Tax Guide for
Manufacturing and Research & Development Equipment Exemption

Tax Guide for Manufacturing and Research & Development Equipment Exemption

Beginning on July 1, 2014, manufacturers and certain research and developers, and beginning on January 1, 2018, certain electric power generators and distributors, may qualify for a partial exemption from sales and use tax on the purchase or lease of qualified machinery and equipment primarily used in manufacturing, research and development, and electric power generation or production, storage or distribution. To be eligible, they must meet all of these conditions:

  • Be primarily engaged in certain types of business, also known as being a "qualified person."
  • Purchase "qualified tangible personal property."
  • Use that qualified tangible personal property in a qualified manner.

The partial exemption is provided by Revenue and Taxation Code (RTC) section 6377.1.

Latest InformationAssembly Bill 398 (Chapter 135, Stats. 2017) which was signed into law July 25, 2017, amended Revenue and Taxation Code (RTC) section 6377.1 including:

  • Expanded the partial exemption to qualified tangible personal property purchased for use by a qualified person to be used primarily in the generation or production, storage or distribution of electric power. (see Qualified Tangible Personal Property under Qualifications tab).
  • Beginning January 1, 2018, expanded the definition of "qualified tangible personal property" to include special purpose buildings and foundations used as an integral part of the generation or production or storage and distribution of electric power. (see Qualified Uses under the Qualifications tab)
  • Beginning January 1, 2018, expanded the definition of "qualified person" to include businesses primarily engaged in operating electric power generation facilities as described in NAICS codes 22111 to 221118, inclusive, or primarily engaged in electric power distribution as described in NAICS code 221122. (see Qualified Person under the Qualifications tab).
  • Beginning January 1, 2018, removed the exclusion from the definition of a "qualified person" for certain persons engaged in agricultural business activities that were previously excluded as an apportioning trade or business under RTC section 25128. (see Qualified Person under the Qualifications tab).
  • Amended the definition of "useful life" to state that tangible personal property that is deducted on the California state franchise or income tax return under RTC sections 17201 and 17255 or section 24356, is deemed to have a useful life of one or more years. (see Qualified Tangible Personal Property under Qualifications tab).
  • Extended the sunset date of RTC section 6377.1 from July 1, 2022, to July 1, 2030.

Please also see the Industry Topics tab, which includes the following topics:

  • Useful Life
  • Special Purpose Building
  • Solar Power Equipment
  • Construction Contractors
  • Electric Power Generators or Distributors
  • Repair Parts
  • Filing a Claim for Refund

Get it in Writing

Our tax and fee laws can be complex and difficult to understand. If you have specific questions about this exemption and who or what qualifies, we recommend that you get answers in writing from us. This will enable us to give you the best advice and will protect you from tax, penalties and interest in case we give you erroneous information.

Requests for written advice can be emailed to the CDTFA or mailed directly to the CDTFA office nearest you.

For more details, please see publication 8, Get it in Writing!

If You Need Help

If at any time you need assistance with topics included in this guide – or with topics not included – feel free to contact us by telephone or email. Contact information and hours of operation are available in the Resources section.

If you have suggestions for improving this guide, please contact us via email.

The list of criteria to qualify for this partial exemption can be quite complex. We suggest you take the time to determine if your business's purchases or leases qualify.

Qualified Person

A "qualified person" means a person who is primarily engaged in those lines of business described in the North American Industry Classification System (NAICS) Codes 3111 to 3399, inclusive, 541711, or 541712, or beginning January 1, 2018, 22111 to 221118, inclusive, and 221122, published by the United States Office of Management and Budget (OMB), 2012 edition. (See Understanding your NAICS code on Industry Topics tab)

These industries generally include those primarily engaged in the business of all forms of manufacturing, research and development in biotechnology, research and development in the physical, engineering, and life sciences and the generation and production, storage or distribution of electric power. (See Electric Power Generators or Distributors on the Industry Topics tab)

A qualified person may be "primarily engaged" either as a legal entity or as an establishment within a legal entity.

To be primarily engaged as a legal entity or as an establishment you must, in the prior financial year, either derive 50 percent or more of gross revenue (including inter-company charges) from, or expend 50 percent or more of operating expenses in a qualifying line of business. For purposes of research and development, gross revenues could be derived from, but are not limited to, selling research and development services or licensing intellectual property resulting from research and development. (See Research & Development on Industry Topics tab)

Alternatively, an establishment is primarily engaged if, in the prior financial year, it allocates, assigns or derives 50 percent or more of any one of the following to a qualifying line of business: (1) employee salaries and wages, (2) value of production, or (3) number of employees based on a full-time equivalency.

In cases where the purchaser was not primarily engaged in a qualifying line of business for the preceding financial year, the one-year period following the date of purchase of the property may be used.

Except as discussed below, a "qualified person" generally does not include:

  • An apportioning trade or business, other than an agricultural trade or business described in subdivision (c)(1) of RTC section 25128, that is required to apportion its business income pursuant to subdivision (b) of RTC section 25128.
  • A trade or business conducted wholly within this state, other than an agricultural trade or business described in subdivision (c)(1) of RTC section 25128, that would be required to apportion its business income pursuant to subdivision (b) of RTC section 25128 if it were subject to apportionment pursuant to RTC section 25101.

In general, these apportioning trades or businesses derive more than 50 percent of their gross business receipts from an extractive business activity, a savings and loan activity, or a banking or financial business activity as defined in subdivision (d) of RTC section 25128.

Please note: Prior to January 1, 2018, an agricultural trade or business described in subdivision (c)(1) of RTC section 25128 was also excluded from the definition of “qualified person” if it was required to apportion its business income pursuant to subdivision (b) of RTC section 25128, or would have been required to apportion its business income pursuant to subdivision (b) of section 25128 if it were subject to apportionment pursuant to section 25101.

