Texas Releases Guidance on the Effects of an Unaffiliated Third-Party Manufacturer
September 18, 2015
On August 12, 2015, the Texas Comptroller of Public Accounts issued Texas Policy Letter Ruling 201508350L which discusses whether a taxable entity that uses an unaffiliated third-party manufacturer to produce products is eligible for the 0.5% tax rate which is available to retailer or wholesalers. (Please note that this rate has changed effective 1/1/2015 and again in 1/1/2016. Please refer to June’s SALT Blog for information on this.)
Texas Tax Code Section 171.002(c) explains that a taxable entity is primarily engaged in retail or wholesale trade if:
- The total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than retail and wholesale trades;
- Less than 50% of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group; and
- The taxable entity does not provide retail or wholesale utilities.
Therefore, as long as the above is true, a taxable entity that sells goods produced by another entity is eligible for the 0.5% rate when the taxable entity is “primarily engaged in retail or wholesale trade.” The issue is when a taxable entity becomes a “producer.”
A taxable entity that sells goods produced by an affiliated member of the group is considered the producer of the goods when making the calculation. However, when a taxable entity contracts with an unaffiliated third-party manufacturer (“contract manufacturer”) for the production of goods, the taxable entity may be considered either a retailer/wholesaler or a producer of the goods.
The ruling continues to state that “production” includes construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth etc. in Tax Code Section 171.1012(a)(2). Under this definition, if a taxable entity that manufacture, develops, or creates tangible personal property, it is then engaged in the production of goods. Further, if tangible personal property is incorporated into, installed in, or becomes a component part of the final product that the taxable entity sells, the taxable entity is considered the producer of the final product the taxable entity sells and therefore is not eligible for the 0.5% rate. If a component part is installed into 100% of the products it sells, the taxable entity is considered a producer. Texas states that a test will need to be done if 50% of total revenue comes from the sale of products it produces if the component part is not installed into 100% of the products the taxable entity sales.
The ruling also provides a bright-line test for determining whether modifications on a product make the entity a producer of that product.
Overall, a taxable entity will be considered a producer of the products it sells if it performs any part of the manufacturing or assembly of the product, produces a component of the product, or makes modifications to an acquired product, barring certain exceptions. For a copy of the letter ruling, click here.