Raw materials are purchased free from sales tax, because they are incorporated into the manufactured product for sale. EVERYONE. KNOWS. THAT. Tax is rarely overpaid on obvious and properly coded raw material purchases.
However, materials can occasionally become a part of the manufactured product for sale when they are not an obvious incorporation into the finished product and even if they are not coded to a raw material account. These oddball, hard to classify items most often get coded to supply or consumable types of accounts. These are the forgotten raw materials. The problem with forgotten raw materials is that sales or use tax is often erroneously overpaid on their purchase. If a material is incorporated into the final product in some way, shape, or form the purchase will most likely qualify for exemption from sales and use tax in your state, regardless of its general ledger account classification.
During overpayment review engagements at V Jordan Inc. we identify overpaid sales and use tax on these quirky purchases with almost every client engagement. The mistakes add up to costly oversights that negatively affect competitiveness and profitability. And, unfortunately, almost no industry escapes these costly errors.
The food processing industry has its share of forgotten raw materials that are coded to expense accounts. Meat processors sometimes inject cryogenic gases such as nitrogen into their products to keep the product at optimal temperatures during the manufacturing process. A meat processor may choose to blast the product with cryogenic gases for quick freezing at various phases of the process. That the gases remain in the finished product and are resold, thus qualifying for exemption, is often overlooked.
Bagged food manufacturers, whether producing a fresh bag of salad mixture or a bag of chips, are also often aided by nitrogen or a gaseous blend for product freshness during a point of processing or packaging. In most circumstances the gas becomes a part of the product sold but are rarely coded to an exempt raw material account.
Water is also often an ingredient in a food product. However, water is almost always coded to a utility account. If the food item is being produced in a state where water is taxable – either at the full rate or at a reduced rate – then chances are great that tax is overpaid on the portion of the water that is incorporated into the product. The portion of the water that becomes an ingredient part of the product manufactured should be purchased exempt from tax like all the other raw ingredients.
In some food processing plants, certain packaging items, such as moisture absorbing pads or food grade ink stamped directly on the product or stamped directly on the product packaging are often overlooked exempt purchases. Manufacturers usually consider them as taxable supplies and simply “the costs of doing business.”
During the process of performing overpayment reviews with manufacturers we see many other hidden raw materials on which tax is overpaid. Some include chemicals used to treat water that remain in the final product, solvents added to paint or ink that become part of the manufactured product, and even instruction manuals that accompany the product.
The takeaway here is this: state sales and use tax laws governing raw material exemptions vary from state to state and should be examined carefully when deciding the tax status of each purchase type. Some states allow only major ingredients as exempt while other states are more generous with their exemption by allowing materials that come in direct contact with the manufactured product even if they do not remain with the final product when sold.
One last takeaway – there is more than one way to skin a cat. If you can’t find an exemption for a purchase as a raw material then move along to other exemptions allowed for manufacturers in your state. There is a chance that you may find another law that will qualify the purchase for exemption – perhaps under the “necessary and essential for production” exemption or the “used and consumed in manufacturing” exemption. Even though it may feel like you are trying to squeeze a square peg into a round hole, sometimes…just sometimes…you will find an exemption for that overlooked raw material.