Qualified Tangible Personal Property

"Qualified tangible personal property" includes, but is not limited to:

  • Machinery and equipment, including component parts and contrivances such as belts, shafts, moving parts, and operating structures.
  • Equipment or devices used or required to operate, control, regulate, or maintain the machinery, including, but not limited to, computers, data-processing equipment, and computer software, together with all repair and replacement parts with a useful life of one or more years, whether purchased separately or in conjunction with a complete machine and regardless of whether the machine or component parts are assembled by the qualified person or another party. (See Useful Life on Industry Topics tab)
  • Operational equipment (i.e. computers, tablets, printers, servers) used to run the manufacturing equipment are eligible for the exemption under this program provided they are used for qualifying activities.
  • Tangible personal property used in pollution control that meets standards established by this state or any local or regional governmental agency within this state. (See Pollution Control on Industry Topics tab)
  • Special purpose buildings and foundations used as an integral part of the manufacturing, processing, refining, fabricating, or recycling process, or that constitute a research or storage facility used during those processes. Buildings used solely for warehousing purposes after completion of those processes are not included. (See Special Purpose Buildings on Industry Topics tab)
  • Beginning January 1, 2018, the definition of qualified tangible personal property is expanded to include special purpose buildings and foundations used as an integral part of the generation or production, storage or distribution of electric power.

"Qualified tangible personal property" does not include:

  • Consumables with a useful life of less than one year. Tangible personal property that is deducted under RTC sections 17201 and 17255 or section 24356 on a state franchise or income tax return shall be deemed to have a useful life of one or more years.
  • Furniture, inventory, and equipment used in the extraction process, or equipment used to store finished products that have completed the manufacturing, processing, refining, fabricating, or recycling process.
  • Tangible personal property used primarily in administration, general management, or marketing. Even though your NAICS code is eligible for the exemption, purchases made for other activities of your operations (i.e. distribution, sales) are not eligible for the exemption.

Leases of qualified personal property may also qualify for the partial exemption. If the lease qualifies, any payments that are due and paid in the eligible period, July 1, 2014, through June 30, 2030, qualify for the partial exemption regardless of the lease inception date. (See Leases on Industry Topic tab)

Qualified Uses

The tangible personal property must be used primarily (50 percent or more of the time) in one of the following manners:

  • Any stage of the manufacturing, processing, refining, fabricating, or recycling process
  • Research and development
  • To maintain, repair, measure, or test any qualified tangible personal property described by the above, or
  • The generation or production, storage or distribution of electric power
  • For use by a contractor purchasing that property for use in the performance of a construction contract for a qualified person, provided that the qualified person will use the resulting improvement to real property as an integral part of the manufacturing, processing, refining, fabricating, or recycling process, the generation or production, storage or distribution, of electric power, or as a research or storage facility for use in connection with those processes. (See Construction Contractor on Industry Topics tab)

Under the amended law "generation or production" means the activity of making, producing, creating, or converting electric power from sources other than a conventional power source as defined in Section 2805 of the Public Utilities Code. "Storage and distribution" means storing or distributing through the electric grid, but not transmission of electric power to consumers regardless of source.

For purposes of this exemption, the manufacturing process begins from the point raw materials are received and introduced into the manufacturing, processing, refining, fabricating, or recycling activity of the qualified person and ending at the point at which the activity has altered the product to its completed form, including packaging, if required.

The partial exemption rate applies to the sale, use, purchase, and lease of qualified tangible personal property on or after July 1, 2014, and before July 1, 2030. Generally, a sale occurs at the time title or possession of the property transfers to the buyer regardless of when a purchase order is issued or payment is made (unless the terms of the sale expressly provide otherwise). Use includes the exercise of any right or power over tangible personal property incident to the ownership of that property but it does not include the sale of that property in the regular course of business. (Rev. & Tax. Code, § 6009.) In addition, “storage” and “use” does not include the keeping, retaining, or exercising of any right or power over tangible personal property for the purpose of transporting the property outside California for use thereafter solely outside the state. (Rev. & Tax. Code, § 6009.1.)

Partial Exemption Rate

The partial exemption rate is currently 3.9375 percent. Accordingly, when the partial exemption applies, the sales or use of the qualifying tangible personal property is taxed at a rate of 3.3125 percent (7.25 percent current statewide tax rate – 3.9375 percent partial exemption rate) plus any applicable district taxes. You can lookup tax rates by city, county, or address on the California City & County Sales & Use Tax Rates webpage.

Required Documentation

In order to document the partially exempt transaction, you need to obtain a timely exemption certificate from your customer.

There are two sample certificates available on our website for your use in documenting the partial exemption.

Any document may be regarded as a partial exemption certificate if it contains all of the following:

  • The signature of the purchaser, the purchaser's agent, or the purchaser's employee.
  • The name, address, and telephone number of the purchaser.
  • The purchaser's seller's permit number, or if the purchaser is not required to hold a seller's permit, a notation to that effect and the reason.
  • A statement that the property purchased is:
    • to be used primarily for a qualifying activity, or
    • for use by a contractor performing a construction contract for a qualified person.
  • A statement that the purchaser is:
    • a qualified person primarily engaged in a qualifying line of business, or
    • a contractor performing a construction contract for a qualified person.
  • A statement that the property purchased is qualified tangible personal property.
  • A description of the property purchased.
  • The date of execution of the document.

Certificates are considered timely if they are taken any time before the seller bills the purchaser for the property, any time within the seller's normal billing or payment cycle, or at any time at or prior to delivery of the property to the purchaser.

When you take a timely partial exemption certificate in the proper form and in good faith, the partial exemption certificate relieves you from the liability for the sales tax or the duty of collecting the use tax subject to the exemption.

Invoices with claimed exempt sales should specify the name(s) of the purchasers in order to relate them to exemption certificates. It is highly recommended that you examine your certificates on a regular basis and keep the purchasers information up to date.

Exemption certificates received from qualified persons must be maintained for a period of not less than four years from the date on which you claim the partial exemption.

