Iowa’s New Sales and Use Tax Exemption for Manufacturing Machinery and Equipment
June 21, 2016
By: K. Dwayne Vande Krol
On March 21, 2016, Governor Branstad signed House File 2433 into law. While the bill received much attention for its income tax implications, including allowing Internal Revenue Code Section 179 expenses to be claimed on 2015 Iowa tax returns, HF 2433 also contained important Iowa sales and use tax changes.
As described below, this new law specifically exempts replacement parts and supplies used by manufacturers that the Iowa Department of Revenue had long held were subject to Iowa sales and use tax.
With the enactment of HF 2433, the sales and use tax exemption provided by Iowa Code Sec. 423.3(47) for items used by manufacturers was amended to specifically exempt qualifying “replacement parts” and “supplies.” While the previous statute listed “replacement parts” as items eligible for exemption, no statutory definition of the term was provided. The Department’s rules contained a definition using a rebuttable presumption which indicated that, in order to qualify for exemption, a part had to have an expected useful life of 12 months or more. However, this definition was widely viewed by manufacturers as being overly narrow and contrary to statute, leading to many controversies with the Department. In contrast, the new statute specifically defines qualifying replacement parts as follows:
“Replacement part” means tangible personal property other than computers, machinery, equipment, or supplies, regardless of the cost or useful life of the tangible personal property, that meets all of the following conditions:
- The tangible personal property replaces a component of a computer, machinery, or equipment, which component is capable of being separated from the computer, machinery, or equipment.
- The tangible personal property performs the same or similar function as the component it replaced.
- The tangible personal property restores the computer, machinery, or equipment to an operational condition, or upgrades or improves the efficiency of the computer, machinery, or equipment.
Under the new statute, it is now clear that replacement parts used by manufacturers for qualified purposes will be eligible for exemption, regardless of their expected useful life. This should provide manufacturers with more certainty as to the Iowa sales and use tax treatment of replacement parts.
The other major change enacted under HF 2433 is the creation of an exemption for certain consumable supplies. The previous statute did not specifically list “supplies” as being items eligible for exemption. When coupled with the Department’s narrow definition of “replacement parts” described above, Iowa manufacturers were often forced to pay sales tax on large amounts of short-lived items used in their manufacturing processes. That is now changed under the new law, which specifically includes “supplies” in the list of items eligible for exemption, and defines the term as follows:
“Supplies” means tangible personal property, other than computers, machinery, equipment, or replacement parts, that meets one of the following conditions:
- The tangible personal property is to be connected to a computer, machinery, or equipment and requires regular replacement because the property is consumed or deteriorates during use, including but not limited to saw blades, drill bits, filters, and other similar items with a short useful life.
- The tangible personal property is used in conjunction with a computer, machinery, or equipment and is specially designed for use in manufacturing specific products and may be used interchangeably and intermittently on a particular computer, machine, or piece of equipment, including but not limited to jigs, dies, tools, and other similar items.
- The tangible personal property comes into physical contact with other tangible personal property used in processing and is used to assist with or maintain conditions necessary for processing, including but not limited to cutting fluids, oils, coolants, lubricants, and other similar items with a short useful life.
- The tangible personal property is directly and primarily used in an activity described in [a qualifying activity], including but not limited to prototype materials and testing materials.
The amendments to the statutes described above take effect July 1, 2016, and should result in significant sales and use tax savings for Iowa’s manufacturers.
HF 2433 also contained provisions requiring the Department to rescind regulations that the Department had proposed in September of 2015 and that were to become effective as of July 1, 2016. These regulations proposed significant changes to the Department’s interpretation of the previous Iowa exemption statutes, including defining the terms “equipment” and “replacement parts” as follows:
Equipment. In general usage, “equipment” refers to devices or tools used to produce a final product or achieve a given result. Equipment includes supplies that do not qualify as “replacement parts,” such as drill bits, grinding wheels, punches, taps, reamers, saw blades, lubricants, coolants, sanding discs, sanding belts, and air filters.
Replacement parts.“Replacement part” means tangible personal property other than computers, machinery, or equipment, regardless of the cost or useful life of such tangible personal property. A replacement part can be separated from the computer, machinery, or equipment. A “replacement part” is a part or component of a computer, machinery, or equipment that came with the original item purchased or has been added over time to improve or restore the computer, machinery, or equipment.
While the language of the Department’s proposed regulations is different than the amendments provided by HF 2433, the impact would likely have been similar. In short, under the proposed regulations, the Department would likely have determined that supplies and other short-lived (including one-time use) items were eligible for exemption, which is contrary to the Department’s previous interpretations of the then-existing statutes. However, representatives of the Department stated in various public meetings that the Department’s proposed regulations were consistent with the scope of the exemption as provided by the previous version of Iowa Code Sec. 423.3(47).
The Department’s proposed regulations also contained provisions clarifying that certain “structures” used by manufacturers in processing, including items such as large tanks and cooling towers, would not have been treated as real property for Iowa sales and use tax purposes and thus would have been eligible for exemption as manufacturing machinery and equipment. The Department and Governor Branstad indicated that these changes were needed to address the sales and use tax treatment of “advanced manufacturing.” Whether these structures qualify for exemption was not addressed by the amendments to Iowa Code Sec. 423.3(47). Accordingly, HF 2433’s rescission of the Department’s proposed regulations leaves no specific guidance regarding the Iowa sales and use tax treatment of these items.
Please contact us with questions or if we can be of assistance concerning the issues and opportunities related to the Iowa sales and use tax treatment of manufacturing machinery and equipment.