cleanrooms in taxing situation due to legal wrangling
By Hank Hogan
To paraphrase Shakespeare, a cleanroom by any other name might smell as sweet but it probably would be taxed differently. Just how differently depends upon where the cleanroom was located and what it was being used for. Most states and localities provide for some kind of sales and property tax relief for manufacturing plants, and manufacturing certainly takes place in cleanrooms. The rub, to again borrow from the Bard, lies in de fining just where a cleanroom begins and ends. Laws which recently went into effect in Texas and Arizona illustrate this.
While Texas can boast of having no income tax the state does have a sales tax, which manufacturing plants are exempt from. This exception applies only to machinery and tools that are essential to manufacturing and not those that are incidental to it. A series of court rulings in 1995 resulted in intraplant piping and transport being declared free from sales tax, a not inconsequential revenue loss in a state with many piping laden petrochemical plants. The Texas Legislature, which meets every two years, set about to correct the situation and produced a law that took effect on October 1, 1997. The law clarified the situation: piping used for transportation was not exempt. However, piping is also used extensively in cleanrooms and often is very expensive.
With sales tax in some areas in Texas as high as 8.25 percent and with the cost of cleanroom equipment often measured in the millions of dollars, a sales tax exemption can be worth quite a bit. What`s more, the impact of such an exemption is felt regardless of the level of profitability. “The exemption from sales tax for qualifying manufacturing equipment makes Texas a very attractive place for a semiconductor fab owner to build a plant,” sums up David Cowling, a partner with the Jones, Day, Reavis & Pogue law firm in Dallas. Cowling is also a tax counsel for the American Electronics Association (AEA) in Texas. Clearly the effect of the piping and other clarifications on the cleanroom industry in Texas was potentially disastrous, and the AEA made sure that lawmakers were fully aware of that. Partly as a result of this the legislature wrote provisions into the law that specifically extended the sales tax exceptions to some but not all cleanrooms.
“The more liberalized provisions apply to semiconductors,” notes Cowling. Cleanrooms used for other manufacturing, such as pharmaceutical or medical devices, don`t get the benefit of the broader exemption but items used directly in manufacturing anywhere are still sales tax free. It`s too early yet to tell what the impact of preserving the Texas cleanroom tax benefit might be. However, by the time the legislature is in session again in 1999 there might be some indications and that could lead to further clarifications of the law.
In Arizona the issue was not sales tax but property tax. Arizona has two property tax rates, with the one for personal property being quite a bit lower than the one for real property. Through a series of edicts, the state Department of Revenue had for years ruled that cleanrooms and the equipment in them were personal property. Given the high cost of a modern semiconductor cleanroom there was good reason for the state government to do this for semiconductor manufacturers.
“You`ve got to have some property tax benefits because they`re so capital intensive that a traditional approach to valuing high tech firms would really give them a very high property tax,” says Barb Dickerson, a principal in the Arizona state and local tax practice of the business services firm Arthur Andersen in Phoenix.
Problems arose when officials with Maricopa County, where Phoenix is located, started looking into taxing cleanrooms as real property. Such a change, according to Dickerson, would have resulted in the property tax on a cleanroom valued at $250 million going from $1.8 million to $6.5 million. Given that in other localities cleanrooms are classified as real property, such a change would not be completely out of line, but the Arizona legislature took care of the matter by issuing a law in May 1997 that codified what had been the standard practice. “The legislation says that cleanrooms used for the manufacturing of semiconductor products will be treated as tangible personal property and then for sales and use tax purposes we had the definition added to the exemptions under machinery and equipment,” explains Dickerson. According to Dickerson, officials in Maricopa County were very cooperative with the effort. Also according to Dickerson, the definition of just what is and isn`t in a semiconductor cleanroom is based on the one used in Texas.
As for the future, the legislative game of tax adjustment is likely to continue. Virginia changed its stand on cleanrooms in May 1995, allowing localities to tax the equipment in them at a special lower property tax rate by creating a special classification for such equipment. While it may be coincidental, the fact is that several major semiconductor facilities have recently gone up in Virginia. Oregon allows a hefty local property tax abatement. California offers an investment tax credit, but one of the problems with this approach is companies must make a profit in order to reap the benefits of the credit. Because of that Apple Computer and other high technology firms are trying to have the law changed so that profitability isn`t mandatory, which could have an impact on any firm in startup operations.
No matter what happens there will continue to be more rounds of taxing debates about just what is and isn`t a cleanroom as well as discussions about which tax breaks, if any, they ought to get.
Hank Hogan is a freelance writer based in Austin, TX.