There is no need to apply to the CDTFA for the exemption. When you make qualifying purchases, you must provide the seller with a timely partial exemption certificate.

Partial Exemption Certificate

There are two sample certificates available on our website for the exemption.

You may provide the certificate for each purchase, or you may issue blanket certificates.

If you issue a blanket certificate, you must advise the retailer on the purchase order, sales agreement, etc. regarding any purchases that are not subject to the partial exemption.

Any document may be regarded as a partial exemption certificate if it contains all of the following:

  • The signature of the purchaser, the purchaser's agent, or the purchaser's employee.
  • The name, address, and telephone number of the purchaser.
  • The purchaser's seller's permit number, or if the purchaser is not required to hold a seller's permit, a notation to that effect and the reason.
  • A statement that the property purchased is:
    • to be used primarily for a qualifying activity, or
    • for use by a contractor performing a construction contract for a qualified person.
  • A statement that the purchaser is:
    • a qualified person primarily engaged in a qualifying line of business, or
    • a contractor performing a construction contract for a qualified person.
  • A statement that the property purchased is qualified tangible personal property.
  • A description of the property purchased.
  • The date of the execution of the document.

Exemption Limitations

The law provides that a qualified person's or combined reporting unit's purchases subject to the partial exemption cannot exceed $200 million in any calendar year.

There is no proration when you are a qualified person for only a portion of the year. For example, you begin business operations on October 1, 2015. You may still claim up to the $200 million annual cap for the year 2015.

You may not carry over any unused amount to a following year. Each year you are limited to the total maximum of $200 million in purchases subject to the partial exemption.

You are responsible for tracking the amount of purchases you make per calendar year. If your purchases exceed the $200 million annual cap, you will be held liable for the full sales tax amount on the purchases exceeding the limit.

If, at the time of purchase, you do not know whether you will meet the qualifications, but anticipate you will meet the qualifications in the one year period following the date of purchase, you may issue a partial exemption certificate. If, however, you do not fulfill the requirements within that one year period, you will be liable for the difference to equal the full payment of tax, with applicable interest as if you were a retailer making the sale at the date of purchase.

If you pay the full amount of sales tax reimbursement at the time of purchase, and later discover that you have met all of the qualifications, you may issue a partial exemption certificate to your retailer. The retailer may then file a claim for refund for the overpaid portion of sales tax on your behalf. If the transaction was subject to use tax, you may file a claim directly with the CDTFA.

"Manufacturing" Exemption vs. California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA) Exclusion (RTC section 6010.8)

The table below highlights the differences between the manufacturing exemption and CAEATFA exclusion.

  Manufacturer's Partial Exemption SB1128/SB71 CAEATFA Sales and Use Tax Exclusion
Eligible Participants All manufacturers described in NAICS codes 3111 to 3399, 541711, or 541712, and beginning January 1, 2018, all electric power generators or distributors described in NAICS codes 22111 to 221118, and 221122 Companies that design, manufacture, produce or assemble advanced transportation technologies or alternative source products, components or systems
Exemption/Exclusion Rate Partial - 3.9375 percent Full rate, including local and district taxes
Application requirements None Participants must apply with CAEATFA and be approved for a "project" for the exclusion to apply. The property purchased must be included approved "project."
Fee requirements None Applicants are subject to an application and administration fee

If you are accepted into the CAEATFA program, you may also take advantage of the manufacturer's exemption, where appropriate. Generally the CAEATFA sales and use tax exclusion will take precedence over the RTC section 6377.1 partial exemption for property that is considered a "project" under the CAEATFA program. This is to your benefit since the full sales and use tax rate is subject to the exclusion.

You may not provide an exemption certificate for both the CAEATFA exclusion and the manufacturer's exemption for the same property. If you purchase property that is not considered part of a "project" under the CAEATFA program, but still qualifies for the RTC section 6377.1 partial exemption, you may provide an exemption certificate for the partial exemption.

Please click here for more information on the CAEATFA program.

You are a manufacturer of wooden furniture in California. You plan to expand your operations to meet the growing demands of your customers. As a result, you need to purchase new manufacturing equipment that includes a table saw, a drill press, and a lathe. You want to know if your purchases will qualify for the Manufacturing, Research and Development partial exemption.

First, you need to find out whether your company is a qualified person for the purposes of the partial exemption. You have been primarily engaged in business for several years as a manufacturer of wooden furniture. You determine your company's North American Industry Classification System (NAICS) code to be 337122. Since the NAICS code for your primary line of business is described within the range of 3111 to 3399, you determine that your company does qualify for the partial exemption.

Next, you examine whether the equipment you are purchasing qualifies for the partial exemption and whether it will be used in a qualifying manner. You are purchasing machinery and equipment that has a useful life greater than one year. You plan to use the equipment at least 50 percent of the time for manufacturing purposes. Therefore, you have determined that your purchases qualify for the partial exemption.

Now that you have determined that both your business and purchases qualify for the partial exemption, you are ready to start buying equipment. You will need to download the Partial Exemption Certificate for Manufacturing, and Research and Development Equipment. Fill it out, print it, and sign it. Then give it to the retailer of the equipment at the time you make your purchase.

The retailer will charge or collect from you at a reduced tax rate thereby saving you 3.9375 percent in sales or use tax on the purchase of your equipment.

In order to be considered a qualified person for the partial exemption, you must be primarily engaged in a line of businesses described in North American Industry Classification System (NAICS) code 3111 to 3399 for manufacturers, 541711 or 541712 if you are engaged in research and development or, beginning January 1, 2018, 22111 to 221118, and 221122 for qualifying electric power generators or distributors.

NAICS codes are used to classify business establishments by a six-digit code system. The first four digits represent the industry group, and the last two digits represent the specific industry. For example, a business that manufactures cardboard boxes will have a NAICS code of 322211:

  • The first four digits (3222) represents Converted Paper Product Manufacturing
  • The last two digits (11) represents Corrugated and Solid Fiber Box Manufacturing

Your business' NAICS code is that which best describes your line of business, based on either its primary revenues or primary operating expenses. If there is no six-digit NAICS code for your specific line of business, you may still qualify for the partial exemption if your business activities are reasonably described in a qualifying four-digit industry group.

