General Laws chapter 63, section 38(l)(2)(v) provides that, for taxable years beginning on or after January 1, 2000, a manufacturing corporation shall apportion its taxable net income based upon one hundred percent of its sales factor rather than the percentage that results from the three factor formula set out in section 38(c). Section 38(l)(1) defines a "manufacturing corporation" as "a domestic or foreign corporation that is engaged in manufacturing. In order to be engaged in manufacturing, the corporation must be engaged, in substantial part, in transforming raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature and adapted to a new use."
As re-stated and elaborated in the Department of Revenue's Apportionment Regulation, 830 CMR 63.38.1(10)(b):
A corporation…is a section 38 manufacturer for any taxable year if (i) it is engaged in manufacturing during the taxable year and (ii) its manufacturing activity during the taxable year is substantial. A corporation that is so engaged in manufacturing and whose manufacturing activities are substantial is a section 38 manufacture[r] for the taxable year regardless of whether, or to what extent, it conducts its manufacturing activities in Massachusetts.
Engaged in Manufacturing
You cite Mobil Oil Corporation v. Commissioner of Revenue, A.T.B. Docket No. F239392 (March 15, 2000) for the proposition that a process that chemically alters the original substances and transforms them into something different qualifies as manufacturing activity. While the Mobil Oil case dealt with that taxpayer's entitlement to certain exemptions from sales/use tax, the Board did find that the raw ingredients were altered using a multiplicity of processes and had a new use as a marketable and useable product. Thus, the taxpayer's petroleum treatment and recovery operations were found to constitute manufacturing for purposes of the sales/use tax exemptions contained in G.L. c. 64H, § 6(i) and (r).
The Department's Manufacturing Corporations Regulation, 830 CMR 58.2.1(6), provides guidelines for determining whether a corporation may be classified as a manufacturing corporation for purposes of G.L. c. 63, §§ 38C and 42B.These guidelines are also applicable by analogy to corporations seeking manufacturing corporation status for purposes of G.L. c. 63, § 38(l). Among the guidelines as to what constitutes manufacturing are the following:
If the process involves chemical change to property rather than only physical change, it is more likely to be manufacturing. 830 CMR 58.2.1(6)(b)2
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A process that does not produce a finished product, but constitutes an essential and integral part of a total manufacturing process, may constitute manufacturing. A process that is a practical and necessary step in the production of a finished product for sale is generally an essential and integral part of a total manufacturing process. 830 CMR 58.2.1(6)(b)7
Based upon the foregoing standards, we conclude that that the Company is engaged in manufacturing as contemplated for purposes of G.L. c. 63, § 38(l)(1).
Substantiality
The Department's Apportionment Regulation, 830 CMR 63.38.1(10)(b)2 provides that:
A corporation's manufacturing activity is substantial for any taxable year if the corporation meets any of the following tests:
a. The corporation derives twenty-five percent or more of its receipts for the taxable year from the sale of manufactured goods that the corporation manufactures;
b. The corporation pays twenty-five percent or more of its payroll for the taxable year to employees working in manufacturing operations and derives fifteen percent or more of its receipts for the taxable year from the sale of manufactured goods that the corporation manufactures;
c. The corporation uses twenty-five percent or more of its tangible property in manufacturing during the taxable year and derives fifteen percent or more of its receipts for the taxable year from the sale of manufactured goods that the corporation manufactures;
d. The corporation uses thirty-five percent or more of its tangible property in manufacturing during the taxable year.
With regard to the substantiality of the Company's manufacturing activities, you have indicated that it is projected that 95% of the Company's gross receipts for the 2007 taxable year will be from the sale of the drug product at issue. Assuming the validity of this percentage and taking into account the discussion in the next two paragraphs, the Company would meet the substantiality requirements set out in G.L. c. 63, § 38(l) and 830 CMR 63.38.1(10)(b)2.
The Apportionment Regulation, at 830 CMR 63.38.1(10)(b)2, further states that a corporation must derive 25% or more of its receipts for the taxable year from the sale of manufactured goods "that the corporation manufactures." Although, as previously indicated, the Company utilizes third-party contract manufacturers to ultimately produce the antibiotic drug, the activities of the Company would constitute a substantial and integral step in the process of manufacturing based upon the standard enunciated in Commissioner of Revenue v. Houghton Mifflin Company, 423 Mass 42 (1996).
In Houghton Mifflin, the taxpayer was engaged in the business of publishing textbooks. It neither printed nor bound the books which it published. Instead, the books were printed and bound by independent contractors. The Court found that Houghton Mifflin's activities, which included researching, writing, editing, the production of page proofs and ultimately a manuscript on diskette, were essential and integral steps in the manufacture of the books. Thus, the Court held that the taxpayer was entitled to classification as a manufacturing corporation under G.L. c. 63, § 38C. In light of the analogous factual circumstances, we reach a similar conclusion in this matter.
