Sales Tax Slice: Carbon Capture Contraptions Create Complicated Considerations for Sales Tax


carbon

On Oct. 24, 2017, news broke that Nicaragua signed the Paris climate accord. While the U.S. might withdraw from the agreement, some legislators are taking steps to support efforts to reduce carbon emissions by introducing legislation to extend federal credits for carbon capture and sequestration projects.[1] And some companies, like Carbon Engineering and Climeworks, are developing and improving direct air capture technology aimed at pulling carbon dioxide directly out of the atmosphere. But as advancements in technology are made, at some point, questions about the sales tax treatment of direct air capture or similar technology (like artificial trees that capture CO2) are sure to arise.

The classification of carbon-capturing equipment/technology for sales tax purposes will likely involve various considerations. For instance, whether the technology is treated as real property or tangible personal property, and, in the latter instance, whether the machinery can be classified as manufacturing equipment or pollution control equipment (assuming it is capable of converting CO2 to alternative energy, which is then sold).

Generally, states do not impose sales tax on real property, and often, tangible personal property attached or affixed to real estate loses its character as such and is treated as real property as well. But states vary in determining when a fixture’s character may change. Assuming the technology is not characterized as real property, whether it is taxable or exempt may depend on how broadly or narrowly states’ manufacturing and pollution control exemptions are construed.

For instance, Texas provides fairly broad exemptions for manufacturing equipment. Although Texas has a direct use requirement,[2] it considers manufacturing operations to be those that begin at the first stage of production of tangible personal property and end with the completed form of tangible personal property ready to be transferred from the manufacturer to another. Texas does allow divergent use of manufacturing property, provided it occurs after the fourth anniversary of the date the property is purchased. Nevertheless, under these circumstances, tangible personal property stored, used, or consumed in the manufacturing process and purchased by the manufacturer is exempt from sales and use tax, including components of equipment considered recycling property that are directly used in the manufacturing process.

Similarly, Pennsylvania provides an exemption for manufacturing equipment and pollution control equipment used in manufacturing, but Pennsylvania’s direct use requirement is seemingly more stringent than Texas’ requirement. Taxpayers seeking an exemption in Pennsylvania must prove that the equipment relates in time, proximity, or causation to the manufacturing activities to satisfy the direct use requirement. In the event that a taxpayer is able to meet its burden of proof, pollution control equipment also qualifies for the manufacturing exemption.

Illinois also provides a manufacturing exemption; however, unlike Texas and Pennsylvania, there is no direct use requirement. Instead, Illinois exempts machinery and equipment used primarily[3] in manufacturing and assembly. Manufacturing activities include processing, fabricating, or refining that change the existing material into material with a different form to produce tangible personal property, whether it is finished or to be used in manufacturing a different article of tangible personal property. On the other hand, Illinois does not exempt pollution control equipment, even if used in manufacturing, unless the equipment is located in an enumerated enterprise zone.

The considerations described above are among the many that will likely be explored as direct air capture and other carbon capture technology advances and states are challenged with classifying this emerging technology.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How do you think states will treat CO2-absorbing artificial trees or other stand-alone direct air capture equipment for sales tax purposes?

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[1] See, e.g., H.R. 3761, the Carbon Capture Act.

[2] The tangible personal property must be directly used or consumed in or during the actual manufacturing, processing, and fabrication of tangible personal property produced for sale.

[3] Machinery is used primarily in manufacturing and assembly if used for these purposes more than 50 percent of the time.