Does the manufacturing machinery and equipment sales/use tax exemption cover equipment, like cleanrooms, that starts out in research and development before being used in production?

Plain-English summary

A biotechnology company asked the Illinois Department of Revenue for a Private Letter Ruling on whether the "cleanrooms" it bought for producing a gene therapy drug qualified for Illinois's manufacturing machinery and equipment exemption from Retailers' Occupation (sales) Tax and Use Tax. The Department declined to issue a PLR and instead issued this General Information Letter, which is not binding and not a statement of Department policy.

Illinois exempts machinery and equipment that is used primarily — meaning over 50% of its useful or economic life — in manufacturing or assembling tangible personal property for wholesale or retail sale or lease. 86 Ill. Adm. Code 130.330 sets out this "primary use" test and lists activities that count as exempt manufacturing use (direct physical changes to the product, in-line inspection/testing, guiding or measuring changes to the product, moving product between production stations, and packaging as part of an integrated manufacturing process) versus activities that don't (pre-production storage/handling, post-production storage/handling of finished goods, waste disposal, and general ventilation/heating/cooling not required by the manufacturing process).

The taxpayer's cleanrooms were mobile, prefabricated units that create the sterile, temperature- and humidity-controlled environment needed to manufacture the drug. They were initially going to be used for research and development (a non-exempt use) before shifting to actual drug manufacturing once the company's Phase 1 clinical trial and subsequent trials progressed. The Department confirmed that an asset's initial non-exempt use (like R&D) does not by itself disqualify it from the exemption later — what matters is whether the equipment is used in an exempt manufacturing manner for more than 50% of its useful or economic life, measured over the depreciation period the Department uses for the asset. But the Department said it could not actually rule on whether these specific cleanrooms qualified, because the letter didn't establish the depreciation period for the equipment or the actual date manufacturing for sale/lease would begin. Its practical suggestion: self-assess and pay Use Tax when the equipment is purchased to avoid penalties and interest, and then file a claim for credit later if it turns out the equipment was used over 50% of its life in an exempt manufacturing manner (subject to the statute of limitations).

What this means for you

Manufacturers with R&D-to-production equipment

If you buy machinery or equipment that will start out in research and development before moving into actual production, this letter confirms that initial non-exempt (R&D) use does not automatically disqualify the equipment from the manufacturing exemption. What matters is the equipment's use over its full depreciation life — if it ends up used more than 50% of that time in qualifying manufacturing activity, it can still be exempt.

Biotech and pharmaceutical manufacturers

Cleanrooms and similar environment-control equipment used to manufacture a drug for sale can be machinery or equipment "used primarily in manufacturing" under 86 Ill. Adm. Code 130.330, according to the Department's reasoning here — but only once the depreciation timeline and actual manufacturing start date are established. If your equipment's future use is still uncertain (e.g., dependent on clinical trial results or FDA approval), the Department may not be able to give you a definitive answer either.

Anyone deciding whether to self-assess tax on new equipment purchases

Where it's genuinely unclear at the time of purchase whether equipment will meet the over-50% exempt-use threshold, the Department's suggested approach in this letter is to self-assess and pay Use Tax on the purchase to avoid penalties and interest, then file a claim for credit later if the exempt-use threshold is ultimately met (as long as the claim is filed within the statute of limitations).

Accountants and tax professionals

Note that the Department refused to issue a binding Private Letter Ruling here and instead gave only general guidance in the form of a non-binding GIL. The letter identifies the relevant test (over 50% of useful/economic life in exempt manufacturing use, measured over the depreciation period) and applicable regulations, but expressly does not commit to an outcome for this taxpayer's cleanrooms. Don't treat this letter as authority that any particular cleanroom or R&D-to-production asset qualifies — it only confirms the framework for analysis.

Common questions

Q: Does the manufacturing machinery and equipment exemption require equipment to be used in manufacturing from day one?
A: No. The Department states that the initial non-exempt use of machinery or equipment (such as research and development of a new product or production technique) does not by itself disqualify the equipment from the exemption, as long as it is later used in an exempt manufacturing manner for more than 50% of its useful or economic life.

