96-102
Response
Request
XXXXX
Director
Auditing
Division
Internal
Advisory Opinion - Determining when a manufacturing activity comprises a
“separate and distinct” establishment.
Dear
XXXXX,
Under
Administrative Rule R865-19S-85, when manufacturing activities are performed at
the same physical location as non-manufacturing activities, the manufacturing
activities may qualify for sales tax exemptions if that activity comprises a
separate and distinct economic activity.
You asked us for guidance on how to make that determination. We offer the following:
When
a business conducts manufacturing and non-manufacturing activities on the same
premise, the determination that the manufacturing activity is a separate and
distinct economic establishment rests on the following analysis:
1. If a business operates in more than
one location (e.g. branch or satellite offices), each physical location is
considered separately from any other locations operated by the same business.
If each activity comprises a
separate corporate entity or subsidiary, the two establishments are presumed to
be separate and distinct from each other, even if operated on the same
premise. However, this presumption may
be overcome if evidence turned up by an auditor reveals that the entities are
so interdependent that they cannot be considered separate and distinct from one
another. For instance, if the taxpayer
is claiming a manufacturing equipment exemption, but the equipment is used in
both activities, the activities probably are not separate and distinct from one
another.
Assuming that qualifying and
non-qualify activities take place on the same premise, and a reasonable
question exists as to whether the manufacturing activities constitute separate
and distinct economic activity.
2. No single SIC classification
includes or encompasses the combined activities conducted at a single physical
location. If the manufacturing
activities are described as part of a non- manufacturing classification, the
entire facility is outside the manufacturing code and no further analysis is
required. Otherwise, move to step 3 of
the analysis.
3. The activities conducted on the same
premise are or could be economically independent from one another. If each of the activities, when considered by
itself, could be economically viable, the activities are “separate and
distinct.” A manufacturing activity is
economically viable if it has an independent and profitable market outside of
the non-qualifying activities conducted on the same premise and if a prudent
business person would undertake the business apart from the other activities
conducted at the facility.
One approach to determining the economic
viability of the manufacturing activity is to ask: if the non-qualifying
activities closed down, could the qualifying activities continue? The following examples help illustrate this
point.
Example A: A contractor agrees to furnish and install
the steel that is incorporated into a building project. The contractor engages in steel fabrication
activities solely to produce the steel to fulfill his construction
contract. Since the contractor does not
manufacture steel for sale in the ordinary course of business, the steel
fabrication activities serve only to support the building activities. The contractor has no independent market for
his steel fabrication activities, and the activities are completely interdependent. The steel fabrication activities do not
constitute a separate and distinct manufacturing establishment.
Example B: The by-product of the contractor’s
fabrication activities in example A is waste steel. Although the contractor may have an
independent market for the by-product (e.g. a recycling company), the sale of
the by-product, by itself, does not convert the fabrication activities to a
separate economically viable business.
Here the question is whether a prudent business person would undertake
to produce waste steel for sale to recyclers, or if the sale of the waste steel
is merely an opportunity to reduce business expenses associated with the non-
qualifying construction activities.
Example C: A micro brewery operating on the same premise
as a restaurant may be a separate and distinct economic activity if the
activities can operate independently as viable businesses. Obviously a restaurant is not dependent upon
having a brewery located on the same premise.
The brewery, however, may or may not be dependent upon the restaurant. If the brewery exists only to produce a
product for sale in the connected restaurant, and the brewery has no
independent market outside the restaurant, it has no separate economic
viability. On the other hand, if the
brewery arm of the business can sell its product in the ordinary course of
business outside the connected restaurant, it may be a separate and
economically viable activity. In this
case the question is this: would a
prudent business person continue to operate this brewery activity if the
restaurant closed? If the brewery could
remain in business even if the restaurant closed, the brewery may have an
independent economic viability. If the
brewery is completely dependent upon the restaurant for its sales, it has no
separate economic viability.
Assuming that, upon conclusion of
the analysis, the manufacturing operation constitutes a separate and distinct
economic activity, the taxpayer must still meet all other qualifications for
the manufacturing exemption claimed.
For
the Commission,
Alice
Shearer,
Commissioner