Summary

This directive explains the application of Morton Buildings, Inc. v. Commissioner of Revenue, 43 Mass. App. Ct. 441 (1997), to taxpayers that manufacture, alter, repair or purchase components out of state and store, use or consume the parts in Massachusetts. The sales and use tax statutes are essentially complementary, but Morton Buildings, which concerns only the use tax, highlights an area of difference.

This directive addresses the situation where the same taxpayer 1) purchases tangible personal property outside of Massachusetts, 2) places the property in inventory for later use, 3) removes that property from inventory and transforms it outside of the state, and then 4) stores, uses or consumes the transformed property in Massachusetts. Use tax applies to "the storage, use or other consumption in the commonwealth of tangible personal property or services purchased from any vendor for storage, use or other consumption" in Massachusetts. G.L. c. 64I, § 2. In general, taxpayers storing or using tangible personal property in Massachusetts that they have acquired outside the state must pay use tax. Imposition of the use tax requires that tangible personal property be "(1) … stored, used or otherwise consumed in the Commonwealth; (2) … purchased from any vendor; and (3) … purchased for storage, use, or consumption within the Commonwealth." Morton Buildings , at 444 . Use tax cannot be imposed unless all of the requirements of the statute have been met. Taxability under the use tax depends in part on whether the property a taxpayer uses in Massachusetts is the same as the property purchased, or whether the taxpayer has so altered the property that its identity has changed. A taxpayer that purchases raw materials outside of Massachusetts for no particular job, places those raw materials into inventory for future use, and then manufactures, processes or converts those raw materials into a new product (performing that transformation entirely outside of Massachusetts), will not be subject to use tax on subsequent use of the property in Massachusetts. The tax does not apply to the purchased raw materials, because that property has been transformed into something else, and no longer exists in its purchased condition; the property that was used in Massachusetts is not taxed because it was not purchased, it was manufactured. If the property is not altered, or is altered in an insignificant way, however, it falls within the use tax statute and will be subject to tax when used in Massachusetts. The taxpayer bears the burden of proving that the property used in Massachusetts is not the same as the property that was purchased and is therefore not taxable.

ISSUE 1: Regarding a taxpayer that acts in part as a building contractor, does use tax apply:

a. if the taxpayer purchased raw materials out of state for no particular job, placed the raw materials into inventory, and then removed the raw materials from inventory and consumed them in the out-of-state manufacture of building components and attached the resulting product to real estate in Massachusetts?

b. if the taxpayer purchased tangible personal property out of state and minimally modified it out of state before attaching it to real estate in Massachusetts?

DIRECTIVE 1: a. A taxpayer that purchased raw materials out of state for no particular job, stored those materials in inventory and then consumed them out of state in the manufacture of building components, is not, under the Morton Buildings decision, subject to use tax when, acting as a building contractor, it attaches the manufactured items to Massachusetts real estate.

b. The Morton Buildings decision does not prevent the imposition of use tax on tangible personal property that a taxpayer purchased out of state and then minimally modified out of state before, acting as a building contractor, it attaches tangible personal property to Massachusetts real estate.

ISSUE 2: Regarding the storage or use of tangible personal property in Massachusetts, does the decision in Morton Buildings prevent use tax from applying to property, including components or parts, that a taxpayer has: (i) purchased out of state for no particular job, (ii) repaired, retrofitted, modified, or customized out of state, and (iii) subsequently used in Massachusetts?

DIRECTIVE 2: While each case will be determined on its own facts and circumstances, out-of-state repairs, retrofits, modifications, or customization of property, including components or parts, are generally not significant alterations that change the character of tangible property, and, accordingly, will not be considered to result in a transformation of that property sufficient to bring it within the Morton Buildings rule. Use tax will be imposed on any previously untaxed portion of tangible personal property that a taxpayer: (i) purchases out of state, (ii) alters out of state by repairing, retrofitting, modifying or customizing, and then (iii) uses, stores or otherwise consumes in Massachusetts.

DISCUSSION OF LAW:

Massachusetts law imposes a five percent sales tax on retail sales by a vendor of tangible personal property in Massachusetts. G.L. c. 64H, § 2. A retail sale is defined as a sale of tangible personal property for any purpose other than resale in the regular course of business. Id. If no sales tax was paid, Massachusetts law imposes a five percent use tax on the storage, use or other consumption in Massachusetts of tangible personal property purchased from a vendor for storage, use or other consumption here. G.L. c. 64I, § 2.

I. Storage or Use in Massachusetts

The use tax statute requires, first, that property be "stored," "used," or "consumed." The term "storage" is defined as any keeping or retention in Massachusetts for any purpose, except sale in the regular course of business or subsequent use solely outside of Massachusetts, of tangible personal property purchased from a vendor. G.L. c. 64I, § 1. "Use" means the exercise of any right or power over tangible personal property incident to the ownership of that property, except that it does not include the sale of that property in the regular course of business. Id. Tangible personal property shipped or brought into Massachusetts within six months of being purchased is presumed to be purchased for use in Massachusetts. G.L. c. 64I, § 8(f).

