IOWA
SALES AND USE TAX
ON MANUFACTURING AND PROCESSING
INTRODUCTION
This publication addresses the taxability of purchases of tangible personal property and services for the manufacturing industry. It should be used only as a general guide. For answers to specific questions, contact Taxpayer Services at 1-800-367-3388 (Iowa, Omaha, Rock Island/Moline) or 515/281-3114 or e-mail a tax specialist.
Manufacturers who also sell the tangible personal property they produce to the final consumer should call Taxpayer Services to see if they need an Iowa sales tax permit. Manufacturers who do not sell to the final consumer do not need sales tax permits.
RECYCLING OR REPROCESSING WASTE PRODUCTS SALES TAX EXEMPTION CERTIFICATES |
MACHINERY, EQUIPMENT, AND COMPUTER EXEMPTION
The purchase or rental of machinery, equipment, computers, and other types of tangible personal property, including fuel used in processing, by manufacturers may be exempt from Iowa sales and use taxes under certain circumstances.
Sales or rentals of the following are exempt from tax:
“Manufacturer” means any person, firm, or corporation who purchases, receives, or holds personal property for the purpose of adding to its value by any process of manufacturing, refining, purifying, combining of different materials, or by packing of meats with an intent to sell at a gain or profit.
A contract manufacturer is considered to be a manufacturer. A contract manufacturer is a manufacturer which processes tangible personal property on the behalf of other manufacturers. A contract manufacturer does not sell the tangible personal property which it processes on the behalf of another manufacturer.
Examples of businesses that qualify as manufacturers:
Examples of businesses that are not manufacturers:
A manufacturer is different from a merchant, dealer or retailer.
To be classified as a manufacturer, the principal business must be manufacturing. A person primarily engaged in selling tangible personal property to earn a profit and only incidentally engaged in creating products from raw materials is not a manufacturer.
“Machinery” is any mechanical, electrical, or electronic device designed and used to perform some function and to produce a certain effect or result. The word includes not only the basic unit of the machinery but also any attachment necessary for the basic unit to function. It also includes all devices used or required to control, regulate, or operate a piece of machinery, provided the devices are directly connected with or are an integral part of the machinery and are used primarily for control, regulation or operation of machinery. Machinery does not include buildings designed specifically to house or support machinery.
Exempt machinery
Machinery is exempt when used directly and primarily in processing by a manufacturer.
This includes machinery...
It also includes...
Taxable machinery
The following are examples of machinery which are not directly and primarily used in manufacturing and processing; they are taxable when...
EQUIPMENT
“Equipment” is any tangible personal property used in an operation or activity by a manufacturer in a manufacturing environment.
Examples of exempt equipment
Equipment is exempt when used directly and primarily in processing by a manufacturer.
The sale or rental of computers used in manufacturing, research and development or in processing or storage of data or information by a manufacturer is, under certain circumstances, exempt from tax.
The sale or rental of computers directly and primarily used in the recycling or reprocessing of waste products is also exempt from tax.
Hardware
“Computer” means stored program processing equipment and all devices fastened to it by means of signal cables or any communication medium that serves the function of a signal cable. Examples of devices fastened by a signal cable or other communication medium include:
Excluded from the definition of computer is point-of-sale equipment, such as scanners and cash registers.
Software
Software consisting of an operating or executive program upon which the basic operating procedures of a computer are recorded and which serves as an interface with an application program and is purchased as a part of the sale of the computer for which it operates is exempt.
Prewritten "canned" application software is taxable even if used in a manufacturing process . “Custom” software written for a specific user is exempt.
Optional maintenance contract
If the maintenance contract is optional to the purchaser of canned software, then only the portion of the contract fee representing improvements delivered on storage media is subject to sales tax if the fee for other services, including consultation services and error corrections, is separately stated.
If the fee for other services, including consultation services and error corrections, is not separately stated from the fee for improvements delivered on storage media, then tax is to be imposed on 50 percent of the gross receipts from the sale of the maintenance contract.
However, if the contract is for technical support only, then tax is not to be imposed on the sale of the contract.
The sale or rental of air or water pollution control equipment is exempt if used by a manufacturer.
“Pollution control equipment” means any disposal system or apparatus used or placed in operation primarily for the purpose of reducing, controlling or eliminating air or water pollution.