It is important to remember that RTC section 6377.1 uses the 2012 edition of the NAICS codes to define a qualified person. To keep up with changes in the economy, OMB publishes a new NAICS edition every five years.

Please note: The six-digit NAICS codes for research and development were changed in the 2017 edition. In general, the 2012 NAICS codes 541711 and 541712 were replaced by 2017 codes 541713 – 541715. Again, only the 2012 NAICS codes are relevant in determining whether a person is engaged in a qualifying line of business.

Most businesses or entities will have one NAICS code that best describes their line of business. However, if your entity is not primarily engaged in a line of business described in a qualifying NAICS code and you operate separate establishments within the entity, that constitute separate "cost centers" or "economic units," a separate establishment may qualify for the partial exemption if it is primarily engaged in a line of business described by a qualifying NAICS code. You must keep separate books and records for each establishment.

For more information including frequently asked questions on NAICS codes, please visit www.census.gov/naics.

Qualified tangible personal property must be treated as having a useful life of one or more years for state income or franchise tax purposes.

Generally, for purposes of the partial exemption, property that is capitalized and depreciated on your state income or franchise tax returns will be regarded as having a useful life of one or more years.

If property is not capitalized and depreciated for income tax purposes, it will be presumed that the property does not have a useful life of one or more years and will not qualify for the partial exemption. However, transactions involving certain property that is not capitalized and depreciated for state income or franchise tax purposes may qualify for the partial exemption in the following situations:

  • The cost of qualifying property is deducted under Revenue and Taxation Code (RTC) sections 17201 and 17255 or 24356 (similar to Section 179 of the Internal Revenue Code, but subject to lower deduction thresholds for state purposes).
  • A qualified person leases qualified machinery or equipment for one or more years, even if the lease payments are expensed for tax reporting purposes.
  • Individual materials and fixtures purchased and installed as a component part(s) of a special purpose building. The special purpose building, as a whole, will be depreciated for tax reporting purposes.

Examples of property that does not have a useful life greater than one year:

  • Property placed in service and sold or otherwise disposed of in the same year.
  • Tools and other supply items.
  • Items that are not expected to have a useful life of one year, even if those items last beyond one year.
  • Items that are replaced on a regular basis of less than one year.

Establishments that are primarily engaged in research and development in biotechnology, physical engineering, and life sciences may qualify for the partial exemption. To qualify for the partial exemption, the establishment must be classified under one of the following two North American Industry Classification System (NAICS) codes: 541711, 541712.

(As noted above, the six-digit NAICS codes for research and development were changed in the 2017 edition. In general, the 2012 NAICS codes 541711 and 541712 were replaced by 2017 codes 541713 – 541715. Again, only the 2012 NAICS codes are relevant in determining whether a person is engaged in a qualifying line of business.)

Qualifying research and development activities may be defined as:

  • Those activities described in Section 174 of the Internal Revenue Code.
  • For the purpose of discovering information that is technological in nature.
  • To discover useful information for new or improved business components.

In general, there are two types of business components in which a taxpayer can claim that it was engaged in qualified research and development:

  1. Product development, and
  2. Process improvement.

If you are primarily engaged in research and development as described above, your purchase or lease of machinery, equipment, or other devices that have a useful life of one or more years, and which will be used primarily for research and development will generally qualify for the partial exemption.

Example
A university has a research and development department. Research and development is not the primary line of business of the University. Therefore, as an entity, the University is not primarily engaged in a line of business described by a qualifying NAICS code. However, if the University can establish that the research and development department is a separate "establishment," then the research and development department may be qualified for purposes of the partial exemption. To be considered a separate establishment, the University must keep separate books and records for the research and development department.

On or after January 1, 2018, businesses that are primarily engaged in electric power generation or distribution may qualify for the partial exemption. To qualify for the partial exemption, the business must be primarily engaged in a line of business described under one of the following North American Industry Classification System (NAICS) codes (2012 edition).

  • 221111 Hydroelectric Power Generation
  • 221112 Fossil Fuel Electric Power Generation
  • 221113 Nuclear Electric Power Generation
  • 221114 Solar Electric Power Generation
  • 221115 Wind Electric Power Generation
  • 221116 Geothermal Electric Power Generation
  • 221117 Biomass Electric Power Generation
  • 221118 Other Electric Power Generation
  • 221122 Electric Power Distribution

In general, qualifying electric power generators includes businesses primarily engaged in operating power generation facilities that convert other forms of energy, such as water power, fossil fuels, nuclear power, and solar power, into electrical energy. Establishments in this industry produce electric energy and provide electricity to transmission systems or to electric power distribution systems.

In general, qualifying electric distributors includes electric power businesses primarily engaged in either:

  • Operating electric power distribution systems; i.e., consisting of lines, poles, meters, and wiring, or
  • Operating as electric power brokers or agents that arrange the sale of electricity via power distribution systems operated by others.

For purposes of this partial exemption, solar electric power generators include those businesses that are primarily engaged in operating solar electric power generation facilities that use energy from the sun to produce electric energy. The energy produced in these businesses is provided to electric power transmission systems or to electric power distribution systems.

If you are a qualified person, your purchase of solar equipment or other electric power generating or producing equipment used to primarily run your manufacturing equipment may qualify for the exemption (see the Solar Power Equipment topic on this page).

Examples

The following are categories and examples of tangible personal property (TPP) that may be used in the generation or production and/or storage and distribution of electric power (in some cases as part of a special purpose building). As always, whether or not the sale or use of a particular item of TPP qualifies for the partial exemption is based on whether the three basic elements have been met: qualified person, qualified tangible personal property, and qualified use. (See Qualifications tab).

Biomass electric power generation

Equipment used to convert renewable fuels into heat and electricity by direct combustion of biomass material, gasification, pyrolysis, and anaerobic digestion.