Q: Did the Department rule that this company's cleanrooms qualify for the exemption?
A: No. The Department said the cleanrooms "may be eligible" but that it could not render an opinion on whether they actually qualified, because the letter did not establish the period over which the cleanrooms would be depreciated or the actual date the equipment would begin manufacturing drugs for sale or lease.

Q: How does the Department measure whether equipment is used "over 50% of the time" in manufacturing?
A: The Department looks at the period during which the asset is depreciated, not the total period the equipment might eventually be used in the manufacturing process.

Q: What should a taxpayer do if it's unsure whether new equipment will meet the 50% exempt-use threshold?
A: The Department suggested the taxpayer self-assess and pay Use Tax at the time of purchase to avoid penalties and interest, and then file a claim for credit later if it can establish the equipment was used over 50% of its useful or economic life in an exempt manner, assuming the claim is still within the statute of limitations.

Q: Why did the taxpayer get a GIL instead of a Private Letter Ruling?
A: The taxpayer requested a binding PLR, but the Department has discretion whether to issue one under 2 Ill. Adm. Code 1200.110(a)(4) and decided not to. It issued this non-binding General Information Letter instead, which only points to relevant regulations rather than resolving the taxpayer's specific facts.

Citations and references

• 35 ILCS 105/3-5 (Use Tax manufacturing machinery and equipment exemption)
• 35 ILCS 120/2-45 (Retailers' Occupation Tax manufacturing machinery and equipment exemption)
• 86 Ill. Adm. Code 130.330 (manufacturing machinery and equipment exemption rule)
• 86 Ill. Adm. Code 130.101 (imposition of Retailers' Occupation Tax)
• 86 Ill. Adm. Code 150.101 (imposition of Use Tax)
• 2 Ill. Adm. Code 1200.110 (private letter ruling procedure)
• 2 Ill. Adm. Code 1200.120 (general information letter procedure)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2017.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2017/st-17-0031-gil.pdf

Original ruling text

`
ST 17-0031-GIL 09/19/2017 MANUFACTURING MACHINERY & EQUIPMENT
Under the Retailers’ Occupation Tax Act, the manufacturing machinery and equipment
exemption is available for machinery and equipment used primarily (over 50% of the time) in
the manufacturing or assembling of tangible personal property for wholesale or retail sale or
lease. Machinery and equipment used to manufacture compressed natural gas can qualify for
the exemption. See 86 Ill. Adm. Code 130.330. (This is a GIL.)

September 19, 2017

Re: Private Letter Ruling Request/COMPANY.
Dear Xxxxx:
This letter is in response to your letter dated June 28, 2017 in which you requested
information. The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are
issued by the Department in response to specific taxpayer inquiries concerning the application of a
tax statute or rule to a particular fact situation. A PLR is binding on the Department, but only as to the
taxpayer who is the subject of the request for ruling and only to the extent the facts recited in the PLR
are correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in
the Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information
Letter (“GIL”) is to direct taxpayers to Department regulations or other sources of information
regarding the topic about which they have inquired. A GIL is not a statement of Department policy
and is not binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website
at www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to
your inquiry.

The nature of your inquiry and the information you have provided require that we respond with a
GIL. In your letter you have stated and made inquiry as follows:

This request is filed on behalf of our client, COMPANY (the Company”). Ruling is
requested to determine the Retailers’ Occupation Tax and Use Tax obligations of
Company related to the purchase of exempt manufacturing machinery and equipment.
Specifically, rulings are requested regarding whether: (i) the Company’s purchase of
machinery and equipment is deemed qualified manufacturing machinery and equipment
under 86 Ill. Admin Code §130.330(c) and (ii) that its primary use could satisfy the
requirement under 86 Ill. Admin Code §130.330(d) to be used greater than 50% in the
manufacturing process given the facts presented.
A. General Information

1. This Private Letter Ruling (‘PLR’) is not requested for hypothetical or alternative
   proposed transactions, but rather to determine the taxability for ROT/UT

ST 17-0031-GIL
Page 2

purposes
of
an
actual
Company, as described below.

