 830 CMR 64H.6.4 is a comprehensive regulation that provides clarity on the sales tax exemption for R&D activities in Massachusetts. Corporations looking to benefit from this exemption must carefully assess their eligibility and ensure compliance with the outlined requirements. Please see below for an important section of 830 CMR 64H.6.4.
The following section is taken directly from 830 CMR 64H.6.4. It is important to understand the letter, spirit, and intent of the law to ensure the best good faith effort to comply with the regulation. Take caution in understanding that “General rule” means that the exemption does not always apply in every instance. “Directly and Exclusively” are defined well in this section but the examples given offer much more clarity on applicable exemptions.
(9) Eligibility for Sales Tax Exemptions under M.G.L. c. 64H, §§ 6(r), (s)
(a) General rule. Under M.G.L. c. 64H, § 6(r), the sales tax does not apply to the sale or use of materials, tools and fuel, or any substitute therefor, which are consumed and used directly and exclusively in research and development by a manufacturing corporation or a research and development corporation. Materials, tools and fuel are “consumed and used” only if their normal useful life is less than one year or their cost is allowable as an ordinary and necessary business expense for federal income tax purposes. Nuclear fuel and nuclear fuel assemblies are regarded as consumed and used even if they do not meet this test. Under M.G.L. c. 64H, § 6(s), the sales tax does not apply to the sale or use of machinery, or replacement parts thereof, used directly and exclusively in research and development by a manufacturing corporation or a research and development corporation.
(b) ” Directly and Exclusively.” For purposes of 830 CMR 64H.6.4, the exemptions in M.G.L. c. 64H, §§ 6(r) and (s) apply only to sales of materials, tools, fuel, machinery and replacement parts used directly and exclusively in research and development by a research and development corporation or manufacturing corporation. An item is not considered used directly and exclusively merely because it is essential to research activities or because its use is required by law. Tangible personal property, machinery and replacement parts or equipment used in managerial or sales activities is not directly and exclusively used in research and development and is therefore subject to tax.
1. ” Directly.” Tangible personal property, including materials, tools, fuel, machinery and replacement parts, is used “directly” in research and development only if it is used in experimental or laboratory activity that qualifies as research and development under 830 CMR 64H.6.4. In determining whether any property is “directly” used, the fact that a particular item of property may be integral and necessary to the conduct of the activity because its use is required either by law or practical necessity does not, in and of itself, mean that the property is directly used in research and development. The following is a non-exhaustive list of machinery and materials which are not directly used in research and development:
a. Machinery and materials used exclusively for the comfort of worker. Examples are air conditioning and ventilation systems.
b. Machinery and materials used in support operations, such as a machine shop, in which R&D machinery is assembled, maintained, or repaired.
c. Machinery and materials used by the administrative, accounting, and personnel departments.
d. Machinery and materials used by plant security, fire prevention, first aid, and hospital stations.
e. Machinery and materials used in plant communications and safety.
Example 1: Laboratory supplies for use in a research laboratory are exempt but supplies, desks and chairs used by clerical personnel are not exempt.
Example 2: Test tubes, flasks, reagents, microscopes and slides purchased by a chemical manufacturer for its research laboratory for developing new pesticides are exempt from sales tax.
Example 3: Technical books and journals purchased for a research and development laboratory for use in doing background research are used directly in research and development.
Example 4: Worcester Widgits, Inc. is a manufacturing corporation that maintains a chemical laboratory for exclusive use in developing new heat-resistant plastics. It purchases the following items for exclusive use in its research and development activities: a computer that will only be used to process data relating to the heat resistance of the plastics, test tubes, flasks and reagents, soap for cleaning laboratory equipment, smocks and gloves for laboratory personnel, an autoclave for sterilizing laboratory equipment, cleaner and wax for laboratory floors, and pencils, pens, paper and a typewriter for use in the office of the laboratory’s director. Its purchases of the cleaner and wax for laboratory floors, and the pencils, pens, paper and typewriter for use in the office of the laboratory’s director, are subject to tax because the items are not used directly in research and development. Its purchases of the test tubes, flasks, reagents, soap for cleaning laboratory equipment, and smocks and gloves for laboratory personnel are exempt from tax if the normal useful life of the items is less than one year or their cost is allowable as an ordinary and necessary business expense for federal income tax purposes. Worcester Widgits’ purchase of the computer to be used exclusively in processing data relating to the heat resistance of the plastics and the autoclave is exempt from tax.
