Does the manufacturing-machinery exemption apply to a contract manufacturer that doesn't own or sell the finished product?

Plain-English summary

A contract manufacturer — a company that owns machinery and machine tools and uses them to perform manufacturing services on property owned by a third party — asked whether Colorado's manufacturing-machinery exemption (§ 39-26-709(1)(a)(II)) still applies when it never owns or sells the finished product. The Department's answer: likely yes, as long as the manufacturer operates for profit.

The exemption covers machinery and machine tools used in Colorado "directly and predominantly in manufacturing tangible personal property for sale or profit." The interesting legal question is whether — like the separate exemption for ingredients used in manufacturing — it secretly requires that the finished product be sold and subject to tax. In Carpenter v. Carman Distributing Co., 144 P.2d 770 (Colo. 1944), the court read the ingredients exemption to apply only if the finished goods are sold subject to tax, because that exemption exists to prevent tax pyramiding (taxing the same value twice through the production chain) — and the court reached that result even though the statute didn't say so expressly.

The Department distinguished the machinery exemption on its text: unlike the ingredients exemption, it expressly says it applies to goods made "for sale or profit." That word "profit" signals a different purpose — "to encourage the purchase of manufacturing machinery … and, more generally, to encourage manufacturing enterprises" — not merely to avoid pyramiding. So Carpenter's "the finished product must be taxable" inference doesn't carry over. The Department had already taken this view in PLR 14-003 (machinery making asphalt the manufacturer itself used for paving was exempt even though the asphalt was never sold).

Applied to contract manufacturing: the contract manufacturer "does not sell the finished product because it does not own the product — it simply is providing the service of manufacturing," and the third party might also just use (not sell) the goods. None of that defeats the exemption. Bottom line: "the Department will likely allow the exemption … even if the finished product is not sold. However, the manufacturer must be engaged in a for-profit enterprise." Because this is a GIL, it's guidance, not a binding determination.

What this means for you

Contract manufacturers and job shops

Don't assume you lose the manufacturing-machinery exemption just because you never own or sell the finished product — your customer does, or even just uses it. The exemption turns on machinery used directly and predominantly in manufacturing for sale or profit, and "profit" is enough. The one firm condition the Department flagged: you must be running a for-profit manufacturing enterprise. (Other statutory qualifications to the exemption exist but weren't at issue here.)

Manufacturers that consume their own output

If you make goods you use yourself rather than sell (the asphalt-for-paving scenario in PLR 14-003), the machinery exemption can still apply — selling the finished product isn't required.

Accountants and tax professionals

The doctrinal point: the machinery exemption (§ 39-26-709(1)(a)(II)) is textually broader than the ingredients exemption (§ 39-26-102(20)) because it says "for sale or profit." Carpenter v. Carman Distributing (144 P.2d 770) tied the ingredients exemption to a taxable sale of the finished goods on an anti-pyramiding rationale; that rationale doesn't bind the machinery exemption, whose purpose is to encourage manufacturing. See PLR 14-003. No determination was made; the conclusion is "will likely allow."

Common questions

Q: Does the manufacturing-machinery exemption require that I sell the finished product?
A: No. Unlike the ingredients exemption, the machinery exemption expressly applies to goods made "for sale or profit," so it can apply even if the finished goods are never sold.

Q: I'm a contract manufacturer and never own the goods — can I still claim the exemption?
A: Likely yes. The Department said the exemption applies even though a contract manufacturer doesn't own or sell the finished product, provided you're a for-profit enterprise.

Q: What's the one key condition?
A: The manufacturer must be engaged in a for-profit enterprise. The machinery must also be used directly and predominantly in manufacturing in Colorado (with other statutory qualifications not addressed here).

Q: Why doesn't the Carpenter case require a taxable sale here?
A: Carpenter dealt with the ingredients exemption, whose purpose is to avoid tax pyramiding, so it required a taxable finished-goods sale. The machinery exemption's "for sale or profit" language shows a different purpose — encouraging manufacturing — so that requirement doesn't apply.

Q: Is this letter binding?
A: No. A General Information Letter is general guidance and is not binding on the Department; it makes no specific determination. For a binding answer, request a private letter ruling.

Q: Does this cover city sales tax?
A: No. The Department administers state and state-collected local taxes only; self-collected home-rule cities and counties set their own rules.

Citations and references

Statutes and cases:
- § 39-26-709(1)(a)(II), (2), C.R.S. (exemption for manufacturing machinery and machine tools used directly and predominantly in manufacturing goods for sale or profit)
- § 39-26-102(20), C.R.S. (exemption for ingredients used in manufacturing)
- Carpenter v. Carman Distributing Co., 144 P.2d 770 (Colo. 1944) (ingredients exemption tied to a taxable finished-goods sale to avoid pyramiding); Bedford v. Hartman Bros., 89 P.2d 584 (Colo. 1939)
- PLR 14-003 (machinery exemption does not require the finished goods be sold — asphalt consumed by the manufacturer)