transaction

engaged

in

by

the

2. The Company is not currently under audit by or engaged in litigation with the
   Department with regard to this or any other tax matter.
3. The Department has not previously ruled regarding this matter for the Company.
   The Company has not submitted the same or similar issue to the Department
   and withdrew it before the Department issued its ruling.
4. We are aware of no authority contrary to the authorities referred to and cited
   below.
   B. Description of Company Business Operations
   The Company is a biotechnology company focusing specifically on gene therapy; the
   company’s gene therapy candidate drug is in the process of completing its Phase 1
   clinical trial and about to initiate multiple additional clinical trials in 2017. The
   company’s gene therapy candidate drug has been granted DRUG DESIGNATION and
   DRUG DESIGNATION 1 for the treatment of CONDITION. The drug, once in
   production, will be a one-time intravenous treatment for CONDITION. The client’s
   activity conducted within Illinois related to the aforementioned clinical phase of the
   drug’s development would be considered research and development as currently
   constituted.
   The Company is currently conducting a Phase 1 clinical trial and will be conducting
   further clinical trials. The Company is also developing the manufacturing process for
   the production of the drug. A manufacturing facility has been constructed in CITY,
   Illinois
   C. Statement of Relevant Facts
   In order to develop and manufacture the drug the Company requires prefabricated and
   autonomous cleanrooms (the “CLEAN ROOMS”). The Company recently purchased
   the aforementioned CLEAN ROOMS from a non-Illinois company which did not charge
   sales tax on the purchase.
   These mobile CLEAN ROOMS are necessary to manufacture the Company’s drug and
   provide all necessary environments. By establishing a controlled setting via the CLEAN
   ROOMS mechanical and sensor systems, the Company can create the environment
   necessary for drug production. The CLEAN ROOMS establish and maintain the
   appropriate temperature, humidity, sterility and asepticity to produce the drug.
   The CLEAN ROOMS are prefabricated, mobile, reusable and have separate
   mechanical and sensor systems; the CLEAN ROOMS only require power to become
   operational. The CLEAN ROOMS have been placed in service within the Company’s
   CITY, IL manufacturing facility.

ST 17-0031-GIL
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The drug development effort involves the creation of a costly manufacturing process,
which includes the purchase of the CLEAN ROOMS. Once the research and
development phase is complete, the CLEAN ROOMS will not be discarded, but rather
will be used in the final process to produce this new drug for human clinical trial
purposes and, ultimately if the drug receives regulatory approval, for commercial
manufacturing purposes. The CLEAN ROOMS will initially be used in a non-exempt
manner (i.e., the research and development of a new production technique). However,
subsequent to this initial non-exempt use, the CLEAN ROOMS will be used 100% of the
time in the manufacturing of a product subject to the laws applicable to the Retailer’s
Occupation and Use Tax – the Company’s new drug. It is anticipated that these CLEAN
ROOMS will be used in the actual manufacturing process for more than 50% of the
assets’ useful and/or economic life.
Without the CLEAN ROOM the Company would not be able to establish the
environment necessary to manufacture the drug and obtain United States Food and
Drug Administration approval for the drug. The CLEAN ROOMS provide a controlled
environment which enables the Company to produce the drug; without the CLEAN
ROOMS the production process would be compromised and the drug potentially
contaminated.
The anticipated drug production start date is July XXXX; the useful life of the CLEAN
ROOMS is estimated to be XX years. Assuming the aforementioned production and
estimated useful life timelines are accurate the CLEAN ROOM will have been used
greater than 50% of the time in the drug manufacturing process.
D. Statement of Law
The Illinois Retailer’s Occupation Tax [35 ILCS 120/1 et seq.] and Use Tax [35 ILCS
105 et seq.] are assessed on the sale or use by Illinois residents of tangible personal
property within the State of Illinois. Each Act provides, however, that the sales or use of
certain tangible personal property may be exempt; one such exemption applies to
manufacturing and assembling machinery and equipment used primarily in the process
of manufacturing or assembling tangible personal property for wholesale or retail sale or
lease. 35 ILCS 105/3-(18)5 [sic].
Under the exemption, manufacturing and assembling machinery and equipment used
primarily in the process of manufacturing are exempt from the imposition of Illinois
Sales/Use Taxes. 35 ILCS 105/3-5; 35 ILCS 120/2-45. Machinery and equipment must
be used primarily in the manufacturing or assembling process; this is defined as use
over 50% in an exempt manner in order to qualify as exempt. 86 Ill. Admin. Code
§130.330(d). The following activities are generally considered to be an exempt use of
machinery and equipment:

1. The use of machinery or equipment to effect a direct and immediate physical change
   upon tangible personal property to be sold;

ST 17-0031-GIL
Page 4

2. The use of machinery or equipment to guide or measure a direct and immediate
   physical change upon tangible personal property, provided such function is an
   integral and essential part of tuning, verifying, or aligning the component parts of
   such property;
3. The use of machinery or equipment to inspect, test or measure the tangible personal
   property to be sold where such function is an integral part of the production flow;
4. The use of machinery and equipment to convey, handle, or transport the tangible
   personal property within production stations on the production line: and
5. The use of machinery or equipment to place the tangible personal property to be
   sold into the container, package, or wrapping in which such property is normally sold
   where such machinery or equipment is used as part of an integrated manufacturing
   process.
   [86 Ill. Admin. Code §130.330(d)(3).]

Certain activities are generally considered to not be manufacturing in nature:

1. The use of machinery or equipment to store, convey, handle or transport materials
   or parts or sub-assemblies prior to their entrance into the production cycle;
2. The use of machinery or equipment to store, convey, handle or transport finished
   articles of tangible personal property to be sold or leased after completion of the
   production cycle;
3. The use of machinery or equipment in the disposal of waste, scrap or residue; and
4. The use of machinery or equipment for general ventilation, heating, cooling climate
   control or general elimination, not required by the manufacturing process.
   [86 Ill. Admin. Code §130.330(d)(4).]

E. Company Position
It is the taxpayer’s position that each Pod utilized in the production processing facility
will be treated as exempt from ROT/UT pursuant to 86 Ill. Admin. Code §130.330
because the CLEAN ROOMS are a required component of the overall manufacturing
process and are used to create, maintain, and monitor the appropriate condition of the
manufacturing process. The CLEAN ROOMS provide the necessary, temperature,
sanitation and contamination prevention to produce the drug for research and
development, the conduct of human clinical trials and ultimately for the commercial
manufacture of the approved drug.

ST 17-0031-GIL
Page 5

It would also appear that pursuant to 86 Ill. Admin. Code §130.330, the purchase of the
machinery and equipment initially used in a non-exempt manner, as described above,
will qualify for the exemption, provided that the purchaser can establish that the
machinery and equipment was used in an exempt manner for more than 50% of the
assets’ useful and/or economic life.
We believe that the property in question will qualify for the machinery and equipment
exemption provided that the asset is used (or will be used) in an exempt manner for
more than 50% of the assets’ economic or useful life. The initial non-exempt use of
machinery and equipment will not in itself preclude a purchaser from taking the
exemption for otherwise qualified manufacturing machinery and equipment.

1. The initial non-exempt use of manufacturing machinery and equipment, as provided
   under 86 Ill. Admin. Code §130.330(d)(4)(B) will not in itself void the exemption
   provided for otherwise qualified manufacturing machinery and equipment.
2. The exemption provided for manufacturing machinery and equipment under Chapter
   120.44(2) of the Illinois Revised Statutes will apply provided that the equipment is
   used for more than 50% of the time in an exempt manner. Accordingly, provided
   that the machinery and equipment is otherwise qualified as exempt manufacturing
   machinery and equipment under 86 Ill. Admin Code §130.330, the exemption will
   apply when the asset is used in an exempt manner for more than 50% of the assets’
   economic or useful life.
   Applicable Rulings: Private Letter Ruling ST 90-0457-PLR; General Information Letter
   ST 00-0255-GIL.
   F. Ruling Requested
   Company respectfully requests the Department issue a Private Letter Ruling that
   specifies whether (i) the Company’s purchase of machinery and equipment is deemed
   qualified manufacturing machinery and equipment under 86 Ill. Admin. Code
   §130.330(c) and (ii) that its primary use could satisfy the requirement under 86 Ill.
   Admin. Code §130.330(d) to be used greater than 50% in the manufacturing process
   given the facts presented.
   G.