Liquid, solid and gaseous wastes are included within the meaning of the word “pollution.”
“Pollution control equipment” specifically includes any equipment required or certified by a government agency of this state or the United States. Examples include wastewater treatment facilities and scrubbers used in smokestacks.
The exemption does not include:
To be exempt, machinery, equipment and computers must not only be used in processing, but must be used directly and primarily in processing.
Property is directly used only if it is used to initiate, sustain, or terminate the transformation of any activity.
In determining whether any property is directly and primarily used, consideration should be given to the following factors:
In general, processing begins with receiving or producing raw materials and ends at the point the products are delivered for shipment or transferred from the manufacturer. This is sometimes referred to as “door-to-door processing.”
Receiving or producing raw materials means activities performed upon tangible personal property only. Activities performed on real property are not exempt.
Examples of processing are:
Processing begins.
Company A manufactures fine furniture. It owns a grove of walnut trees which it uses as raw material. Employees cut the trees, transport the logs to the factory, offload them there, and store the logs in a warehouse to begin curing the wood before taking it to the sawmill.
“Processing” begins when the logs are loaded for transport to the factory.
The same company also buys mahogany logs from a supplier in Honduras. Company A uses its own equipment to offload the logs from railroad cars at its manufacturing facility. It then transports, stores, and saws the logs as described above.
In this case, processing begins when Company A offloads the logs from the railroad cars.
Middle stages of processing.
Company C is a microbrewery. It uses a variety of kettles, vats, tanks, tubs, and other containers to mix, cook, ferment, settle, age, and store the beer it brews. It also uses a variety of pipes and pumps to move the beer among the various containers involved in the activity of brewing.
All stages of this brewing are part of processing. Transforming the raw materials from one state to another, such as fermenting and aging, is part of processing. Simply holding the materials in an existing state, such as storage of hops in a bin or storage of beer prior to bottling, is also a part of processing. Any movement of the beer between containers is an activity which is a part of processing, whether this movement is an “integral part” of the production of beer or not.
End of processing.
After the brewing process is complete, Company C places its beer in various containers, stores it, and moves it to its customers by a common carrier who picks up the beer at the brewery. The following are still part of processing: C’s activities of placing the beer into bottles, cans, and kegs; storing it after packaging; and moving the beer by use of a forklift to the common carrier’s pickup site.
A replacement part is any machinery or equipment part which is substituted for another part that has broken, become worn out or obsolete, or is otherwise unable to perform its intended function. The part must materially add to the value of industrial machinery and equipment or appreciably prolong their lives or keep them in their ordinarily efficient operating condition. A replacement part must have a useful life of one year or more. A part that meets these requirements is exempt from tax.
Supplies are not replacement parts.The following are examples of taxable supplies:
Fuel consumed in processing is exempt from Iowa sales and use tax. If the machinery, equipment, or computer is exempt to a manufacturer, the fuel used to operate or run the machinery, equipment, or computer is also exempt.
“Fuel” includes heat, steam, electricity, gas, water or any other tangible personal property consumed in creating heat, power, steam, or for generating electric current.
“Fuel consumed in processing” means fuel that is directly applied in the actual processing of tangible personal property.
Fuel used for the purpose of general heating, ventilating or lighting of buildings – even if the buildings are warehouses, processing plants, or offices – and any use other than that of direct processing is taxable.
When practical, electricity consumed as power or used directly in processing must be separately metered and separately billed by the supplier. The manufacturer must give the supplier a Sales Tax Exemption Certificate for Energy used in Processing and Agriculture .
If it is impractical to separately meter and bill the fuel, the manufacturer must give the supplier an exemption certificate which shows what percentage of the fuel is exempt. The exemption certificate must be supported by a study showing how the percentage was developed. The study must show the taxable use and the nontaxable use to correctly report the exempt percentage.
See Appendix A for information on how to calculate a fuel exemption.
The lease of industrial machinery and equipment is exempt if their purchase is exempt.
Quarrying and mining businesses are considered manufacturers with respect to activities performed after raw materials are severed from the ground. These subsequent activities can include crushing, washing, sizing, and blending of aggregate materials.
Example:
Company A owns and operates a gravel pit. It sells the gravel extracted from the pit to others who use the gravel for surfacing roads and as an ingredient in concrete. Company A removes overlay and raw gravel from the pit. It then transports the gravel to a plant where washing and sizing of the gravel takes place. Company A is a manufacturer, but only with respect to those activities which occur after it severs the gravel from the ground.
