DOR Seeks To Limit Manufacturers' Tax Exemption | R&D expenses for startups could be taxed
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Richard Jones, attorney with corporate firm Sullivan & Worcester LLP.
In 2003, Onex Communications of Bedford got a message that no start-up company, let alone a manufacturer, wants to get: it owed the state $136,175 in back taxes plus interest and penalties.
The company has so far been victorious in its fight against the state Department of Revenue, but in mid-August DOR asked the state Supreme Judicial Court to review the case, and a reversal from the state’s highest court could have disastrous consequences for start-up manufacturers across the state.
Taxation With Representation
At issue in the case is when a manufacturing company actually becomes a manufacturing company. In other words, does a start-up that intends to make stuff eventually deserve the same tax benefits of full-fledged manufacturer?
The dispute also raises questions about the role of DOR auditors and how young companies can possibly afford to research and develop the products they intend to manufacture in Massachusetts.
Between 1999 and 2001, Onex didn’t manufacture anything. The company had just been founded. But it did buy equipment used in the research and development of the telecommunications computer chips it would eventually make. On those purchases, Onex claimed exemption from state sales and use taxes under a decades-old state tax exemption program for manufacturers.
In demanding $136,175 plus more than $20,000 in penalties from Onex, the DOR argued that the company could not be considered a manufacturing company before it completed a finished product.
For the DOR, it’s simple. The department “continues to believe that the manufacturing credit is reserved for companies that are actually manufacturing something,” said Bob Bliss, a department spokesman.
When DOR came looking for the back taxes, Onex requested an abatement and was denied, and the case went before the Massachusetts Appellate Tax Board, a quasi-judicial state agency, which sided with Onex. The DOR appealed that decision, but it was upheld in July by the state Appeals Court.
A month later, the DOR filed a brief with the state Supreme Judicial Court asking it to review the case.
“If the DOR position stands, how does a start-up company claim it’s a manufacturing company and get purchases for R&D exempt from sales and use tax?” said Richard Jones, Onex’s attorney at Boston-based law firm Sullivan & Worcester LLP.
DOR’s position seems to be that it cannot know for sure when a company that claims to be a manufacturer is performing R&D in the lead-up to actual manufacturing.
In its brief, it argues that “only companies whose present activities are an integral part of ongoing manufacturing qualify for favorable treatment as a manufacturing corporation.”
Without such concrete assurances, the commissioner of revenue would have “to guess as to whether a company engaged in only R&D today should nonetheless be treated as a manufacturing corporation because it may turn out that, someday, the fruits of those R&D efforts will become an integral part of the manufacture of some finished product.”
Every Dime
DOR’s argument also seems to favor established manufacturers. Under its logic, a manufacturer can begin R&D on a new product entirely unrelated to the products it already makes and claim the exemption for the purchase of equipment used in the research and development of the new product.
“That would make the exemption illusory,” Jones said.
The Associated Industries of Massachusetts has unsuccessfully filed legislation a number of times to update the language of the manufacturing tax exemption.
“You could have computers very much involved in the manufacturing process, but if it doesn’t actually touch the final product” the purchase of those computers may not be tax exempt, said Eileen McAnneny, senior vice president of government affairs at AIM.
“Ninety percent of ATB (Appellate Tax Board) decisions are upheld,” she said. “The DOR really does go after every dime, so it’s certainly not surprising” that it would ask the state Supreme Court to review the ATB decision.
Jones agreed. “It seems to be clear that DOR of Massachusetts is strapped for cash and wants to maximize revenues for the state. If DOR feels as if the exemption isn’t working as designed, or is too broad or its cost is greater than its benefit, then it can ask the legislature to repeal it,” he said.
Neither that scenario, nor one in which only companies with established manufacturing operations could qualify for the exemption is comforting to Catherine Phillips of Phillips Precision in Boylston.
“We take full advantage of the tax breaks we get as a manufacturer,” she said. “This year, we bought $100,000 in new equipment with this incentive.”
But Phillips, a machine shop, does a lot of prototype work. A lot of that is for established companies like Bose and Saint-Gobain. But some of it is for start-up companies still developing the products they intend to produce.
“We support those companies,” Phillips said, by making the prototypes of start-ups’ components. “That’s our job.”
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