  • Grinders, wood chip processors, baggers, hammermills, shredders, screening equipment, auger systems
  • Anaerobic digesters, pumps
  • Fixed or moving bed gasifiers, fluid bed gasifiers, entrained flow gasifiers
  • Bubbling fluidized bed pyrolyzers, circulating fluid bed and transported bed pyrolyzers
  • Rotating torrefied shells, furnace, dryers
  • Fuel or feedstock receipt and storage equipment
  • Belt conveyors, screw conveyors, drag conveyors, pneumatic conveyors
  • Direct combustion equipment, thermochemical conversion equipment, biological conversion equipment

Solar electric power generation

Equipment that converts renewable energy from sunlight into electricity, either directly using photovoltaics, indirectly using concentrated solar power, or a combination.

  • Inverters
  • Switchgear and transformers
  • Photovoltaic panels, concentrating mirrors and lenses, and trackers

Wind electric power generation

Equipment that converts wind energy to electric power.

  • Engines, turbines, generators, and equipment housings

Geothermal electric power generation

Equipment that uses steam produced from geothermal reservoirs to generate electricity.

  • Pipes, plumbing, and equipment necessary to remove and transfer geothermal energy to equipment that converts it to electric power
  • Heat recovery steam generators, steam turbines, steam generators, condensers, cooling towers, water treatment equipment, heat transfer plumbing and storage systems and heat exchangers

Hydroelectric power generation (less than 30 megawatts)

Equipment that uses the movement of water to generate electricity.

  • Dams and water conveyance systems and penstocks
  • Electrolyzers and tanks
  • Generators and power electronics converters

Electric power conversion and storage

Equipment that converts energy into another form which can be stored and later reconverted to electricity on demand.

  • Battery charging equipment
  • Flywheels
  • Capacitors, converters, corrosion control rectifier, motor, receiver, exciter, enclosures, rotors and stators, generators,
  • Cooling and heating systems,
  • Breakers, disconnects, isolators,
  • Access control and monitoring equipment
  • Energy conversion monitors and controllers, communications equipment, Supervisory Control and Data Acquisition (SCADA) equipment, protection equipment, power quality and metering equipment
  • Support cranes, cables, gear boxes
  • Inverters
  • Switches and switchgears
  • Transformers

Electric power distribution equipment

  • Fully dressed towers and poles, conductors, conduits and insulators
  • Transformers, regulators, or switchgears
  • Fuses, reclosers, protective relays, circuit breakers, surge arrestors, Fault Location, Isolation, and Service Restoration (FLISR)
  • Meters and other measuring devices, switches, remote terminal units (RTU), line sensors, and SCADA devices and controls

You are a new company that manufactures breakfast cereal and you are planning to acquire a new oven for manufacturing. You have decided to lease the oven instead of purchasing it and you want to know if your lease of the oven qualifies for the partial Manufacturing, Research and Development exemption.

For your company and oven lease, you:

  • Determine that you will be primarily engaged in a line of business described in North American Industry Classification System (NAICS) code 311230, because more than 50 percent of your gross revenue will be from manufacturing during the entire time you lease the oven.
  • Will lease the oven for more than one year. The lessor did not make an election to report tax on the purchase price of the oven and will therefore collect tax on the lease receipts.
  • Will use the oven more than 50 percent of the time for manufacturing purposes.

Your lease of the oven qualifies for the partial exemption. When you enter into the lease agreement, you can provide the leasing company a Partial Exemption Certificate for Manufacturing, Research and Development Equipment to obtain the partial exemption from sales and use tax on the lease payments.

During your lease agreement, the leasing company will charge you a monthly lease payment, with tax separately added. However, the Manufacturing, Research and Development partial exemption is only in effect until June 30, 2030. Any lease payments due after June 30, 2030, will be subject to the full sales and use tax rate even if the lease began during the exemption period.

You are a construction contractor hired by a manufacturer to build a special purpose building. Your sales or purchases of materials or fixtures that you furnish and install in the performance of a construction contract for a qualified person may qualify for the partial exemption.

Please note, beginning January 1, 2018, the definition of "qualified tangible personal property" expanded to include special purpose buildings and foundations used as an integral part of the generation or production, storage or distribution of electric power.

In order to document that the partial exemption applies, you must obtain from the qualified person, and keep in your records a valid partial exemption certificate signed by the qualified person. The exemption certificate must indicate that the qualified person and special purpose building meet the qualifications for the partial exemption, and that the property will be used in a qualifying manner. For this purpose, you may obtain a Partial Exemption Certificate for Manufacturing, Research and Development Equipment (CDTFA-230-M) prescribed by the CDTFA, or a similar form.

Depending on the percentage of usable volume of a building being used in a qualifying manner, the entire building or only a portion of the building may qualify for the partial exemption (see Special Purpose Buildings below). In the event that all materials and fixtures do not qualify for the partial exemption, it is necessary that the exemption certificate accurately lists the property to be purchased subject to the partial exemption.

Materials versus Fixtures

As explained on the Industry Guide for Construction Contractors, the performance of a construction contract generally involves the furnishing and installation of materials and/or fixtures that are incorporated into realty. Due to the unique nature of the manufacturing, research and development partial exemption and the ability of the qualified person to pass the partial exemption on to a construction contractor that is furnishing and installing materials and/or fixtures as part of the construction of a special purpose building, a detailed explanation of the application of tax and the documentation requirements is provided below.

Contractors as Consumers

As a construction contractor, you are generally a consumer of materials that you furnish and install in the performance of a construction contract. Therefore, once you have obtained the required form CDTFA-230-M, Partial Exemption Certificate for Manufacturing, Research and Development Equipment" or similar form from the qualified person indicating that the partial exemption applies, you may purchase materials to be furnished and installed on the special purpose building at the partially exempt rate by issuing a form "CDTFA 230-MC, Construction Contracts-Partial Exemption Certificate for Manufacturing, Research and Development Equipment" to your suppliers.

