Transactions involving manufacturing machinery or equipment pose many challenges for taxpayers and tax professionals. There are several factors to consider when evaluating a potential transaction in this area, not the least of which is whether the state offers favorable sales tax treatment on the transaction. Most states do, but the law changes frequently, and there are countless state-specific nuances. An upcoming change in Minnesota law offers a case study in why taxpayers and tax professionals should understand and stay aware of evolving sales tax laws in this area.
Beginning July 1, 2015, Minnesota will begin offering an up-front sales tax exemption for eligible capital equipment purchases. In doing so, Minnesota will join the majority of states that exempt eligible purchases, and it will move away from its existing refund program.
Whether or not you operate in Minnesota, this shift presents a good opportunity to review some basic practical differences between exemptions and refunds. A taxpayer might prefer the former for several reasons. First, if the taxpayer purchases machinery in a state with an exemption, then the taxpayer can deploy for other purposes funds that it would have otherwise paid for sales tax. In contrast, if the taxpayer purchases machinery in a state that offers a refund, then the taxpayer must wait until it receives the refund before deploying the funds for other operations or investments.
Similarly, a taxpayer might also prefer an exemption over a refund because the exemption could decrease the taxpayer’s cost to finance the transaction. For example, suppose AutoCo must borrow to purchase a $1 million robotic arm that it would use to produce automobiles on an assembly line in State A. Assuming State A’s sales tax rate is 5 percent, State A offers a manufacturing exemption, and the robotic arm is eligible, then AutoCo must borrow $1 million to purchase the arm in State A.
Contrast that with AutoCo’s experience in State B, which offers a refund rather than an exemption. Assuming the other facts remain the same, AutoCo must borrow $1.05 million to purchase the arm in State B. The additional $50,000 borrowed would cause AutoCo to incur additional interest expenses and might even prevent AutoCo from qualifying for the loan itself.
Minnesota is not the only state whose sales tax treatment of manufacturing purchases has changed recently. For example, the past two months have witnessed updates in Arkansas, Illinois, Missouri, and Tennessee. Taxpayers and tax professionals alike would be wise to understand and consider these and other changes. Not only can the evolving tax law profoundly affect a proposed transaction, but also it can open up new opportunities or investments.
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