The Supreme Judicial Court (SJC) recently decided Associated Testing Laboratories, Inc. v. Commissioner in favor of the taxpayer. 429 Mass. 628 (1999). The decision reversed a prior determination by the Appellate Tax Board. This TIR discusses the Commissioner's application of Associated Testing.

In Associated Testing, the taxpayer operated an in-state testing laboratory in a building containing over 1,400 pieces of testing equipment. The taxpayer rendered testing services for its clients' products to ensure that the items met certain specifications. The taxpayer did not own the items tested, which remained the property of the taxpayer's customers throughout the testing process. Once the taxpayer completed the required tests, it returned the items to its customers. Although customers typically hired the taxpayer to test products prior to their sale to third parties, one customer, a Federal agency, requested testing on products that it purchased to determine whether the goods were in conformance with specifications.

The sole question in Associated Testing was whether the equipment at issue was exempt under c. 64H, § 6(s). The Court found that the equipment was exempt because it met the five requirements set forth in § 6(s). In particular, the equipment was used (1) directly and exclusively; (2) in an industrial plant; (3) in the actual manufacture, conversion, or processing; (4) of tangible personal property; (5) to be sold.

The Court noted that, under the statute, the first and third requirements listed above are deemed met where the machinery is "used solely during a manufacturing, conversion or processing operation … to test or measure such property where such function is an integral part of the production flow or function." The Court concluded that these criteria were satisfied on the facts because "the testing services were an essential part of bringing the product to market." The Court declined to read into the statute a requirement that the testing must be performed by the same entity that performs the rest of the manufacturing process.

The Court also concluded that the second and fourth requirements set forth in the statute were met. The Court determined that the industrial plant requirement was satisfied in part because the equipment was deemed used "in the actual manufacture" of tangible personal property as discussed above. The Court stated that once equipment is deemed to meet the actual manufacture standard, the industrial plant requirement is met if the taxpayer proves the building that houses the machinery is fixed in its location and is primarily engaged in the testing process. These facts were proved in Associated Testing.

Finally, the Court concluded that the equipment in question satisfied the requirement that it manufacture tangible personal property "to be sold." The Court found that this requirement was met even though the taxpayer performed testing services for a party that "was buying rather than selling the goods." The Court concluded that these goods were nonetheless "to be sold" since the purchasers "requesting the taxpayer's services did so to determine whether they should accept the … goods and thereby consummate their purchase."

Discussion
Section 6(s) provides an exemption for machinery used "directly and exclusively" in an industrial plant in the "actual" manufacture of tangible personal property to be sold. An "industrial plant" is defined as a "factory at a fixed location primarily engaged in the manufacture, conversion or processing of tangible personal property to be sold in the regular course of business." In addition, § 6(s) references five uses pursuant to which machinery is deemed used directly and exclusively in the actual manufacture of tangible personal property to be sold. Machinery meets this requirement if used solely during a manufacturing, processing, or conversion operation:
  1. to effect a direct and immediate physical change upon the tangible personal property to be sold;
  2. to guide or measure a direct and immediate physical change upon such property where such function is an integral and essential part of tuning, verifying or aligning the component parts of such property;
  3. to test or measure such property where such function is an integral part of the production flow or function;
  4. solely to store, transport, convey, or handle such property during the manufacturing, converting or processing operations heretofore specified; or
  5. solely to place such property in the container, package or wrapping in which such property is normally sold to the ultimate consumer thereof.

There is also language in a provision set forth in the next to last sentence ("penultimate provision") of § 6(s) that relates to the machinery exemption. This provision states, inter alia, that machinery used for any use except those specified are not exempt even though the machinery is "an integral or essential part of a continuous production flow or manufacturing process." (1)

I. The two requirements that machinery be used "directly and exclusively" in "actual" manufacture
In keeping with Associated Testing, the Commissioner's focus under § 6(s) when evaluating the machinery exemption will be the five uses of machinery referenced above. Under the Court's analysis in Associated Testing, any machinery that is used solely in these five activities is used "directly and exclusively" in the "actual" manufacture of tangible personal property. Therefore, the Commissioner will not require additional proof regarding the qualifiers set forth in the first sentence of § 6(s), i.e., "actual," "directly," and "exclusively." Further, Associated Testing does not consider the penultimate provision as imposing an additional requirement under § 6(s). See also Commissioner of Revenue v. Fashion Affiliates, Inc., 387 Mass. 543, 546-547 (1982).

Associated Testing specifically applied to the third use of machinery referenced in § 6(s). That provision refers to machinery that is used to "test or measure" property to be sold "where such function is an integral part of the production flow or function." Associated Testing concluded that testing machinery qualifies under this provision when the testing is "an essential part of bringing the product to market." Consequently, when evaluating the third use of machinery set forth in § 6(s), this is the applicable standard. (2)

Associated Testing also determined that the taxpayer's activity would not be disqualified under § 6(s) by reason of the fact that another party performed most of the manufacturing activity. Although, as noted, Associated Testing applied specifically to the third use of machinery referenced in § 6(s), the Commissioner will apply this same standard to each of the five statutory uses of machinery. See generally Commissioner of Revenue v. Houghton Mifflin Co., 423 Mass. 42 (1995).

II. Industrial plant requirement
One of the other requirements under § 6(s) identified by Associated Testing is that the machinery in question be used in an industrial plant. See 429 Mass. at 634. Associated Testing determined that this requirement is met when the machinery is deemed to be used in "actual" manufacture as discussed above, so long as the building that houses the machinery is fixed in its location and is primarily engaged in the testing process. Consequently, in any instance in which the taxpayer's activity is referenced in one of the five uses of machinery set forth in the statute, the Commissioner will conclude the industrial plant requirement is met when the building that houses the machinery is fixed in its location and is primarily engaged in the statutory activity. (3)

III. "To be sold" requirement
Finally, Associated Testing concluded that the machinery in question satisfied the § 6(s) requirement that it manufacture tangible personal property "to be sold." The Court found this requirement was met in this case where the taxpayer performed testing services for one customer that "was buying rather than selling the goods" in question. The Court determined that, though these goods had been purchased, they nonetheless were "to be sold" within the meaning of § 6(s) since the buyers sought the taxpayer's services to determine whether they should accept the goods and "thereby consummate their purchase."

In accord with Associated Testing, when the buyer requires testing of purchased goods and the buyer retains the right to accept or reject the goods based on the results of these tests, the Commissioner will treat the goods as "to be sold" within the meaning of § 6(s). In such cases, the Commissioner will not disqualify the testing activity under the statute whether or not the goods are ultimately rejected.


Frederick A. Laskey,
Commissioner of Revenue

November 30, 1999
TIR 99-16


Notes
:

1 The penultimate provision states in its entirety that:
Machinery used directly and exclusively in the actual manufacture, conversion of processing of any tangible personal property which is not to be sold and which would be exempt under (r) of this paragraph if purchased from a vendor thereof or machinery used during any manufacturing, conversion, or processing, conveying or packaging operation or function or for any other purpose, except as heretofore specified, shall not be exempt under this paragraph even though such operation, function or purpose is an integral or essential part of a continuous production flow or manufacturing process.

2 Other cases have evaluated the other uses of machinery referenced in the statute. See, e.g., Commissioner of Revenue v. V.H. Blackinton & Co., 420 Mass. 259 (evaluating the first and second uses); Fashion Affiliates, 387 Mass. 543 (evaluating the second use).

3 In Letter Ruling 99-14, the Commissioner concluded that a physical building is not required in order to meet the industrial plant requirement. Rather, the facility where the manufacturing occurs must be at a fixed and well-defined location.