RECYCLING OR REPROCESSING WASTE PRODUCTS
The sale or rental of machinery, equipment, computers, and their replacement parts are exempt from tax if they are used directly and primarily in the recycling or reprocessing of waste products. This includes equipment used in the movement of property which is integral to recycling or reprocessing.
“Recycling” means any process by which waste – or materials which would otherwise become waste – are collected, separated or processed and revised or returned for use in the form of raw materials or products. The term includes the composting of yard waste. Recycling does not include any form of reprocessing or energy recycling.
Recycling or reprocessing ends when waste or a material which would become waste is in the form of a raw material or in the form of a product.
Machinery and Equipment
Machinery and equipment which may be exempt if used directly and primarily in the recycling or reprocessing of waste products includes...
- compactors
- grinders
- forklifts
- balers
- cutters
- trucks
- crushers
- shears
- endloaders
- other moving devices
Note: The sale of a bin which is only for storage ordinarily is taxable.
The Process
1. Recycling or reprocessing begins when waste or material which will become waste is collected or separated.
A vehicle used directly and primarily for collecting waste could be a vehicle used for an exempt purpose. Thus, the purchaser of a garbage truck could claim this exemption if the truck were directly and primarily used in recycling and not, for instance, in hauling garbage to a landfill. Machinery or equipment used to segregate waste from material to be recycled or reprocessed or used to separate various forms of materials which will be reprocessed (glass and aluminum) can also be used at the beginning of recycling or reprocessing.
2. An operation or series of operations which do not actually recycle or reprocess waste may be exempt.
For example, an endless belt which moves aluminum cans from a machine where they are shredded to a machine where the shredded aluminum is crushed into blocks is not taxable.
3. Any equipment used after the recycling or reprocessing ends is taxable.
For instance, a corporation purchases a machine which grinds logs, stumps, pallets, crates and other waste wood into wood chips. After grinding, the wood chips are sold and transported to purchasers to various sites where the chips are dumped and spread out over the ground for use in erosion control. The machine which grinds the wood chips is a machine used in recycling. The truck which transports the wood chips from the machine to the sites is not used in reprocessing because, at the time the chips are placed in the truck, they are in the form in which they will be sold for use other than as a raw material in manufacturing, so recycling has ended.
The sale or rental of machinery, equipment and computers used in research and development is exempt from tax.
“Research and development” means experimental or laboratory activity which has as its ultimate goal the development of new products, processes of manufacturing, refining, purifying, combining of different materials, or meat packing. The ultimate goal of research and development must be to add value to products. It does not include testing or inspection for quality control purposes, efficiency surveys, management studies, consumer surveys, advertising, promotions, or research in connection with literary, historical, or similar projects.
Machinery, equipment, and computers are used directly in research and development only if they are used in actual experimental or laboratory activity that qualifies as research and development.
Example:
Frontier Hybrid, Inc., maintains a research and development laboratory to develop a corn plant. It purchases the following items: a computer which will process data relating to the genetic structure of the various corn plants which Frontier Hybrid is testing, an electron microscope for examining the structure of corn plant genes, a steam cleaner for cleaning rugs in the laboratory offices, and a calculator for use by the laboratory director’s secretary. The computer and the microscope are directly used in the research; the steam cleaner and the calculator only indirectly used. Therefore, purchase of the computer and microscope is exempt from tax; purchase of the steam cleaner and calculator is taxable.
ITEMS THAT DO NOT QUALIFY FOR EXEMPTION
Machinery, equipment, and computers purchased by a business that is centrally assessed by the department for property tax purposes. Examples of this type of business include electric, gas and water companies, railroad, telephone, pipeline, and electric transmission line companies.
Hand tools: Tools which can be held in the hand or hands and are powered by human efforts.
Point-of-sale equipment: Input, output, and processing equipment used to consummate a sale and to record or process information pertaining to a sale transaction at the time the sale takes place and is normally located at a counter, desk or other specific point where a sale transaction occurs.
Vehicles subject to registration: Vehicles are subject to a one-time registration fee at the rate of 5% on the purchase price unless directly and primarily used in recycling or reprocessing of waste products.