Contractors as Retailers

As a construction contractor, you are generally regarded as a retailer of fixtures that are furnished and installed in the performance of a construction contract. You may issue a resale certificate when purchasing fixtures from a vendor. You may purchase fixtures for resale and sell them subject to the partial exemption to the qualified person.

A construction contractor might install machinery and equipment in connection with a construction contract. Such a sale of machinery and equipment is considered a sale and installation of tangible personal property, rather than an improvement to realty. As with a fixture, the construction contractor may generally purchase the property for resale and the subsequent sale to the qualified person will be subject to the partial exemption (except where the retailer is the subcontractor, as discussed below.)

Subcontractors

The same rules discussed above apply when subcontractors are hired by a prime or general contractor to construct all or part of a special purpose building for the qualified person. In order to document that the partial exemption applies to the contract to construct the special purpose building, the subcontractor must obtain from the prime contractor and retain in its records a copy of the CDTFA-230-M, Partial Exemption Certificate for Manufacturing, Research and Development Equipment or similar form that the qualified person provided to the prime contractor. The subcontractor must also obtain and retain in its records a CDTFA-230-MC, Construction Contracts - Partial Exemption Certificate for Manufacturing, Research and Development Equipment signed by the prime contractor for property the subcontractor is furnishing and installing for the prime contractor in order to document that the partial exemption applies. The subcontractor may issue the necessary documentation as discussed above to their vendor, depending on whether the subcontractor is a consumer or a retailer of the property that is furnished and installed.

Documenting the Exemption

The qualified person is responsible for issuing the CDTFA-230-M as evidence that the construction is for qualified tangible personal property. A prime or general contractor will be responsible for issuing a CDTFA-230-MC to a supplier of materials or fixtures if purchased tax-paid. In addition, if the person furnishing and installing the materials is a subcontractor, the prime or general contractor will also need to provide the subcontractor with a copy of the CDTFA-230-M issued by the qualified person. Subcontractors will need to also issue a CDTFA-230-MC to their suppliers of materials or fixtures if purchased tax-paid.

Documenting the Annual Limit

Qualified persons are responsible for tracking their purchases to ensure they do not exceed the $200 million annual cap. All materials consumed by a contractor or subcontractor, or fixtures, machinery or equipment sold by a contractor or subcontractor in the performance of a contract to construct or modify a special purpose building count against the $200,000,000 annual limit of the qualified person. All construction contractors, including subcontractors, must make available cost information regarding all items sold or used in performance of a qualifying construction contract for purposes of tracking the qualified person's $200,000,000 yearly exemption limit.

If you construct a new special purpose building or modify an existing structure that is designed and constructed, or reconstructed, for manufacturing or research and development, or, beginning January 1, 2018, for the generation or production, storage or distribution of electric power, your purchases of materials and fixtures that become part of the building, and machinery and equipment installed in the building, may qualify for the partial exemption.

In order to qualify (be eligible), the special purpose building must be used for manufacturing, processing, refining, fabricating, recycling, or it may be used as a research or storage facility for these processes. Buildings such as warehouses, solely used to store product after it has completed the manufacturing process, are not eligible for the partial exemption.

For example, a semiconductor manufacturer is constructing a building for manufacturing microchips. The building is designed and constructed with certain requirements to control temperature, humidity, and contaminants that are necessary for microchip production. Materials and fixtures that become a component part of the building, as well as machinery and equipment purchased and installed in the building, are qualifying property for the partial exemption.

All materials and fixtures that become a component part of the building will qualify for the partial exemption if no more than one-third (1/3) of the building's total usable volume (generally Length x Width x Height) is devoted to a non-qualifying use, such as administrative purposes, parking, break rooms, etc. However, in those instances where more than one-third (1/3) of the total usable volume is devoted to a non-qualifying use, only the materials and fixtures that become a component part of the building that is used in manufacturing, processing, refining, fabricating, or recycling, or as a research or storage facility for these processes, or the generation or production, storage or distribution of electric power will be qualifying property for the partial exemption.

Calculating Usable Volume

Please see the examples below which illustrate examples of buildings that qualify entirely and buildings of which only a portion will qualify.

Example #1

ABC R&D Inc. is constructing a new research facility that is designed specifically for the type of research they conduct. The overall dimensions of the building are 400 feet long by 200 feet wide by 40 feet tall for a total usable volume of 3,200,000 cubic feet.

400' Length x 200' Width x 40' Height = 3,200,000 cubic feet

The building will be partitioned to have offices for management, the accounting department, and the marketing department, and areas for restrooms and break rooms. These areas will occupy an area of the building that measures 80 feet long by 60 feet wide by 40 feet tall for a total volume of 192,000 cubic feet.

80' Length x 60' Width x 40' Height = 192,000 cubic feet used in a non-qualifying use

The remaining volume will be used for the research and development activities. The percentage of volume used in a non-qualifying use is computed as:

192,000 cubic feet / 3,200,000 cubic feet = 6% total volume used in a non-qualifying use

Since the total volume of the non-qualifying area is less than one-third (1/3) of the building's total usable volume, all of the materials and fixtures that become a component part of the building will qualify for the partial exemption.

Example #2

XYZ Manufacturing is constructing a new facility that is designed with specifications to house its widget manufacturing equipment and other administrative departments of its business. The building will have a foundation that is 200 feet long by 100 feet wide. Based on the schematics of the building, the foundation of the manufacturing floor will be 100 feet by 100 feet and have a ceiling that is 15 feet tall to accommodate the large machinery. The offices for management, the accounting department, and the marketing department, restrooms, and break rooms will occupy the remaining floor area (100 feet by 100 feet). This area has a 10-foot ceiling. The total usable volume of the building is calculated as:

100' Length x 100' Width x 15' Height = 150,000 cubic feet of area used in manufacturing

100' Length x 100' Width x 10' Height = 100,000 cubic feet area of non-qualifying use

150,000 cubic feet + 100,000 cubic feet = 250,000 cubic feet of total usable volume

Even though the floor space of the manufacturing area is equal to the floor space of the rest of the building, the overall usable volume of the area of the manufacturing area is significantly greater than the volume of the rest of the building due to the higher ceiling.

