Colorado's Machinery Exemption
| Publication year | 1996 |
| Pages | 65 |
1996, January, Pg. 65. Colorado's Machinery Exemption
Colorado law provides that the sale or use of machinery, machine tools or parts costing in excess of $500 and used "directly and exclusively" in manufacturing tangible personal property for sale or profit is exempt from state sales and use tax.(fn1) Some examples of machinery exempt from sales and use tax include lathes or saws, welding machines, photoprocessing equipment, printers and machine shops. Notwithstanding an apparent broad sweep, businesses operating in Colorado should look closely at this machinery exemption, because along with promising significant tax avoidance, the exemption provision creates several traps for the unwary.
Colorado's exemption provision states that
purchases of machinery or machine tools, or parts thereof, in excess of five hundred dollars to be used in Colorado directly and exclusively in manufacturing tangible personal property, for sale of profit, are exempt from taxation under this part 1. . . . [M]anufacturing means the operation of producing a new product, article, substance, or commodity different from and having a distinctive name, character, or use from raw or prepared materials.(fn2)
Colorado's version of the machinery exemption contains two primary problems equally troubling to taxpayers and tax administrators. At first blush, the definition of manufacturing seems clear. However, problems arise in its application. For example, the statutory exemption makes no distinction between manufacturing, processing and fabrication. Secondly, the statute fails to describe what items constitute "machinery or machine tools, or parts thereof." For instance, it is unclear whether packaging or test equipment constitutes machinery.
Some possible interpretations can be construed from the statute; others can be found in the regulations or in case law. Unfortunately, some applications of this exemption cannot be satisfactorily answered at all.
The first, and perhaps the most confusing, hurdle to jump to get the Colorado machinery exemption is deciding whether or not an entity is a manufacturer. As mentioned above, the statute provides that
The Colorado Revenue Department's interpreting regulation provides thatmanufacturing means the operation of producing a new product, article, substance, or commodity different from and having a distinctive name, character, or use from raw or prepared materials.(fn3)
The difference between the two definitions lies in the regulation's addition of the phrase "in an industrial use."[m]anufacturing means the operation of producing, in an industrial use, an item of tangible personal property different from and having a distinct name, character, or use from raw or prepared materials.(fn4)
The language of both the statute and regulation have a long history.(fn5) The Colorado Supreme Court addressed the machinery definition in the 1948 case of Zook v. Perkins.(fn6) Zook was a tire company in the business of retreading and recapping tires. It asserted that this process qualified as manufacturing. As a consequence, the company argued that it should not have to pay sales tax on the materials (camel back, cushion gum, rubber cement and cord) used in retreading the tires because such purchases were exempt as resale sales. Zook asserted that the materials became part of the manufactured product that was subsequently sold at retail.
However, the Supreme Court in Zook held that a manufacturer must produce a new article, stating that "in order that one may be a maker, it is essential that he be the efficient cause of the coming into existence of something that did not before exist."(fn7) Furthermore, "manufacture implies change, but every change is not manufacture. There must be transformation: a new and different article
Despite the seeming clarity of the statute and the Zook opinion, controversies continue for those trying to ascertain manufacturing status. Interpretational problems and arguments with auditors recur time and time again in business activities as varied as restaurants, bakeries, dairies, mining, meat processing, printing and software programming. All may struggle with attempting to ascertain whether they fall within the definition of a manufacturer.
Most people would not think of an owner of a fast-food restaurant as a manufacturer; neither does the Department of Revenue. However, when that restaurant makes its chocolate shakes by mixing together powder, syrup and milk, some have argued it is making "a new and different article. . . having a distinctive name, character, or use." Generally, the courts have not affirmed this argument, asserting instead that food preparation in a restaurant setting, even drink dispensers or malt machines, is not manufacturing.(fn10)
Some restaurant owners, however, have been quick to point out that Colorado allows the machinery exemption for the drums on cement trucks, raising the question about what distinctions should be made between mixing sand, water and cement to make concrete, and mixing milk, syrup and powder to make shakes.(fn11) The Department of Revenue's position is based on the small...
To continue reading
Request your trial