Signature

Under penalties of perjury, I declare that I have examined this request, including the
accompanying documents, and to best of my knowledge and belief the facts presented
in support of the requested ruling are true correct and complete
Please send all questions or requests for additional information to me via email, by
phone, or by mail.
DEPARTMENT’S RESPONSE:

ST 17-0031-GIL
Page 6

The Department’s regulation “Public Information, Rulemaking and Organization” provides that
“[w]hether to issue a private letter ruling in response to a letter ruling request is within the discretion of the
Department. The Department will respond to all requests for private letter rulings either by issuance of a
ruling or by a letter explaining that the request for ruling will not be honored.” 2 Ill. Adm. Code
1200.110(a)(4). The Department recently met and determined that it would decline to issue a Private
Letter Ruling in response to your request. We hope, however, the following General Information Letter will
be helpful in addressing your questions.

The Retailers' Occupation Tax Act imposes a tax upon persons engaged in this State in the
business of selling tangible personal property at retail to purchasers for use or consumption. See 86
Ill. Adm. Code 130.101. Use Tax is imposed on the privilege of using, in this State, any kind of
tangible personal property that is purchased anywhere at retail from a retailer. See 86 Ill. Adm. Code
150.101. These taxes comprise what is commonly known as “sales tax” in Illinois.
Retailers' Occupation Tax, however, does not apply to sales of machinery and equipment used
primarily in the manufacturing or assembling of tangible personal property for wholesale or retail sale
or lease. See 86 Ill. Adm. Code 130.330. The manufacturing process is the production of articles of
tangible personal property or assembling different articles of tangible personal property by procedures
commonly regarded as manufacturing, processing, fabricating, or refining which changes some
existing material or materials into a material with a different form, use or name. These changes must
result from the process in question and be substantial and significant. See Section 130.330(b)(2).
Machinery means major mechanical machines or major components of such machines
contributing to a manufacturing or assembling process, including machinery and equipment used in
the general maintenance or repair of such exempt machinery and equipment or for in-house
manufacture of exempt machinery and equipment. See Section 130.330(c)(2).
The law requires that machinery and equipment be used primarily in manufacturing or
assembling. Therefore, machinery that is used primarily in an exempt process and partially in a
nonexempt manner would qualify for exemption. However, the purchaser must be able to establish
through adequate records that the machinery or equipment is used over 50 percent of its useful life in
an exempt manner in order to claim the deduction. 86 Ill. Adm. Code 130.330(d)(1)
The use of machinery or equipment to guide or measure a direct and immediate physical
change upon the tangible personal property to be sold, provided this function is an integral and
essential part of tuning, verifying, or aligning the component parts of such property; and the use of
machinery or equipment to inspect, test or measure the tangible personal property to be sold where
the function is an integral part of the production flow; will generally be considered to constitute an
exempt use Section 130.330(d)(3)(B)-(C). The use of machinery or equipment in research and
development of new products or production techniques, machinery or equipment will generally not be
considered manufacturing. Section 130.330(d)(4)(B). The product produced as a result of the
manufacturing or assembling process also must be for sale or lease. Section 130.330(c)(1).
For purposes of determining whether machinery or equipment is used over 50 percent of its
useful life in an exempt manner, the Department looks at the period during which the asset is
depreciated, not the period the equipment may ultimately be used in the manufacturing process.

ST 17-0031-GIL
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Based on your letter, it is the Department’s opinion the CLEAN ROOMS are machinery or
equipment that may be eligible for the manufacturing machinery and equipment exemption.
However, without knowing the period of time over which the CLEAN ROOMS will be depreciated and
the actual date the machinery begins manufacturing drugs for sale or lease, the Department cannot
render an opinion whether the CLEAN ROOMS qualify for the exemption.
Under the circumstances described in your letter, the best course of action was for the
Company to self-assess Use Tax at the time the CLEAN ROOMS were purchased to avoid penalties
and interest in the event the CLEAN ROOMS do not meet all the requirements for claiming the
exemption. The Company could file a claim for credit if it determines the CLEAN ROOMS will be
used over 50 percent of their useful life in an exempt manner, assuming that at the time of the
determination the claim would be within the statute of limitations.
If you have further questions related to the Illinois sales tax laws, please visit our website at
www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.
Very truly yours,

Richard S. Wolters
Associate Counsel
RSW:bkl