Are pallet rental fees and related delivery/transfer charges taxable for a food manufacturer, given the packaging-supplies exemption for pallets?

Plain-English summary

A Texas food manufacturer packed its products (all falling within the general food-for-human-consumption definition) onto leased pallets for shipment in three scenarios: directly to retail customers for resale; to its own company-owned warehouses for repacking or further distribution; or to a third-party warehousing/distribution company for repacking and shipment. No separate charge or deposit applied to the pallets, and they weren't returned to or reused by the manufacturer. The pallets were provided by an out-of-state rental company — the manufacturer didn't hold title but could transfer them to authorized "Participating Distributors." The manufacturer was billed a Daily Rental Fee, an Issue and Delivery Fee (delivering a pallet from a depot to the manufacturer), and a Transfer Fee (shipping a pallet to a participating distributor).

The manufacturer argued these charges should be tax-exempt under Rule 3.314(a)(4), which defines "packaging supplies" — a category exempt when purchased or leased by manufacturers as part of completing the manufacturing process — to specifically include pallets.

The Comptroller ruled tax IS due on the daily rental fee and all related transfer, issue, and delivery fees, in each of the three scenarios. The reason: Tex. Tax Code Sec. 151.318(e) carves out an exception to the manufacturing exemption — it does not apply to any taxable item rented or leased for less than one year to a person engaged in manufacturing. Because these pallets were rented on a daily basis, they fall outside the exemption regardless of their "packaging supplies" classification.

The letter does note a path to exemption: pallets leased for more than one year, under an agreement executed on or after October 1, 1995, along with their related fees, WOULD qualify for exemption when used to package products for delivery to retail customers.

What this means for you

Manufacturers leasing pallets or other packaging equipment

Even though pallets generally qualify as exempt "packaging supplies" under Rule 3.314(a)(4), that exemption is defeated if you lease them short-term (under one year) rather than purchasing them or leasing them for a year or more. If cost matters, structuring a pallet lease for a term of one year or longer (under an agreement dated Oct. 1, 1995 or later) can preserve the manufacturing/packaging-supplies exemption on both the lease charges and related delivery/transfer fees.

Accountants and tax professionals

This is a useful example of Sec. 151.318(e)'s short-term-lease carve-out overriding an otherwise-applicable manufacturing/packaging exemption — the classification of the item (pallet = packaging supply) isn't enough; the lease term itself is independently determinative.

Common questions

Q: Are pallets always tax-exempt for manufacturers under Rule 3.314?
A: Not automatically -- per this letter, Sec. 151.318(e) removes the exemption for any taxable item leased for less than one year, regardless of its packaging-supplies classification.

Q: What lease term would preserve the exemption?
A: Per this letter, a lease of more than one year, under an agreement executed on or after October 1, 1995, used to package products for delivery to retail customers.

Q: Does it matter which of the three shipping scenarios the pallets are used in?
A: No -- per this letter, tax is due on the daily rental and related fees in all three scenarios described (direct-to-retail, company warehouse, or third-party distributor).

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318(e) (manufacturing exemption does not apply to items leased for less than one year)
• 34 Tex. Admin. Code Rule 3.314(a)(4) (packaging supplies definition, includes pallets)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9806576L

Original ruling text

June 3, 1998

Dear Mr. **:

This is in response to your request for a written ruling regarding the proper
application of Texas sales and use tax to your client's business operations in
Texas. You have attempted to describe the exact nature of the transactions in
question as fully as possible. To the best of your knowledge, no material facts
or circumstances have been omitted.

Your client is a producer of food products with manufacturing and distribution
facilities in the state of Texas. All of your client's inventory products are
for resale and fall within the general definition of food products for human
consumption per Texas Section 151.314, Tax Code.

In the normal course of their business operations, your client packs their food
products onto leased pallets for shipment in the following scenarios:

1. directly to retail customers for resale to the public;

2. to company-owned warehousing and distribution facilities for either: a)
   repacking and subsequent delivery to retail customers for resale b) subsequent
   delivery directly to retail customers for resale or c) customer- pick-up by
   retail customers for resale; or

3. to a third party warehousing and distribution services company for repacking
   and subsequent shipment to retail customers for resale to the public.

In all scenarios, no separate charge or deposit is made or required for the
pallets and they are not returned directly to our client or reused by our
client.

The pallets used by our client are provided by an out-of-state company under a
rental agreement. The terms of the agreement state that our client does not
retain title to the pallets, but can transfer the pallets to authorized parties
(i.e. Participating Distributors).

Your client is charged a "Daily Rental Fee" for the use of the pallets, as well
as an "Issue and Delivery Fee" for the actual delivery of a leased pallet from
a depot to your client's location and a "Transfer Fee" charge for the shipping
of a leased pallet to a participating distributor, which may include a retail
customer or distribution center not related to my client.

Based on the facts presented you feel that your clients use of pallets may fall
within Texas Regulation, 34 TAC Sec. 3.314, which states that:

"sales or use tax is not due on containers or packaging supplies purchased (or
leased) by manufacturers for use as a part of the completion of the
manufacturing process."

Section 3.314(a)(4) specifically defines "packaging supplies" to include
pallets.

With the above facts and circumstances in mind, you respectfully request an
opinion regarding the proper application of the Texas sales and use tax to the
three scenarios described above. As well as to the taxability of the individual
charges billed to your client of "daily rental fees", and the service charges
consisting of "issue and delivery charges" and "transfer fees".

Response: Tax would be due on the daily rental fee for the pallets and the
related transfer, issue and delivery fees by your client in each of the three
scenarios. Subsection (e) of Texas Tax Code 151.318 - Property Used in
Manufacturing states that "(t)his section does not apply to any taxable item
rented or leased for less than one year to a person engaged in manufacturing."

Pallets leased for a period of more than one year under an agreement executed
on or after October 1, 1995, and related fees, would qualify for exemption when
used to package products for delivery to retail customers.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts. You may also e-mail our tax help section at:
.

Sincerely,

Gilbert Zamora
Tax Policy Division