A taxpayer protested Washington State auditors’ conclusions that a facility operated by the taxpayer was not entitled to a manufacturing exemption for equipment used at a facility. During this review, the auditors also noted that the taxpayer took wholesale deductions which were not allowed, and the taxpayer did not challenge. The taxpayer is a manufacturer of vitamins, which are delivered to the warehouse in question where the vitamins are packed and distributed. The vitamins are manufactured at separate facilities both inside and out of state. Washington’s manufacturing exemption is location based, and taxpayers must prove the activities of the location are a qualified manufacturing facility, which the auditor found the facility in question did not. The auditor determined that this particular location was ineligible for the manufacturing exemption because the operations at the site in question were limited to packaging, packing, and distribution. The taxpayer first challenged the auditors’ findings related to the manufacturing exemption by claiming that the warehouse performed quality control or testing, which would include the location as part of the manufacturing process. Further, the taxpayer asserted, the twenty-five-pound bags of vitamins which were delivered to the warehouse in question were not suitable for retail sale, it was only the processing at the facility that turned them into saleable items, which transformed the items into new products.
Though the parties agreed on the activities at the warehouse, the Administrative Review and Hearings Division of the Washington State Department of Revenue had to determine if the three requirements for the manufacturing exemption were met. These three requirements are the user must be a “manufacturer or processor for hire”, the item must meet the definition of “machinery and equipment”, and the items must be directly used “in a manufacturing operation or research and development operation”. The statute does allow taxpayers to claim the exemption on machines or equipment used for both qualifying and non-qualifying operations if the majority of use is in qualifying activities. Washington places the burden to establish that an exemption applies, squarely on the taxpayer, and the determination goes on to note that ambiguity in the law is considered strictly and against the taxpayer. It is also pointed out that the primary issue in this case is the third requirement, where the item must be used directly in manufacturing. The Audit Division held that the machines were used only for packaging, packing, and distribution, which the taxpayer did not argue against. The taxpayer held the additional quality control and testing were sufficient to establish the location and all its machinery as an exempt manufacturing site. However, the Washington State law goes on to clearly state that manufacturing begins at the raw materials processing stage and is complete when the processed material leaves the manufacturing site. While some property that may fall outside of the standard scope may qualify for the exemption, the machines must be used directly in the manufacturing and at the manufacturing site. Though the taxpayer continued to hold that the processing done at the site in question was enough to qualify, the Department of Revenue determined otherwise, stating that the activity of the warehouse was to take a completed product and package it for sale, thus falling short of the requirements for the exemption. The actions undertaken at the facility did not change the form, function, quality, or properties of the vitamins, even though there is an enhancement in value created by the repackaging. The taxpayer was found to be ineligible for the exemption.
This determination highlights the importance of knowing the definitions a state is using and understanding how the state will interpret those definitions. Here, Washington state not only defined what is considered manufacturing, they also dictated this must be narrowly interpreted against the taxpayer. The approach of the taxpayer was to impose the definition onto their actions and interpret the actions to fit, but they were disallowed from doing so because of the high burden of proof established in the State. Other taxpayers wanting to use novel definitions of activities should carefully consider states’ previous behavior in interpreting their laws before claiming exemptions they may not be entitled to. (Determination No. 21-0152, Washington Department of Revenue Administrative Review and Hearings Division, dated 15 September 2021, released 9 September, 2024)