The percentage of the building's volume used in a non-qualifying use is computed as:

100,000 cubic feet / 250,000 cubic feet = 2/5th or 40% of the building’s volume used in a non-qualifying use

Since more than one-third (1/3) of the total usable volume is used for a non-qualifying use, not all of the materials and fixtures that become a component part of the building qualify for the partial exemption. Only the materials and fixtures that become a component part of the manufacturing area of the building will qualify. Qualified persons and contractors must know which purchases will qualify for the partial exemption.

Determining which materials and fixtures will qualify may not be a straight allocation based on the ratio of qualifying volume to total volume. For instance, 50 percent of the foundation was for the manufacturing floor and the other 50 percent was for the administrative areas. Thus, 50 percent of the materials to construct the foundation may qualify.

Suspended ceilings will be installed only in the administrative offices. This requires the use of specialized T-bar metal and ceiling tiles. Since none of these materials will be used in the manufacturing portion of the building, all of the T-bar metal and ceiling tiles used in the suspended ceiling are subject to the full tax rate.

Also, the manufacturing equipment requires significantly more electrical output to run than does the area occupying the administrative functions. The qualified person must identify which electrical materials are being used for manufacturing, a qualified use, and which materials are used for the area that is a non-qualifying use. Contractors involved in the project should be instructed to only purchase materials or sell fixtures at the partial tax rate if installed in the portion of the building used in manufacturing.

To determine whether materials or fixtures installed in a special purpose building may qualify for the partial exemption, you must look at whether the installed items are being used for a qualifying portion of the building.

If more than one-third (1/3) of the usable volume of a special purpose building is used for non-qualifying activities, only the materials or fixtures that are installed or used in the qualifying area may qualify for the partial exemption. For example, if only half of the structure is used in the manufacturing process or for research and development, new light fixtures installed in the manufacturing and research and development area of the building will qualify. However, light fixtures installed in the administration area of the building will not qualify for the partial exemption.

For example, 400,000 cubic feet of a 1,000,000 cubic feet building is being used for administrative functions while the remaining 600,000 cubic feet is being used for manufacturing. Since the useable volume of the administration area of the building is greater than one-third of the useable volume of the entire structure, the whole building will not qualify for the partial exemption. Any light fixtures installed in the manufacturing area of the structure will qualify for the partial exemption, while light fixtures installed in the administration area of the structure will not qualify for the partial exemption. An air conditioning unit will be installed outside the manufacturing area, but will be used for cooling the whole building. The primary function of the air conditioning unit will be used to cool the manufacturing area since this area represents more than 50 percent of the building. The air conditioning unit will qualify for the partial exemption even though it is not physically located in the manufacturing area.

If one-third or less of the useable volume of a special purpose building is used for a non-qualifying line of business, the entire building qualifies as a special purpose building. If the entire building qualifies, where the materials or fixtures are installed or how they will be used will not matter, and all materials and fixtures installed will qualify for the partial exemption. For example, if the entire building qualifies and the employee restroom needs to be remodeled, all materials and fixtures that are installed to remodel the restroom qualify for the partial exemption.

If you are a qualified person, your purchase of solar panels and solar power equipment used to primarily run your manufacturing equipment may qualify for the partial exemption.

There are three ways that your solar power equipment may qualify for the partial exemption:

Directly wired

If your solar power equipment is directly connected to qualifying manufacturing equipment to power the qualifying manufacturing equipment, your purchases of solar power equipment will qualify for the partial exemption.

Wired to a Power Grid

If your solar power equipment is tied to the local power grid and is not directly attached to qualifying manufacturing equipment, your solar power equipment may still qualify if it is designed to generate power primarily for your manufacturing equipment. The solar equipment is deemed to generate power primarily for the qualifying manufacturing equipment if the solar power equipment is designed to generate at least 50 percent of the power used by the qualifying manufacturing equipment.

To determine whether solar power equipment is used at least 50 percent in manufacturing, divide the annual amount of power consumed by qualifying manufacturing equipment by the total annual amount of power generated by the solar equipment. Please note that the power generated by the solar equipment when the facility is not operating is regarded as power that is effectively "banked" in the local power grid such that the calculation is not limited to those periods when the facility is operating.

For example, your:

  • Qualifying manufacturing equipment consumes 600 kilowatts of electricity per year, and
  • Your solar equipment produces 1000 kilowatts of electricity per year.

Your solar power equipment is used 60 percent in manufacturing, (600/1000 = 0.60, or 60 percent). Therefore, the solar power equipment is used at least 50 percent in manufacturing and is eligible for the partial exemption.

Fixtures on a Special Purpose Building

If your solar power equipment is purchased as part of the construction of a qualifying special purpose building, then your solar equipment will qualify for the partial exemption regardless of the percentage of generated power that is used to power manufacturing equipment.

Property purchased for use in pollution control may qualify for the partial exemption.

If you are a manufacturer and you install equipment used to reduce or remove pollution, your purchases of this equipment may qualify for the partial exemption. The pollution control equipment must meet or exceed state or local government standards at the time it is purchased.

For example, you are in the printing industry. Your business's primary line of business falls within one of the qualifying NAICS codes. You purchase a carbon absorber or catalytic reactor used to control pollution that meets or exceeds state or local government standards. Your purchase will generally qualify for the partial exemption.

Your purchase of repair or replacement parts may qualify for the partial exemption.

If you are a qualified person purchasing parts that will be used to repair qualified manufacturing or research and development equipment, you may take advantage of the partial exemption. However, the repair or replacement parts must be treated as having a useful life of one or more years for state income or franchise tax purposes. Tools and other supply items are not considered repair or replacement parts and do not qualify for the partial exemption.