Taxable use of property includes improvements to real estate by contractors. Under the contractor rule, building contractors are the consumers of tangible personal property they purchase for the performance of their contracts. LR 94-5; LR 94-6, citing Ace Heating Service, Inc. v. State Tax Commission, 371 Mass. 254 (1976); LR 85-68; LR 88-8; and Emergency Regulation 12. As consumers of tangible personal property, building contractors pay sales tax on their purchases, or use tax on their use. Id.

II. Purchase vs. Manufacture

The use tax applies to "the storage, use or other consumption in the commonwealth of tangible personal property or services purchased from any vendor for storage, use or other consumption in Massachusetts." G.L. c. 64I, § 2. If the raw materials purchased out of state have been transformed into different tangible personal property, the raw materials are not subject to use tax in Massachusetts. Likewise, if the tangible personal property in use in Massachusetts has been manufactured, not purchased, the statutory requirements have not been met and use tax will not be imposed. Morton Buildings requires an analysis of the degree to which a taxpayer transforms raw materials out of state before it uses the resulting tangible personal property in Massachusetts.

Morton Buildings concerned a foreign corporation ("Morton") that manufactured, sold and erected prefabricated, timber-framed, metal-sheathed structures, most often warehouses, for agricultural and industrial use. Morton made bulk purchases of raw materials, predominantly lumber and steel, outside of Massachusetts and stored them in warehouses out of state. Morton's purchases were not made for a particular job. When Morton received an order for a building, it took raw materials from stored inventory and made them, outside of Massachusetts, into building components such as trusses. After completing the building components, Morton transported them directly to the building site where it erected them. Morton was a building contractor that was also engaged in manufacturing, according to the Appellate Tax Board ("ATB") and the Appeals Court.

Manufacturing means "change wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use." William F. Sullivan & Co. v. Commissioner of Revenue, 413 Mass. 576, 579 (1992). An element of manufacturing, according to the Appeals Court, is that one could not disassemble the manufactured item and have recognizable component parts that can be used or consumed. The Appeals Court, affirming the decision of the ATB, held that "the building components of its own manufacture that Morton brought into Massachusetts so significantly altered the raw materials that those raw materials do not come within the reach of G.L. c. 64I, § 2, as written." Morton Buildings, Inc. v. Commissioner of Revenue, 43 Mass. App. Ct. 441, 445 (1997). The windows and doors purchased by Morton and used without significant alteration, on the other hand, met all of the criteria in the use tax statute, and were subject to use tax.

The Appellate Tax Board explored the difference between "manufacture," on the one hand, and "alteration," on the other, in The Anthony Galluzzo Corporation v. Commissioner of Revenue, A.T.B. Docket No. 195606 (1997). In Galuzzo, the Appellate Tax Board held that a part that had been merely altered fell within the use tax statute. The Galluzzo case involved a New Hampshire corporation that supplied construction materials and made custom millwork. Under "furnish and install" contracts that it entered into with Massachusetts general contractors, the corporation was held to have acted like a contractor. It purchased items, such as wood, lumber and molding, with specific knowledge of where and for what jobs the items would be used. The corporation performed the alterations needed to meet the specifics of the contracts at its New Hampshire facility, and then shipped the altered materials to Massachusetts for installation.

The corporation argued that because it had altered some of the materials in New Hampshire, the product used in Massachusetts was not the same as the product it had purchased, and that therefore, the use of the altered property in Massachusetts was exempt from use tax. The ATB held that the corporation failed to meet its burden of proving that its out-of-state processing operations were manufacturing because no evidence was presented to the Board as to the actual work done outside of Massachusetts. The Board concluded, therefore, that the alterations made by the corporation did not result in the "manufacture" of a new item of tangible personal property with a different use, name and nature from that of the raw materials, and that consequently the corporation's purchases of such materials for use in Massachusetts were subject to use tax. Galuzzo, supra, at 16.

Taken together, the Morton Buildings and Galuzzo cases elucidate the use tax statute's requirements that tangible personal property be (1) stored, used or otherwise consumed in the Commonwealth; (2) purchased from any vendor; and (3) purchased for storage, use or consumption within the Commonwealth. Whether an item meets these criteria depends in part upon the degree of modification, processing, or fabrication the taxpayer performs before it uses the item. Goods manufactured outside Massachusetts from raw materials purchased by the user in bulk outside Massachusetts, for no particular job, as in Morton Buildings, will not be subject to use tax. The Morton Buildingsstandard requires that the goods be "significantly altered" to escape taxation. Clearly, property that is used unaltered is subject to use tax. In addition, the Morton Buildingsrule will not apply to goods that have been merely customized, altered in ways that are not significant, or modified without changing their nature or identity. Repair of a machine or machine part, for example, does not change its identity, and therefore does not fit the Morton Buildings rule for manufactured property.

Examples

The following examples are illustrative, and are not intended to be exhaustive.