Not a manufacturer: A business may be engaged in processing, but is not a manufacturer. Examples include restaurants, retail bakeries, food stores and blacksmith shops.
Supplies: See “Replacement Parts.”
Other examples of non-qualified items can be found in the “Machinery" and "Equipment” sections.
The services of design and installation of new industrial machinery and equipment are exempt from sales tax if the following criteria are met:
A. The industrial equipment and machinery are new, not used, AND
B. The industrial equipment and machinery are used in processing by a manufacturer.
New machinery and equipment designed or installed for rental as well as for sale are exempt. The charges for design or installation must be separately identified, charged separately, and reasonable in amount for the exemption to apply.
“New” means never having been used or consumed by anyone. Installation of reconstructed, rebuilt, or repaired or previously owned machinery or equipment is taxable.
A computer is not considered to be machinery or equipment, and its installation or design is taxable.
The following are examples of services that are taxable unless they meet the criteria above:
The exemptions listed for industrial machinery, equipment and computers also apply to manufacturers that create food products for human consumption. (Note that bakeries and restaurants are not manufacturers.) Food manufacturers are also entitled to certain exemptions that may not be available to other manufacturers. The law specifically addresses the following items.
Fuel is exempt when used in:
Examples include washing, sorting, and grading of fruits, vegetables and eggs; mixing and agitation of liquids; sterilization
For example, electricity used to air condition a room in which meat is stored to maintain the meat in a condition in which it is easy to slice.
Examples:
- Fuel used in pH meters, microbiology counters, and incubators to test the purity or sanitary nature of a food product.
- Electricity used in egg-candling lights.
- Electricity used to power refrigerators used to store food samples for testing.
- Electricity used to power “bug lights” or other insect-killing equipment used where food is manufactured or stored.
For example, electricity used by a food manufacturer in plastic-bottle-forming machines is exempt if the bottles will be used to hold a marketable food product such as milk.
For instance, electricity used by a food manufacturer to run machines that place food products into packing cases, pallets, crates, shipping cases or other similar receptacles.
See Appendix A for information on how to calculate a fuel exemption.
Chemicals, solvents, sorbents, and reagents are exempt from tax if the following apply:
The chemical, solvent, sorbent, or reagent does not need to become an integral or component part of the processed tangible personal property.
“Chemical” is a substance which is primarily used for producing a chemical effect. A chemical effect results from a chemical process wherein the number and kind of atoms in a molecule are changed in form; for example, when oxygen and hydrogen are combined to make water. A chemical process is distinct from a physical process wherein only the state of matter changes; for example, when water is frozen into ice or heated into steam.
“Solvent” is a substance, usually liquid, primarily used in dissolving something. For example, water is a solvent of most salts; alcohol of resins; ether of fats.
“Sorbent” is a substance which takes up and holds either by adsorption or absorption. To be exempt, the sorbent must be a substance that is primarily used as a sorbent.
“Reagent” is a substance used for various purposes which takes part in one or more chemical reactions or biological processes. Examples include using a reagent in detecting, examining, or measuring other substances, in preparing materials, and in developing photographs. A reagent is also a substance used to convert one substance into another by means of the reaction it causes. To be exempt, the reagent must be a substance that is primarily used as a reagent.
“Catalyst” is considered to be a chemical, solvent, sorbent, or reagent. A catalyst is a substance which promotes or initiates a chemical reaction. It is exempt if it is consumed, dissipated, or depleted during processing of tangible personal property which is intended to be ultimately sold at retail.
Note: The chemical, solvent, sorbent, and reagent exemption only applies during processing. The definition of processing is limited for this exemption. Processing means a change to the form, context, or condition of tangible personal property. There must be a change occurring during the chemical activity before this exemption applies. The "door-to-door" definition of processing for a manufacturer under the machinery, equipment, and computer exemption does not apply.
Chemical compounds placed in water are exempt from tax if:
The water is ultimately sold at retail, or
The water is directly used in processing, or
The water is consumed during processing.
Special boiler compounds used when live steam is injected into mash or another substance are exempt from tax because it liquefies and becomes an integral part of the product. The product must be ultimately sold at retail.
