The House Ways and Means Committee is considering two key areas of tax reform of importance to manufacturers. The first is a carryover of proposals from last year to change the way corporate taxable income is apportioned to Vermont, which would benefit manufacturing. The second is a new proposal from the Administration to expand the sales and use tax exemption for manufacturing machinery and equipment.
Both issues are long-standing priorities for AIV and Vermont manufacturers, and represent opportunities for meaningful improvements in Vermont’s tax environment for manufacturing. However, there are several details that must be addressed to ensure maximum benefit for the sector and to avoid unintended consequences, and active support and engagement by Vermont’s manufacturers will be critical to winning enactment.
The following are brief highlights of the issues. For more information and to discuss further, please contact us at firstname.lastname@example.org.
Single Sales Factor Apportionment and Related Issues
Traditionally states have taxed a portion of a company’s (including the larger corporate family’s) national income based on a blend of the percentage of the total national sales, payroll, and property that is actually located in the given state. Over the years, a number of states have increased the weighting of sales, several going to using sales as the single factor (Vermont currently double weights sales relative to payroll and property).
Essentially, the more a state weights sales and reduces the weighting of payroll and property, the greater the benefit for manufacturers located in that state. This is because for most manufacturers, most sales are to customers outside the state. This thereby reduces tax burdens and encourages investment in employment and facilities in that state. The working proposal in Ways and Means moves toward only factoring sales, but whether it moves to a full single sales factor only or just makes interim steps in that direction remains to be resolved.
There are additional issues to address, including the so-called “throwback rule”, which Vermont currently has, which effectively taxes sales in other states that do not themselves tax them, as if they happened in Vermont. It is critical to eliminate this rule as a state moves toward only using the sales factor to avoid potentially significant and capricious tax impacts. The working proposal might move in this direction but this question remains to be resolved.
An additional provision in the working proposal would eliminate the Overseas Business Organization exclusion or the so called “80/20 rule”, which can impact the taxable income of certain US corporations with significant (more than 80%) property and payroll outside the US. It is not entirely clear how this might impact Vermont manufacturers that are part of multinational corporations, depending on how they are structured, and it will be important to get feedback from such companies to understand if there might be any unintended consequences that will need to be addressed.
Sales and Use Tax Exemption for Manufacturing Machinery and Equipment
Most states have a sales and use tax exemption for machinery and equipment used in the manufacturing process. However, there are differences in how states define the manufacturing process (where it begins and ends), how integral the machinery and equipment must be (including factors like physical integration vs. mobility, etc.), and how often multi-use machinery and equipment can be used for non-manufacturing process uses before being disqualified.
Vermont’s exemption is more limited than many other states. The scope of the manufacturing process is not as broad as many other states, there have been issues with machinery and equipment being deemed integral to the manufacturing process, and the threshold for multiple uses is extremely low – using something more than 4% of the time for non-manufacturing processes is disqualifying under current Vermont law. This latter threshold is not only unreasonably low but narrow and specific enough to practically invite compliance disputes.
The proposal before the Ways and Means Committee would make important improvements, including by expanding the definition of being integral to the manufacturing process and raising the multiple use threshold to 50%, a more reasonable and commonly used standard for predominant use. As currently drafted, the language does not appear to fully address issues with the scope of the manufacturing process. Nevertheless, it would make real improvements and would be a step forward that can be further built upon.
It will be critically important for Vermont manufacturers to engage on these issues. This is especially true for those who might be impacted by the throwback rule or the 80/20 rule with regard to the apportionment proposals, and those who have experience with the issues surrounding Vermont’s machinery and equipment sales and use tax exemption.
We strongly encourage companies with interest and experience in these issues, as well as those who want more information or to discuss them further, to contact us at email@example.com to learn more, share recommendations, and consider ways to engage.