Texas sales and use tax exempts tangible personal property that becomes an ingredient or component of an item manufactured for sale, as well as taxable services performed on a manufactured product to make it more marketable.
The exemption also applies to tangible personal property that makes a chemical or physical change in the product being manufactured and is necessary and essential in the manufacturing process. Some items, such as hand tools, are excluded from the exemption. A hammer, for example, is taxable even if it is used in fabricating a product for sale.
Who Qualifies for Exemption?
Manufacturers (including sub-manufacturers) who perform any of the following activities are eligible to claim manufacturing exemptions:
Performing one or more of the manufacturing operations for a manufacturer.
Fabricating or assembling components into tangible personal property for ultimate sale.
Modifying or changing the characteristics of the product being manufactured for ultimate sale, or its component parts.
Who Does Not Qualify for Exemption?
The following non-manufacturers do not qualify for manufacturing exemptions:
Persons repairing real or tangible personal property belonging to others.
Service providers, such as telecommunications service providers or data processors.
What Items and Services Are Exempt?
The manufacturing exemption applies to machinery or equipment that causes a physical or chemical change in a product in order to make it saleable. The manufacturing process begins with the first stage of production. Typically, the first activity that changes raw materials or ingredients of the product begins the manufacturing process. The manufacturing process ends when the product has the same physical properties as when sold or transferred by the manufacturer to another, including any packaging.
For software, the manufacturing process includes the design and writing of the code, as well as testing and demonstrating the software.
Used directly in, and is essential to, the manufacturing process and makes a chemical or physical change in the product being manufactured, or to an intermediate or preliminary product that will become an ingredient or component part of the product being manufactured.
Used for quality control during the manufacturing operation that tests products for ultimate sale.
Used or consumed in the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale, if the use or consumption of the property is necessary to comply with federal, state or local public health laws.
Necessary for pollution control, such as:
Steam production equipment.
Specifically installed to:
Reduce water use and wastewater flow;
Reuse and recycle wastewater; or
Treat wastewater from other sources to replace the use of fresh water.
Manufacturers can also claim exemption when purchasing, renting or leasing the following items:
Chemicals, catalysts and other materials used to:
Make a product more marketable;
Produce a chemical or physical change; or
Gas and electricity used in powering exempt manufacturing equipment other than equipment used in preparation or storage of prepared food, subject to a predominant use study.
Lubricants, chemicals, chemical compounds, gases and liquids necessary to prevent the failure or deterioration of exempt manufacturing equipment.
Safety apparel and work clothing required for the manufacturing process the manufacturer buys but does not resell to its employees, such as:
Hairnets required by regulations to be worn by employees during the manufacturing process.
Machinery and equipment used for manufacturing support, but not directly in the manufacturing process, generally do not qualify for the manufacturing exemption.
Examples of non-qualifying, taxable manufacturing support equipment include air conditioning for employee comfort, equipment used to make molds or dies, and equipment used to make other equipment that is then used to make a product for sale.
Exemptions for Specific Industries
Besides the exemptions available to all manufacturers, additional exemptions are available for certain classes of manufacturers.
Printers and Newspaper Publishers
Printers and newspaper publishers can claim an exemption for pre-press machinery, equipment and supplies that are necessary for the printing process.
Other qualifying items include:
Color separation negatives.
Film developing chemicals.
Typesetting or composition proofs.
Production companies can claim an exemption for certain items necessary and essential to, and used or consumed directly in, producing a motion picture, video, or audio master recording, if copies are sold, licensed, distributed, broadcast or otherwise exhibited. This exemption also applies to producing live cable, radio or television programs.
Qualifying items include:
Audio or video routing switchers located in a studio.
Film and film developing chemicals.
Special effects equipment and supplies.
Tangible personal property that becomes a component part of the qualifying motion picture, recording or broadcast.
Certain services and other equipment used in the production.
Semiconductor and Pharmaceutical Biotechnology Manufacturers
Semiconductor and pharmaceutical biotechnology manufacturers can claim exemption on semiconductor fabrication cleanrooms and equipment and pharmaceutical biotechnology cleanrooms and equipment. The exemption includes all tangible personal property, without regard to whether the property is an improvement to realty, that is used in a cleanroom environment and in connection with the manufacturing, processing, or fabrication of a semiconductor product or a pharmaceutical biotechnology product.
A qualifying item can be affixed to or incorporated into realty and does not have to be contained in a cleanroom environment.
Qualifying items include:
Movable cleanroom partitions.
Production equipment and machinery.
Property necessary or adapted to:
Control airflow, temperature, humidity, chemical purity or other environmental conditions or manufacturing tolerances.
The exemption does not apply to the building that houses the cleanroom or its permanent, nonremovable components. The exemption does not apply to intraplant transportation equipment.
The exemption certificate must include the following:
The purchaser’s name and address;
A description of the item to be purchased;
The reason the purchase is exempt from tax;
The purchaser’s signature and the date; and
The seller’s name and address.
Divergent use of exempt manufacturing equipment occurs when a manufacturer uses the equipment for purposes other than manufacturing items for sale. For example, a photographer uses a camera to take pictures for sale. If the photographer uses that same camera to take personal photos, the photographer has used the camera in a divergent and taxable manner.
Even though a manufacturer uses exempt equipment in a divergent way, they can give their supplier an exemption certificate (PDF) when purchasing the qualifying equipment. The manufacturer must calculate and remit tax on the amount of divergent use of the equipment.
Calculating Divergent Use
For equipment purchased less than four years ago, divergent use is calculated on a monthly basis. The percentage of divergent use of machinery or equipment is measured either in hours of use, or by the total output.
When divergent use occurs, the manufacturer must maintain supporting documentation reflecting the exempt and non-exempt use to self-assess tax each month or other filing period. If divergent use during a month is 5 percent or less of the total use of the equipment, no tax is due in that month.
After four years, there is no tax on divergent use.
Formulas for Determining Divergent Use
Hours of divergent use formula:
Total hours of divergent use operation in the month divided by total hours of operation during the month equals percent divergent use for the month.
Total output formula:
Total output during divergent use in the month divided by total output during the month equals percent divergent use during the month.
Tax due formula:
Tax due equals 1/48 of the purchase price of the exempt item times the percent of divergent use times the tax rate applicable at the time of purchase.