Note: The chemical, solvent, sorbent, and reagent exemption only applies during processing. The definition of processing is limited for this exemption. Processing means a change to the form, context, or condition of tangible personal property. There must be a change occurring during the chemical activity before this exemption applies. The "door-to-door" definition of processing for a manufacturer under the machinery, equipment, and computer exemption does not apply.
The repair of machines of all kinds is taxable. Qualifying replacement parts are exempt if itemized separately. Labor charges are taxable. There is no exemption for labor used to repair machines. If there is a lump sum billing for both labor and material, the entire amount will be subject to tax.
Containers, including packing cases, shipping cases, wrapping
materials and similar items are exempt from tax when purchased for the purpose
of packaging or facilitating the transportation of tangible personal property
to be sold at retail or for resale.
Pallets purchased by manufacturers for this purpose are also exempt.
WARRANTIES AND MAINTENANCE CONTRACTS
“Mandatory warranty” is when the buyer, as a condition of the sale, is required to purchase the warranty or guarantee contract from the seller. The cost of the warranty is part of the cost of the item. Therefore, the sale of a mandatory warranty is taxable only if the item is taxable. Sales of replacement parts and materials to the seller furnishing them under a mandatory warranty is a sale for resale and not taxable. Labor performed under a mandatory warranty is exempt.
“Optional warranty” is when the buyer is not required to purchase the warranty or guarantee contract from the seller. The price of the optional warranty is taxable.
A preventive maintenance contract is a contract which requires only the visual inspection of equipment and no repair is or will be included. The sale of a preventive maintenance contract is not subject to tax.
Additional charges for parts (except qualifying replacement parts) and labor furnished in addition to what is covered by a warranty or maintenance contract are taxable if the service is taxable. Only parts (not labor) are subject to tax when a nontaxable service is performed, but the labor charge must be separately stated.
SALES TAX EXEMPTION CERTIFICATES
Manufacturers must use a Sales Tax Exemption Certificate under two circumstances:
(1) To purchase machinery, equipment, computers and other materials used in the manufacturing process.
A manufacturer does not need a sales tax permit to claim this exemption.
Manufacturers who repeatedly make the same purchase from the same supplier may give the supplier a single exemption certificate to cover multiple transactions. Called a “blanket certificate,” it should be updated every three years or as needed so that it remains accurate and complete.
When a manufacturer buys an item tax free and then removes it from inventory for uses other than resale and processing, the manufacturer is responsible for reporting and paying the tax to the Department.
(2) Manufacturers who also sell the tangible personal property they produce must ask for exemption certificates when selling their products to other businesses who will then resell them. The information given above about suppliers selling to manufacturers also applies in this situation.
Please refer to the publication Exemption certificates: How and when to use them for further details.
Urban revitalization property and industrial machinery may also be exempt from tax. This property must meet other requirements in order to be exempt. Contact the Iowa Department of Economic Development at 1-800-532-1216 for more information about the type of property and the qualifications. For tax information, contact the Iowa Department of Revenue.
Electricity: Determine the percentage used in processing
The following method may be used to determine the percentage of electricity used in processing. It is suggested that conservative exempt estimates be made to avoid future liability for sales tax.
To calculate use for a new business, an existing similar business may be willing to share its information if not in direct competition with your business.
First, the base period for the calculations must be selected.
Ordinarily, 12 prior months are used as the base period. However, individual circumstances can dictate that a shorter or longer period should be used or that some 12-month period other than that immediately prior should be used.
Examples:
Company A manufactures its product in a factory that has no windows and is heavily insulated. The factory always runs 40 hours per week, 52 weeks per year. Because of these and other circumstances, Company A’s electrical usage does not vary significantly from month to month, and it is easy to document this. Company A can calculate its percentage of exempt use based on a one-month period rather than a 12-month period.
Company B manufactures widgets. The “economic cycle” for widget production is, on the average, 36 months long. During this time there are times when, for months at a time, the plant will operate three shifts. At other times, for weeks at a time, the entire factory will shut down and its personnel will be laid off. The only accurate way to determine the exempt percentage of electricity used is to calculate the use over the entire economic cycle. Therefore, 36 months, rather than 12 months, would be the base period.
Second, calculate kilowatts used per hour by each electrical device.
Kilowatts consumed per hour may be listed on the device itself. If not, formulas can be used to determine this information.
Lights
For incandescent bulbs, add rated wattages and divide by 1,000. Multiply by the total number of hours which the light is used during the base period.
