Utility Exemptions Can Help Manufacturers Save on Sales Tax
One of the most fascinating aspects of helping businesses save sales tax on their utility bills is marveling at the incredible machinery during a facility tour.
Whether it be a frozen pizza manufacturer with a walk-in freezer so large you could practically drive a semi-truck into it, or a lumber mill with ferocious log cutting equipment that could have easily doubled as a set piece on Game of Thrones, manufacturers have some amazing machinery. The scale and technology embraced by the industry has changed beyond recognition over the past two centuries.
As you can imagine, tremendous volumes of water, gas, and electrical energy can go into these types of production facilities.
Typical candidates for a utility sales tax study:
- Pharmaceutical manufacturers
- Food production facilities
- Lumber sawmills
- Agricultural production facilities
- Equipment manufacturers
The good news is that when these utilities are used directly in a manufacturing, processing, fabrication, assembly, agriculture, or mining process, they may be exempt from state and local sales tax. Some states even allow you to go back as far as four years to claim refunds on tax paid on past utilities.
The challenge that manufacturers face when claiming these exemptions is calculating how much utility energy is applied toward the production process — since the cost of utilities that keep the parking lot lights on at night and the staff refrigerator running are not exempt.
A utility sales tax study can parse the difference between exempt and non-exempt uses by examining a manufacturer’s utility meters, production equipment, and building support systems to determine the percentage of exempt energy that applies to the production process.
How a utility study works
Utility studies typically come to us in one of two ways:
- Companies have never heard of the exemption and see it as a no-brainer tax savings opportunity.
- The state is challenging the validity of an exemption and wants proof (and fast — often requesting a utility study to be performed within 90 days after an audit begins).
Those time-sensitive jobs can be another satisfying part of our work. The frozen pizza operation is an example of a business that reached out to us after the state requested documentation of their sales tax exemption claim.
This company’s main production room is held at a constant 76 degrees and is lined with continuously operating conveyors that move the pizzas to each topping station. After the pizzas are made, some are placed into a giant conventional freezer which cools the pizzas down to -20 degrees and also doubles as storage.
The state conducting the audit took the position that the freezer was primarily used for storage and not production, and therefore it concluded that none of the energy used by the refrigeration system was considered exempt. This was significant because the refrigeration system operates year-round and consumes a high volume of electrical energy.
In this case, we analyzed the typical pizza ingredients, recorded the number of pizzas that entered the freezer at room temperature each day, and calculated the energy required to reach the -20 degree storage temperature.
This allowed us to determine how much of the freezer’s capacity was dedicated to finishing the pizza production process, and how much was used for storage. Our study determined that 45 percent of the freezer’s electricity was still being used to freeze and preserve the food as part of the manufacturing process. With the help of this engineering study, we were able to work with the state’s sales tax auditor to file a utility exemption claim for the client that covered the 45 percent of the company’s electrical bill allocated to the freezer.
Natural gas utility study
While no two cases are alike, there are tremendous opportunities across the utility spectrum. For example, consider a manufacturer that uses natural gas. Perhaps it’s a facility that has a production process that requires 100 percent outside air to be delivered at 85 degrees to balance air that is being exhausted. In colder climates, that outside air may need to be heated by 105 degrees before it hits the production line. The colder the climate, the more natural gas is needed to treat that outside air, which can come with a significant cost.
If that facility averages $500 per month in sales tax paid on natural gas, the potential annual savings would be as much as $6,000 every year going forward. But beyond the craft brewery tours and helping clients save on their energy bill, this work offers an even greater satisfaction for us.
A utility study helps a production manager and a business truly gain a better understanding of their equipment and their facilities. That knowledge can help a business be more strategic and thoughtfully plan how new machinery might fit into existing systems, determine timing on HVAC upgrades, and help make other important capital and operational planning decisions.
How we can help
Determining if a utility study makes sense for your manufacturing business doesn’t require a large commitment. We only need two or three months’ worth of utility bills to give you an initial sense of whether a utility study may be valuable for you. At no point in the study does production need to be shut down. Plus, if you’ve recently completed a cost segregation study with CLA, we already have key information in hand.
CLA combines state and local tax professionals with in-house professional engineers to evaluate your manufacturing process and perform a utility study. We can handle the processing of the exemption certificates with the utility providers and prepare all the necessary state forms to claim refunds when applicable. And our utility study model works in any state that offers the exemption.