The Massachusetts Department of Revenue ruled that a California lubricant and cleaning products manufacturer was a manufacturing corporation, even though 70% of its production activities were outsourced to third parties. As a result, the Department permitted the company to use a single sales factor to apportion its taxable net income to Massachusetts. Mass. Ltr. Rul. 11-8: Qualification as a Manufacturing Corporation under G.L. c. 63, s. 38(I) (Dec. 16, 2011).

Under Massachusetts Law, a “manufacturing corporation” that has income from business activity that is taxable both in Massachusetts and outside the state is required to apportion its net income to Massachusetts using a single sales factor. There are two requirements to be a “manufacturing corporation.” First, the corporation must be engaged in manufacturing during the year, and second, the manufacturing activity must be substantial. A corporation’s manufacturing activities are substantial if the corporation meets one of the five statutorily enumerated tests. The first test is that the corporation derives 25% or more of its receipts for the taxable year from the sale of manufactured goods that it manufactures.

The taxpayer was engaged in the development, manufacture, and distribution of lubricants and cleaning products. Approximately 70% of the taxpayer’s revenue was attributable to the manufacture and sale of a specified lubricant. Although the taxpayer’s internal production did not generate 25% of its receipts, the Department concluded that the taxpayer met the statutory test.

The Department explained that when products are produced through an outsourcing arrangement, “the issue is whether the Company’s activities are essential and integral to the overall manufacturing process such that its activities constitute manufacturing.” The Department determined that the taxpayer was integrally involved in the creation of the product from start to finish. The taxpayer invented the product formula, manufacturing processes, and testing procedures. The Department also found that the taxpayer controlled the overall manufacturing process. As a result, the Department ruled that the Company was engaged in manufacturing that was substantial and, therefore, was permitted to use a single sales factor to apportion its net taxable income to Massachusetts.

Companies filing in Massachusetts that are considering outsourcing their manufacturing activities, and those that have already done so, should evaluate whether their own activities are “essential and integral” to the overall manufacturing of their product such that they could be permitted or required to source their receipts using a single sales factor.