Watts ÷ 1,000 = Kilowatts per hour X hours operated in base period = Total
For fluorescent lights, add rated wattages plus an additional 20 percent of rated wattages and divide by 1,000. Multiply by the total number of hours which the light is used during the base period.
(Watts + 20% of Watts) ÷ 1,000 = Kilowatts per hour X hours operated in base period = Total
Devices other than lights
For these devices, use the wattage rating given by the manufacturer and divide by 1,000. Multiply by the total number of hours which the device is used during the base period.
Watts ÷ 1,000 = Kilowatts per hour X hours operated in base period = Total
Note: If using energy efficient lights, appropriate adjustments to calculations should be made.
Examples:
1. A machine used in processing consumes 20,000 watts per hour of operation. It is operated 40 hours per week for 50 weeks during a 12-month period. The machine does not operate when the factory closes for two weeks for employee vacation.
(1) 20,000 watts ÷ 1,000 = 20 kilowatts per hour
(2) 20 x 40 hours per week = 800 kilowatts per week
(3) 800 x 50 weeks per 12 months = 40,000 kilowatts per 12-month period
(4) 40,000 kilowatts are exempt for the 12-month period for this machine
2. Assume that a machine uses 30,000 watts per hour of operation. During a 12-month base period, the machine is used in processing 200 hours per month for three months. The calculation for a 12-month period is as follows:
(1) 30,000 watts ÷ 1,000 = 30 kilowatts per hour
(2) 30 x 200 hours per month = 6,000 kilowatts per month
(3) 6,000 x 3 months per 12 months = 18,000 kilowatts per 12-month period
(4) 18,000 kilowatts are exempt for the 12-month period for this machine
3. The following is a very simplified example of a worksheet for determining the percentage of exempt electricity when a single meter records both exempt and taxable use. Assume that all items (except air conditioners and space heaters) are active 100 hours a week for 50 weeks in a 12-month period. Assume air conditioners and space heaters are active 100 hours a week for 20 weeks in a 12-month period.
| Items | k per hr. | hrs./wk. | wks./period | Total |
| ALL EXEMPT | ||||
| Machine 1 | 10 | 1,000 | 50,000 | 50,000 |
| Machine 2 | 20 | 2,000 | 100,000 | 100,000 |
| Other | 10 | 1,000 | 50,000 | 50,000 |
| Total Exempt: | 200,000 | |||
| ALL TAXABLE | ||||
| Air Conditioners | 10 | 1,000 | 20,000 | 20,000 |
| General Lighting | 15 | 1,500 | 75,000 | 75,000 |
| Office Equipment | 10 | 1,000 | 50,000 | 50,000 |
| Space Heaters | 5 | 500 | 10,000 | 10,000 |
| Other | 10 | 1,000 | 50,000 | 50,000 |
| Total Taxable | 205,000 | |||
| Total All Usages | 405,000 |
To determine the exempt percentage of total usage, divide 200,000 by 405,000, which equals 49.38%.
Once the percentage of exemption has been calculated, that percentage must be applied during any period for which a purchaser is requesting exemption. The percentage should be recomputed if a substantial and permanent change in the amount of electricity consumed occurs or if the proportion of exempt to nonexempt usage changes.
Alternatives to the previous method of determining exempt usage of electricity
If currently only one meter measures both exempt and nonexempt use of electricity, the manufacturer should seriously consider separate meters. This choice is especially practical if all exempt use results from the activities of one machine.
It may be helpful to contact the manufacturer of the machine used in processing. Often, the manufacturer has a study available which gives a more accurate measure of the machine’s use of electricity than the formulas. This is especially true in regard to large electric motors.
Fuel exemption certificate
A Sales Tax Exemption Certificate for Energy used in Processing and Agriculture is given by a buyer to a seller when making tax free purchases.
The seller has the right to demand additional documentation be attached to the certificate, as long as it is reasonably necessary to support the claim of exemption. This could be an electrical consultant’s study or a document prepared by the purchaser.
The purchaser does not have to file a certificate or attach documentation every time a transaction takes place unless a substantial change in the operation has occurred.
A buyer who makes tax-free purchases and then uses or otherwise disposes of the fuel in a taxable manner is liable for the sales tax and must remit that tax directly to the Department.
78-530 (12/02/08)