Understanding and comprehending tax law is often a difficult task in general. It can be even more so if you are looking towards specific applications of tax law in particular industries. Take manufacturing, for example. I have had quite a bit of questions relating to manufacturers and the applicability of use tax for them.
Before getting into more of the specifics regarding use tax, it is important to differentiate between the transaction privilege tax (often mistaken as sales tax) and the use tax. The transaction privilege tax is imposed upon income or proceeds derived from engaging in a taxable business within the State of Arizona. The use tax is imposed upon the purchaser of tangible personal property which is used, stored, or consumed in Arizona when the sale was not subject to the transaction privilege tax.
Arizona imposes a 5.6% use tax on purchases of tangible personal property from an out-of-state retailer that are used, stored, or consumed in Arizona. There is an exemption from the transaction privilege tax for sales of machinery or equipment used directly in manufacturing, processing, fabricating, job printing, refining, or metallurgical operations. The key phrase in the exemption is “used directly.” This is where it can be difficult to determine the applicability of the use tax for manufacturers, as there can be many components that can go into the manufacturing process. Take, for example, expendable materials.
Expendable materials could include anything from tooling to drill bits to lubricants used in the manufacturing process. Generally, expendable materials are excluded as an exemption. However, there have been different rulings over the years that pertain to expendable materials. An amendment in 1999 held that a drill bit (on a stationary drill used in a manufacturing process) is considered a replacement part rather than an expendable item. So, items that perform a function as machinery or equipment qualify for exemption. On the other hand, all lubricants and other necessary fluids that do not themselves function as machinery and equipment are considered taxable expendable materials.
So, the use tax for Arizona manufacturers is not always clear. It is best to consult a tax professional to get direction.
By Kelly Lynch, CPA