California Code of Regulations (CCR), tit. 18, section 23649-5 states that for purposes of CCR sections 23649-1 through 23649-11, inclusive, the term "qualified property" includes tangible personal property, whether new or used, that is defined in Internal Revenue Code (IRC) section 1245(a)(3)(A) and is used by a qualified taxpayer in both an activity that is described in Division D of the SIC Manual and primarily in a qualified activity.
In order for property to be treated as qualified property, the property must satisfy each of the requirements of each subsection of CCR section 23649-5. In order for property to qualify for the MIC, it must be tangible personal property used by a qualified taxpayer in a qualified activity in California.
The first requirement is that the property must be tangible personal property. Section 23649-2 defines "tangible personal property" to mean any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures). Tangible personal property includes all property (other than structural components), which is contained in or attached to a building. Thus, for example, production machinery, printing presses, and testing equipment that is contained in or attached to a building is tangible personal property. Furthermore, all property which is in the nature of machinery (other than structural components of a building or other inherently permanent structures) shall be considered tangible personal property even though located outside a building. The determination of whether property will be treated as an inherently permanent structure shall be made under IRC section 1245(a), so that generally property will be treated as an inherently permanent structure (and thus not tangible personal property) if the property is either intended to be or is in fact affixed permanently, and is either incapable of being moved or, if movable, would suffer a significant degree of damage upon its removal. Local law, including state, county, city, or regional, shall not be controlling for purposes of determining whether property is or is not "tangible" or "personal," so that the fact that under local law property is held to be personal property or tangible property shall not affect the determination of whether such property is tangible personal property for purposes of the MIC.
The basic definition of tangible personal property is that it is not:
- Land or land improvement;
- Buildings; or
- Inherently permanent structures; nor
- Structural components
It is in the nature of machinery even though located outside a building.
To help in the clarification of the definition of tangible personal property, we need to examine Federal Treasury Regulation section 1.48-1 which defines and provides examples of tangible personal property for the Federal Investment Tax Credit (ITC) under IRC section 38. Many Revenue Rulings and court cases further developed the various issues regarding tangible personal property. The following discussion may assist you in determining whether an item of property is tangible personal property for purposes of the MIC.
One area of property that does not qualify for the MIC is Section 1250 real property. The term "real property" includes land, improvements, and personal property associated with the use of real property. Examples of real property may include sidewalks, roads, canals, waterways, drainage facilities, sewers, wharves and docks, bridges, fences, landscaping, shrubbery, or radio and television transmitting towers. Treasury Regulation section 1.48-1(e) provides some general guidelines for defining items that are classified as land and land improvements.
The following Revenue Rulings and cases discuss land improvement in regards to the ITC and may be helpful in understanding the term land improvements. For purposes of the ITC, land improvements may qualify as section 38, "other tangible property", if they are an integral part of the specified activities for the ITC but they would not qualify for the MIC.
Rev. Rul. 66-269, 1966-2 CB 13
Rev. Rul. 68-281, 1968-1 C.B. 22
Rev. Rul. 69-329, 1969-1 CB 30
Algernon Blair, Inc. [CCH Dec. 22,906], 29 T. C. 1205 (1958)
John J. Johnston and Evelyn R. Johnston [80-1 USTC 9199]
Most courts considering buildings for the federal ITC have assumed that the structure could only qualify for the ITC as "other tangible property" under IRC section 48(a)(1)(B). However, other tangible property does not qualify for the MIC. Therefore, buildings which qualify for the MIC will generally be limited to special purpose buildings and foundations described in California Revenue and Taxation Code (RTC) section 23649(d)(4)(A), which are specifically included irrespective of their status as tangible personal property. Treasury Regulation section 1.48(a)(1)(E) defines the term "building" to generally mean:
". any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores."
Earlier court cases employed an "appearance test" following plain language of the regulations (e.g., if the structure looked like a building, it was a building). Subsequent case law developed a "functional test" in addition to the appearance test. The functional test analyzes whether the structure is a specialized structure that its utility is primarily and principally a significantly contributive factor in manufacturing or producing the product.