For example, you need to replace a motherboard in a computer that controls a certain piece of manufacturing equipment. As long as the motherboard has a useful life of one or more years as described above, you may purchase the replacement motherboard at the partially exempt tax rate.

To take advantage of the partial exemption you must download the CDTFA-230-M, Partial Exemption Certificate for Manufacturing, Research and Development Equipment. Fill it out, print it, and sign it. Then provide it to the retailer at the time you make your purchase.

Your purchase of a concrete or cement mixing truck may qualify for the partial manufacturing exemption.

If you are primarily engaged in truck-mixed concrete manufacturing and will use the mixing truck primarily for this purpose, your purchase of a concrete or cement mixing truck may qualify for the partial exemption.

You are considered engaged in truck-mixed concrete manufacturing if your line of business is most accurately described by a qualifying NAICS code (see NAICS code 327320); your NAICS code is that which best describes your line of business, based on either your primary revenues or primary operating expenses. Please note a construction contractor who owns a cement mixing truck would not generally qualify under a qualifying NAICS code.

Concrete or cement mixing trucks are considered Mobile Transportation Equipment for sales and use tax purposes. Leases of Mobile Transportation Equipment do not typically qualify for the partial exemption. Therefore, if you are a lessee of concrete or cement trucks, your lease will generally not qualify. For more information on leases of mobile transportation equipment, please see Regulation 1661, Leases of Mobile Transportation Equipment.

Your purchases of material handling equipment such as forklifts, pallet jacks, and reusable transport containers may qualify for the partial exemption under certain uses.

If you are a qualified person purchasing material handling equipment with a useful life of one or more years that will be used primarily in a stage of the manufacturing process, it will qualify for the partial exemption. The equipment must be for use in handling goods through a production line, and within a single geographic location. It will not qualify if the primary use is for handling goods after the establishment's production has completed, or used to transport unfinished goods from one geographic location to another.

For example, you use a pallet jack to pick up a pallet of goods that has just completed one phase of processing and take it over to another area in the building to begin a second phase of processing. Since the use of the pallet jack is at the same geographic location and it is used to move the materials between production phases, the pallet jack qualifies for the partial exemption.

On the other hand, if you primarily use a forklift to move pallets of finished product from your warehouse onto delivery trucks for final shipment, it will generally not qualify for the partial exemption. A forklift used to transport unfinished goods between two facilities at different geographic locations will also not qualify since the transportation to or between facilities is not considered a part of the manufacturing process.

If you are a manufacturer or research and developer and you make purchases of qualifying equipment from out-of- state sellers who do not collect tax, you may still take advantage of the partial exemption and pay your use tax at the reduced rate.

Not all out-of-state retailers are registered to collect California use tax. If your supplier does not collect use tax, it is your obligation to self-report the use tax to the CDTFA. You may do so by reporting the purchase amount on your California Sales and Use Tax return or Consumer Use Tax return. There is no need to provide an unregistered, out-of-state seller with an exemption certificate.

To ensure that tax is reported at the partial rate when filing a return, you will need to report the qualifying purchase amount on the line PURCHASES SUBJECT TO USE TAX as well as on the line SALES MADE SUBJECT TO THE MANUFACTURING AND RESEARCH AND DEVELOPMENT EQUIPMENT EXEMPTION.

Tax does not apply to separately stated shipping or delivery charges when delivery is made directly to the purchaser by common carrier, U.S. mail, or an independent contractor as long as the cost is the actual delivery charge. However, tax generally applies to delivery charges when delivery is made using the seller's vehicle.

Handling charges are generally subject to tax. If you charge a single amount for "postage and handling" or "shipping and handling," only the portion of the charge which represents the actual amount for shipping or delivery is not taxable, while the portion of the charge that represents handling is generally taxable (for more information, see publication 100, Shipping and Delivery Charges).

Taxable shipping or handling charges added to sales or purchases that qualify for the partial manufacturing and research and development equipment exemption are also partially exempt. For example, a qualified person purchases manufacturing equipment and pays $80 for "shipping and handling." The actual shipping cost by the common carrier for delivery to the qualified person is $30. The $30 shipping charge is exempt from tax. Tax applies to the remaining $50 handling charge at the partial tax rate. To support the nontaxable shipping charges, the seller must keep records of the actual shipping costs.

If you purchased qualifying tangible personal property at the full tax rate you may be entitled to a refund of any overpaid tax or tax reimbursement.

For example, if you purchased machinery and paid tax at the rate of 7.25 percent and your purchase qualifies for the partial exemption, then the applicable tax rate for the transaction is 3.3125 percent. A refund may generally be claimed at any time within the statute of limitations (generally, within three years). If you are seeking a refund for overpaid taxes on qualifying purchases of manufacturing or research and development equipment the procedures are different depending on whether the original purchase was subject to sales tax or use tax.

If the tax you paid is use tax (typically use tax applies when you purchase from an out-of-state vendor), you may file a claim for refund directly with the CDTFA. Simply complete form CDTFA-101, Claim for Refund or Credit and mail it to the address provided. Include as the reason for the refund that the property purchased qualifies for the manufacturing and research and development partial sales and use tax exemption.

If the tax you paid was sales tax, you must request a refund from the retailer. The retailer would then file a claim for refund with the CDTFA. As the purchaser, you will need to provide the retailer with a completed partial exemption certificate (CDTFA-230-M or similar form) and documentary evidence that the original purchase should have qualified for the partial exemption.

For more information on refunds see publication 117, Filing a Claim for Refund.

Need to know more? Follow the links below for more information about the topics covered in this guide, as well as other information you might find helpful:

Webinar

Laws and Regulations

NAICS – North American Industry Classification System

The Census Bureau is the official US Government Authority who manages the NAICS Coding System. Go to their 2012 NAICS search tool to determine your NAICS code.

Partial Exemption Certificates

Publications

Notices

Additional Sources

Other Helpful Resources