Minnesota has become increasingly aggressive in its audits of sales and use tax.  Because such audits usually cover multiple years of activity and include interest and potential penalty assessments of 10%, noncompliance can be costly.  To assist you in reducing your company’s exposure upon audit, the following is a summary of the general rules and exemptions applicable to manufacturers.

Rules Applicable to Sales

While most manufacturers’ sales are exempt from sales tax because the purchaser intends to resell the product, these sales are not automatically exempt.  A signed resale certificate from each customer must be kept on file verifying that their purchases are indeed for resale.  In addition to the resale exemption, several other exemptions are also available.  If you are not taking advantage of such exemptions, you are overcharging your customers and thereby reducing your ability to compete.  The following are some of the most common:

Sales of property shipped to a customer outside of Minnesota using your own trucks or a common carrier.   Minnesota can only tax those transactions which take place within its boundaries. 

Sales to a government unit or school.  Minnesota does not tax sales to the U.S. government and its agencies.  Other customers qualifying for exemption include: other state and local governments (provided the purchase would be exempt in the home state), public schools, hospitals and nursing homes owned and operated by a local government, and public libraries. Other limited exemptions apply to Minnesota local governments.  While Minnesota state agencies are not exempt from sales tax, they pay tax on taxable goods directly to the state of Minnesota but are required to pay tax on most taxable services to their vendors.

Sales to certain nonprofit entities providing a completed Certificate of Exemption.  All nonprofit entities do not qualify for this exemption.  Exemptions are available to religious, charitable, and educational organizations, and for qualifying purchases by certain senior citizen and veterans’ organizations.

Sales to American Indian tribes, enrolled members, and certain Indian corporations or partnerships.  Generally, sales to tribal members are only exempt if the sale occurs on the tribal reservation and no agreement exists between the tribe and the state to collect sales tax.  Sales to tribal governments and their businesses are generally exempt.

Rules Applicable to Purchases

Generally, a manufacturer must pay Minnesota sales or use tax on each of its purchases, including those purchased from an out-of-state vendor, unless a specific exemption applies.  The most common of those exemptions are discussed below.

Capital equipment (including repair and replacement parts and accessories) purchased or leased and used in Minnesota primarily for manufacturing, fabricating, mining, or refining tangible personal property for ultimate sale at retail.  Manufacturers are first required to pay sales tax on the transaction and then file for a refund of tax paid.  To qualify for the refund, the equipment must be used by the purchaser or lessee in Minnesota as part of an integrated production process.  Activities that qualify as part of the integrated production process include:

• Research and development and product testing
• Constructing, cleaning, maintaining, and repairing equipment, tools, or parts for equipment used in a qualifying process
• Conveyance of raw materials from inventory to the first work point
• Production activities
• Outside fabrication labor services
• Maintaining conditions necessary essential to the production process (but not general heat and lighting)
• Storing work-in-process
• Quality control and testing
• Packaging of completed product (but not addressing, applying postage, invoicing, etc.)

The following activities do not qualify as part of the integrated production process:

• Receiving or storing raw materials
• Plant security, fire prevention, first aid, and hospital stations
• Pollution control or abatement
• Plant maintenance, safety, or communications
• Support operations or administrative functions

Materials and supplies that are a component or ingredient or are consumed, destroyed, or lose their identity in the manufacture of products you will sell to customers.  This exemption allows nontaxable purchases not only of raw materials, but also any other materials consumed during manufacturing that do not actually become a part of the finished product, including acids, bleaching agents, oils, greases, sandpaper, etc.  This exemption does not include apparel or safety equipment worn by employees, chemicals and cleaning agents used to clean the plant or production equipment (except food processing), and tools.

Containers, labels, boxes, and other packaging and shipping materials that you will use to transport your product to customers.  Nonreturnable materials used to package products can be purchased exempt.  Returnable containers are taxable, except when used to package food and beverages.  Packaging and shipping materials include materials used inside a package to stabilize or protect the contents and include cardboard fillers, shredded paper, twine, gummed tape, wrapping paper, rubber bands, pallets, skids, and mailing tubes.

Special tooling and separate detachable units.  Tooling that is custom-made may be purchased exempt.  Materials purchased to make custom tooling are taxable.  Separate detachable units such as accessory tools, dies, molds, and other short-lived items may be purchased exempt if they are purchased separate from the machine (or have the cost separately stated), attach to the machine while in use, have a ordinary useful life of less than 12 months, and are used in producing a direct effect on the product.  Materials purchased to make such items are exempt. Examples of items that may qualify as a separate detachable unit include:  cutting tools, dies, drill bits, jigs, etc.

Advertising materials distributed outside of Minnesota for use outside of Minnesota.  This exemption may apply to the purchase of items in final form or to the purchase of an item that is incorporated into a product that ultimately leaves the state and is limited to materials used to advertise and promote the sale of merchandise or services.

Conclusion

Noncompliance with sales and use tax rules can prove very expensive if your business is audited.  Therefore, Minnesota taxpayers must take steps to ensure they have adequate procedures in place and monitor their compliance with such procedures if they want to avoid a costly surprise upon audit.