Thirup v. Comr., 508 F.2d 915 (9th Cir. 1974) & US-CT-APP-9, [75-1 USTC 9158], Thirup v. Comr.
Consolidated Freightways, Inc., v. Comr., 708 F.2d 1385 (1983) & [80-1 USTC 9356]Consolidated Freightways, Inc., v. United States
Tamura v. United States, 734 F.2d 470 (1984)
Brown-Forman Distillers Corporation v. United States, 205 Ct.Cl. 402 (1974) (IRS No Certiorari)
Adolph Coors Co., 27 T.C.Memo 1968-256.
Mcmanus v. United States, 863 F.2d 491 (7th Cir. 1988)
Munford, Inc. v. Comr., 849 F.2d 1398 (11th Cir. 1988)
McKenzie v. Comr., 85 T.C. 875 (1985)
The term structural component refers to improvements relating to the general operation or maintenance of a building as opposed to improvements which service specific items of tangible personal property. Federal regulations 1.48e(2) states that structural components includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components thereof; sprinkler systems; and fire escapes. However, as courts have stated, "We are not clear as to exactly what distinguishes a structural from a non-structural component of a building or other inherently permanent structure" (Weirick et. al. v. Comr., 62 T.C. 446 (1974), n.5). There are no general rules concerning these assets and the specific facts of each case must be analyzed in light of the examples in the regulations. The one exception is the "sole justification" test, which provides that the term does not include machinery required to meet the temperature or humidity requirements of other machinery. Some ITC cases addressing various types of building components are as follows:
A. C. Monk & Co. v. Comr., 686 F.2d 1058 (4th Cir. 1982) & [83-2 USTC 9678]A. C.
Monk and Company, Inc. v. United States
Scott Paper Co., v. Comr., 74 T.C. 137 (1980) Illinois Cereal Mills, Inc. v. Comr., 789 F.2d 1234 (7th Cir. 1986) & 86-1 USTC 9371]
Illinois Cereal Mills, Inc. v. Comr.
Morrison, Inc. v. Comr., 891 F.2d 857 (11th Cir. 1990)
Texas Instruments v. Comr., T.C. Memo 1992-306
L.L. Bean, Inc. v. Comr., T.C. Memo 1997-175 & (CA-1), U.S. Court of Appeals, 1st Circuit, 97-2104, 97-2105, 5/28/98
Piggly Wiggly Southern, Inc., 84 T.C. 739 (1985) (IRS Non-acquiescence
In the analysis of both building and structural components, the question of inherent permanence is often examined. When categorizing property as either tangible personal property or real property, the IRS initially established a functional use or equivalency test. This test looked at the consequences surrounding the purpose for which an asset was used instead of the inherent characteristics. (See Rev. Rul. 67-23, Rev. Rul. 68-345 and 69-14.) The functional use test examined whether the property in question served a function normally performed by a permanent structure or structural component in which case the property itself was considered a permanent structure or component. The IRS formally abandoned the functional use test in Rev. Ruling 75-178, 1975-1 C.B. 9. The Revenue Ruling also established the following criteria to use in evaluating property: (1) whether the property is removable or movable; (2) its means of attachment; (3) its design; and (4) whether it bears a load. The inherent characteristics of the property are more important than the property's function or use.
In Whiteco Industries, Inc. v. Comr. (65 T.C. 664 (1975)) the Court reviewed case law and concluded the following six questions should be addressed to determine whether a particular asset is tangible personal property.
(1) Is the property capable of being moved and has it in fact been moved?
(2) Is the property designed or constructed to remain permanently in place?
(3) Are there circumstances which tend to show the expected or intended length of affixation, i.e., are there circumstances which show that the property may or will have to be moved?
(4) How substantial a job is removal of the property and how time-consuming is it?
(5) How much damage will the property sustain upon its removal?
(6) What is the manner of affixation of the property to the land?
