Sales Tax Slice: Should States Exempt Food Processing Equipment Purchased by Retail Establishments?

Rotisserie Chicken

In a recently released decision, the Illinois Department of Revenue denied a supermarket the state’s manufacturing exemption for rotisserie systems it used to slow roast chickens. Illinois’ regulations state that food processing equipment generally qualifies for this exemption. However, they also state that this does not apply to food processing equipment used by “restaurants, food service establishments, and other retailers.” The recent ruling held that this disqualified food processing equipment purchased by supermarkets from exemption. 

The distinction that Illinois draws between food processing performed at a retail location and that performed at a separate facility is not uncommon. The Arizona Court of Appeals has ruled before that dough mixing equipment purchased by a pizzeria is ineligible for exemption. Similarly, Minnesota disqualifies restaurants, bars and eating establishments from its manufacturing exemption. Notably, Indiana, Texas and Alabama do extend their manufacturing exemptions (partial exemption in Alabama’s case) to restaurants, supermarkets and other retail establishments. However, the overwhelming majority of states do not permit retail establishments to claim a manufacturing exemption for food processing equipment.   

Why treat food processing performed away from the retail location differently? If it can be performed away from the retail location, it can be performed out-of-state. To attract manufacturers, most states have enacted some form of machinery and equipment exemption. Likewise, the concern of losing business to other states may explain the current popularity of data center exemptions. Without the need to be located near population centers, transportation hubs or natural resources, data centers have a unique flexibility in selecting their location.  

States’ competition for business may be less able to explain other exemptions. For instance, exemptions for mining machinery and equipment would be difficult to justify based on the fear of losing mining businesses to other states. A mining business seeking to recover shale oil from the Appalachian Basin within Pennsylvania could not relocate to Kentucky to extract that same oil if Pennsylvania repealed its mining exemption. 

What then justifies exempting mining, agriculture and other businesses that are not as capable of being relocated as manufacturers or data centers? One plausible justification for doing so is that it prevents the “pyramiding” of tax. As the Council on State Taxation points out, pyramiding occurs when business-to-business transactions are subjected to sales and use tax, resulting in an “embedded tax” being passed on in the price of consumer products and services. This unstated tax distorts the tax scheme and effectively increases the tax burden on consumers. From this perspective, taxing food processing equipment purchased by a retail establishment is just as bad as taxing food processing equipment used at a dedicated manufacturing facility. 

If legislators want to avoid tax pyramiding, why not just exempt all purchases expensed or capitalized for federal income tax purposes? Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn

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