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-17-016.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL 17-016
August 21, 2017
XXXXXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXX
Re: Manufacturing Machinery
Dear XXXXXXXXXXXX,
You submitted on behalf of your client (“Company”) a request for guidance
regarding the applicability of the sales tax exemption for manufacturing machinery
and machine tools used for contract manufacturing.
The Colorado Department of Revenue (“Department”) issues general information
letters and private letter rulings. A general information letter provides a general
overview of the relevant tax issues, but is not binding on the Department. A
private letter ruling provides a specific determination for a specific set of facts, is
binding on the Department but not on the taxpayer, and requires payment of a
fee. For more information about general information letters and private letter
rulings, please see Department Rule 1 CCR 201-1, 24-35-103.5 at
www.colorado.gov/pacific/tax/letter-rulings
The Department treats this request as a general information letter. It is important to
remember that general information letters, such as this one, are general discussions of
tax law and are not binding on the Department. If Company would like the Department
to issue a private letter ruling on the issue raised here, Company can submit a request
and pay the fee in compliance with Department Rule 1 CCR 201-1, 24-35-103.5.
Issue
Does the exemption for manufacturing machinery and machine tools set forth in
§39-26-709(1)(a)(II), C.R.S. apply to the purchase and use of these items when
the manufacturer is contracted by a third party for manufacturing services, known
as contract manufacturing?
Background
Company owns manufacturing machinery and machine tools. It uses these
machines and tools to perform manufacturing services on tangible personal
property owned by a third party.

Discussion
Colorado levies sales and use tax on the sale and use of tangible personal
property. Manufacturing machinery and machine tools used in Colorado directly
and predominantly in manufacturing tangible personal property for sale or profit is
exempt from sales and use tax.1
Exemptions are sometimes enacted to avoid pyramiding of sales and use taxes.2
For example, Colorado exempts the sale and purchase of ingredients used in
processing or manufacturing of tangible personal property but only if the finished
product is subject to sales or use tax.3 In Carpenter v. Carman Distributing
Co.,144 P.2d 770 (Colo. 1944) the court concluded that the exemption for
ingredients used in manufacturing applied only if the finished goods are sold
subject to sales tax because the purpose of the exemption was to avoid
pyramiding of sales taxes. Notably, the court reached this conclusion even
though the statute did not expressly state that the sale of the finished product
must be taxable. The question posed by this request for guidance is whether the
exemption for manufacturing machinery also requires that the finished product
must be subject to tax even though the statute does not expressly contain such a
requirement.
The manufacturing machinery exemption is similar to the exemption for
ingredients used in manufacturing in that both involve the manufacturing process
where there is the potential for pyramiding taxes. Indeed, other states have
enacted exemptions for manufacturing machinery but restrict the exemption to
situations where the finished product is sold by the manufacturer, presumably in
order to avoid pyramiding of taxes.4 However, and unlike the exemption for
manufacturing ingredients discussed in Carpenter, the exemption for
manufacturing machinery expressly states that it applies to manufactured goods
for sale or “profit.” Thus, this exemption applies even though the finished goods
are not sold. For example, a company may use the machinery to produce
finished goods that the manufacturer itself uses.5 Some manufacturers provide
manufacturing services to third parties who furnish the raw material that will be
manufactured into a finished product. This is sometimes referred to as “contract
1

§ 39-26-709(1)(a)(II) and (2), C.R.S. There are several qualifications to this exemption that are
not relevant to the issue addressed in this letter and, therefore, are not discussed.
2
There is no legal prohibition to pyramiding sales and use taxes, but the legislature may, for policy
reasons, elect to exempt certain sales and uses to avoid such pyramiding. Bedford v. Hartman
Bros., 89 P.2d 584 (Colo. 1939); Carpenter v. Carman Distributing Co. 144 P.2d 770 (Colo.
1944).
3
§ 39-26-102(20), C.R.S.
4
See, Department Private Letter Ruling (PLR) 14-003, citing, inter alia, Armrel Byrnes Company v.
Tax Commissioner of Ohio, 2008-A-1261, Ohio Board of Tax Appeals (Ohio 2011)
(manufacturer of asphalt did not sell the asphalt to a third party but, rather, consumed the
asphalt as a contractor providing paving services).
5
The department previously provided guidance that this exemption for manufacturing machinery
and machine tools does not require that the finished goods be sold. See, Department Private
Letter Ruling (PLR) 14-003 (machinery used to produce asphalt used by the manufacturer is
exempt from tax even though the asphalt was not sold but, instead, was used by the
manufacturer as a contractor providing paving services for a profit.)
2

DR 4010A (06/11/14)

manufacturing.” The contract manufacturer does not sell the finished product
because it does not own the product - it simply is providing the service of
manufacturing. The third party also may not sell the finished goods, but, instead,
may use the finished goods.
The term “profit” suggests that the purpose of this exemption is not to avoid
pyramiding of taxes but, rather, to encourage the purchase of manufacturing
machinery and tools and, more generally, to encourage manufacturing
enterprises. Given this apparent purpose, the rationale used in Carpenter to infer
that the finished product must be subject to a taxable sale does not apply to this
exemption.
For these reasons, the Department will likely allow the exemption set forth in §3926-709(1)(a)(II), C.R.S. even if the finished product is not sold. However, the
manufacturer must be engaged in a for-profit enterprise.
Miscellaneous
This letter represents the good faith opinion of Department personnel who are
knowledgeable on state taxes issues. However, the Department does not make a
specific determination here on any of the issues raised and the Department is not
bound by this general information letter.
The Department administers state and state-administered local sales and use
taxes. This letter does not address sales and use taxes administered by home-rule
cities and home-rule counties. You may wish to consult with local governments which
administer their own sales or use taxes about the applicability of those taxes. Visit our
web site at www.colorado.gov/tax for more information about state and local sales
taxes.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this
redacted letter will be made public within 60 days of the date of this letter. Please let
me know in writing within that 60 day period whether you have any suggestions or
concerns about this redacted letter.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

3

DR 4010A (06/11/14)