The IRS accepted Whiteco factors in Rev. Ruling 80-151, 1980-1 C.B. 7, and illustrated how to apply the six factors. This analysis was applied repeatedly by the courts to determine if the property was a inherently permanent structure or a structural component. The analysis of an asset must be made on a case by case basis to determine if it is tangible personal property.
There are exceptions to the MIC's tangible personal property rule for:
Off-The-Shelf software used in a qualified activity by a qualified taxpayer and upon which California sales or use tax has been paid can qualify for the MIC. Software costs usually include cost of tangible media such as a disk, CD-ROM or DVD but often include costs for such things as a license agreement and labor costs relating to the customizing of the software. Board of Equalization Regulation 1502 provides that under certain circumstances these items can also be subject to sales tax. You may wish to review this regulation to make sure that the software costs are subject to California sales tax as well as examine the amount upon which sales tax was paid.
Special Purpose Buildings and Foundations
Special purpose buildings and foundations can qualify for the MIC if they are primarily used by any qualified taxpayer engaged in a manufacturing activity described in SIC Codes 3571-3579 (computer and office equipment), SIC Codes 3671-3679 (electronic components and accessories), an activity related to biotechnology described in SIC Code 8731 (commercial physical and biological research), a biopharmaceutical activity described in SIC Codes 2833-2836, those activities related to space vehicles and parts described in SIC Codes 3761-3769, those activities related to space satellites and communications satellites and equipment described in SIC Codes 3663 and 3812 (but only with respect to "qualified property" that is placed in service on or after January 1, 1996), or those activities related to semiconductor equipment manufacturing described in SIC Code 3559 (but only with respect to "qualified property" that is placed in service on or after January 1, 1997). For more information on special purpose buildings and foundations see RTC section 23649-(d)(3) and CCR section 23649-5(c).
Other Tangible Property
For qualified taxpayers engaged in refining activities properly classified in SIC Code 2911, "qualified property" also includes other tangible property that is defined in IRC section 1245(a)(3)(B) and that satisfies each of the following requirements:
(1) Used in that line of business properly classified in SIC Code 2911;
(2) Used primarily in refining; and
(3) Used to produce "reformulated gasoline" or "oxygenated gasoline", as defined in and pursuant to the requirements imposed by Section 219 of Public Law 101-549, relating to certain amendments to Section 211 of the federal Clean Air Act, and, on or after March 1, 1996, is used principally to produce gasoline that meets the California Air Resources Board standards set forth in Title 13, Division 3, Chapter 5, Article 1, Subarticle 2, California Code of Regulations (as in effect on February 1, 1996).
In addition, the following types of tangible personal property are specifically excluded (RTC section 23649-(d)(4) and CCR section 23649-5(d)):
(1) Any item of furniture, regardless of how used or where located.
(2) Property used for warehousing purposes after completion of the manufacturing process. For example, a manufacturer of engine components that stores its finished products in a separate warehouse building prior to shipment and thereafter uses forklifts and other heavy equipment to move the inventory within the warehouse building shall not treat the forklifts and other heavy equipment as qualified property.
(3) Any property that is properly treated as inventory of the qualified taxpayer. For this purpose, the term "inventory" includes any property which is required to be included in the qualified taxpayer's inventory under IRC section 263A or that is described in IRC section 1221(1).
(4) Any equipment used in the extraction process. Thus such items as drill bits, rigging, and pumps used in wells and mines to extract oil, water or minerals would not be treated as qualified property.
(5) Any equipment used to store finished products that have completed the manufacturing process. For example, if a qualified taxpayer primarily uses a forklift in the finished goods portion of its manufacturing plant to transport finished products to its loading dock for shipping to customers, the forklift would not be qualified property. On the other hand, if the forklift was primarily used to transport raw materials to the assembly line and was occasionally used to transport finished products to the loading dock for shipment to customers, the forklift would be treated as qualified property.
(6) Property that is used both in a qualified activity and for administration, general management, or marketing, shall be treated as qualified property only if the item is primarily used in a qualified activity.
(7) Any property for which the qualified taxpayer has claimed the low-emission vehicle credit provided in RTC sections 17052.11 and 23603.