1. a. Company A installs and services heating and cooling systems. Company A purchases furnace and air conditioner parts, for no particular job, from various out-of-state vendors. Parts are stored in inventory in its out-of-state facilities. Company A programs thermostats in its out-of-state facility according to customer specifications. Company A, acting as a building contractor, installs the modified thermostats into new or existing heating and cooling systems in Massachusetts. The thermostats are taxable, as are all of the purchased products Company A uses in Massachusetts. If after a part has been modified according to a customer's specifications the original part still retains its name, nature, or use, Morton Buildings does not prevent use tax from being imposed.

b. Company B manufactures, installs, and services heating and cooling systems. The company purchases, outside of Massachusetts, raw materials in bulk for no particular customer or job and places the raw materials in inventory at its plant. The company's manufacturing plant is located outside of Massachusetts. At the plant, it takes raw materials out of inventory and assembles and fabricates materials, supplies, and parts into finished units ready for installation. This process requires fabrication, such as molding plastic, or shaping metal parts as part of a multi-step production process such that (i) the character of the inputs is changed from their purchased condition, or (ii) the parts are permanently attached and cannot be disassembled without being destroyed. When Company B, acting as a contractor, takes a heating system that it has manufactured and installs it to Massachusetts real estate, Morton Buildings prevents the application of use tax to the manufactured parts.

2. Taxpayer C has a facility in New Hampshire where it stores, manufactures, and refurbishes computer parts and components. C manufactures some components and purchases others (all purchases are made in bulk for no particular customer or job outside of Massachusetts). C sells computer systems nationwide, and also uses its computers in its own business. Business C has its payroll office in Massachusetts, which it equips with computers taken from inventory in its New Hampshire facility. The modifications described in the scenarios below are all performed entirely in C's New Hampshire facility. Use tax treatment of any previously untaxed item for the below-indicated modifications to the computers that C uses in its Massachusetts office would be as follows:

a. Customization of a computer. C customizes a computer purchased in New Hampshire from another manufacturer by installing a new hard drive to provide faster computing capacity. C purchased the hard drive in New Hampshire and installed it in the same condition in which it was purchased. Use of the computer and of the hard drive in Massachusetts are both taxable. The character of neither one has changed.

b. Installation of new canned software. C loads new canned software purchased in New Hampshire into a computer also purchased in New Hampshire from another manufacturer. Use of the computer and software in the Massachusetts office are taxable. Their character has not changed.

c. Attachment of peripheral devices. [1] C attaches peripheral devices, purchased in New Hampshire from another manufacturer, to computers also purchased from another manufacturer. Its use in Massachusetts of each of the components is taxable. The components are not altered from their purchased condition. They are merely attached to a personal computer. Connecting or assembling components together, without materially changing the components, does not change their character and is not manufacturing.

d. Replacing a damaged component. C sends a damaged computer from its Massachusetts payroll office to its New Hampshire facility where a damaged hard drive is removed and replaced with another hard drive purchased outside of Massachusetts and kept in the parts and components inventory at C's New Hampshire facility. The new hard drive is taxable when used in Massachusetts.

e. Manufacturing a computer. C manufactures and ships to C's Massachusetts office a new mainframe computer produced in its New Hampshire facility from raw materials purchased in bulk out of state and stored in its warehouse inventory. Assembly of this computer requires fabrication, such as molding plastic, shaping metal parts, and stamping silicon chips, as part of a multi-step production process such that (i) the character of the inputs is changed from their purchased condition, or (ii) the parts are permanently attached and could not be disassembled without being destroyed. Use in Massachusetts of the resulting product is not taxable under the Morton Buildings rule. Purchased components that are used unchanged in the new computer would, however, not be excluded from use tax.

3. Company D is an air carrier whose operation in Massachusetts includes both scheduled and unscheduled replacement of aircraft parts on company aircraft. Parts are purchased out of state for use, storage or other consumption in several markets, including Logan International Airport in Boston. A malfunctioning fuel pump, which had been used in Massachusetts, is removed from a jet at Logan and shipped to the carrier's central repair facility in New Hampshire for diagnostics and repair. Diagnostics indicate that the pressure relief valve in the fuel pump is broken. The broken part is replaced with a new pressure relief valve that was purchased in New Hampshire. The repaired fuel pump is returned to stock at Logan Airport and the new pressure relief valve is subject to use tax when it is used in Massachusetts.

/s/Frederick A. Laskey
Frederick A. Laskey
Commissioner of Revenue

FAL:DMS:lab

May 8, 2001

DD 01-2



[1] Peripheral device is defined here as any device that is not part of the computer's motherboard and contains circuitry designed to provide expanded capability to the basic computer functions that are provided by the central processing unit (CPU), memory chips, internal communication pathways (e.g., buses), and basic input/output interfaces on the motherboard. The term "peripheral device" includes devices that are external to the main computer case, attached by a wired or wireless connection (such as monitors, keyboards, mouses, and printers), as well as devices and boards (or cards) that are plugged into one of the computer's expansion slots on the motherboard inside the case (such as a video card, sound card, modem, hard drive or CD-ROM).