2. ” Exclusively.” Materials, tools, fuel, and machinery and replacement parts are used exclusively in research and development if 100 percent of their use is in such function. However, for purposes of 830 CMR 64H.6.4, a de minimis use will not defeat the exclusivity requirement of the exemptions in M.G.L. c. 64H, §§ 6(r) and (s). Whether a use is de minimis shall be determined by the Commissioner based on the facts and circumstances of a taxpayer’s overall operations.
Example 1: A company purchases a computer system which it uses directly for research and development. However, on two separate days during the year the computer is used to generate management reports that include information with respect to research projects but also address many other issues facing the company. No other taxable usage is made of the computer. Although the generation of management reports may be a taxable usage of research equipment, this use of the computer is de minimis.
Example 2: Facts are the same as Example 1, except that instead of generating the two management reports, the computer is used to generate weekly payroll and employment tax return reports. The generation of these reports on a regular basis is not a de minimis taxable usage of the computer. Therefore, the computer is not considered used exclusively for research and development, and is taxable.
Example 3: Marblehead Microchips, Inc. is a manufacturing corporation that maintains a laboratory containing machinery used 75 percent of the time for research and development of new products and 25 percent of the time for quality control purposes. The machinery is not considered used exclusively for research and development. Therefore, the corporation’s purchases of the materials and machinery are subject to tax.
Example 4: Company D, a foreign corporation, performs research and development in Massachusetts. It purchased computers, other hardware, printers and software for its use in its research and development department. The computers, other hardware, printers, and software products were used in data analysis and for documentation of testing results. The equipment and software were also used in other applications for purposes related to the conduct of research and development. Word processing applications were used to generate technical reports, notebook records, and monthly reports. E-mail applications were used for data acquisition and calculation programs as well as communication among research colleagues. Graphics and spreadsheet software played a role in the activities of the research and development department. Software also supported technical information storage, retrieval, and dissemination operations for the use of the research and development staff.
The software required a computer system and its hardware components to perform these functions. The printers were similarly indispensable to the effective utilization of the computers in the ways described in this example. Software, hardware and printers generally function as a single, interconnected system. Assuming that the computer system is used solely for exempt purposes or non-exempt purposes that are de minimis, the computers, hardware, printers, and software qualify as being used directly and exclusively in research and development.
Example 5: A research and development corporation purchases gas, electricity, refrigeration and steam which is used in bulk or in a continuous flow at its research and development facility in Massachusetts. The electricity is used in all areas of its facility, including the areas in which its administrative functions are performed. The corporation may present an Exempt Use Certificate with respect to the exempt portion of the energy, ( e.g., the portion use directly and exclusively in research and development) if known at the time of purchase. If the exempt portion is not known at the time of purchase, the taxpayer may present its vendor with an Exempt Use Certificate and pay use tax on the non-exempt portion of the energy purchased. If a taxpayer either did not provide a certificate at the time of the purchase or subsequently determines that all or a portion of its purchases were exempt from tax, it may subsequently request its vendor to provide a refund or credit for the tax paid on the portion used directly and exclusively in research and development. The vendor may apply for an abatement of the portion of the tax paid in accordance with the rules of the Abatement regulation, 830 CMR 62C.37.1. The user must maintain adequate records with respect to the allocation of gas, electricity, refrigeration and steam used directly and exclusively in research and development from that used for non-exempt purposes.
Follow the following link which explains potential sales tax exemptions for sales of certain power used in manufacturing and Massachusetts Research and Development activities: TIR 98-5
Link to B2B Sales Tax, LLC Inflation article
Link to B2B Sales Tax, LLC Manufacturing article
This overview simplifies the complex legal language of the regulation into key points that businesses can use to understand their eligibility for the sales tax exemption on R&D activities in Massachusetts. For detailed information and guidance, it’s recommended to consult the full text of the regulation or seek professional advice – which is something that I can help you with!