The Massachusetts Appellate Tax Board held that a corporation relying on contract manufacturing to produce its products was a “manufacturing corporation” and, therefore, required to use a single-factor apportionment formula in calculating its corporate excise.  Deckers Outdoor Corporation v. Commissioner of Revenue, Appellate Tax Board Docket Nos. C320020 and C321955 (June 21, 2018).  The Board’s decision is the latest in a line of decisions concluding that corporations utilizing contract manufacturers are engaged in manufacturing under Massachusetts tax law, although the Board emphasized that the resolution of the contract‑manufacturing issue continues to turn on a fact‑driven analysis. 

The Findings of Fact

Deckers Outdoors Corporation (“Deckers”) was a California-based footwear company whose major brands included UGG boots and Teva sandals.  It was the parent corporation of a large corporate group of domestic and international subsidiaries, including Chinese subsidiaries Deckers Macau Ltd. (“Macau”) and Deckers Outdoor (Guangzhou) Consulting Co., Ltd. (“Guangzhou”).

Deckers’ footwear products were manufactured in China by third parties.  Guangzhou was a liaison between Deckers and the third-party manufacturers.  Its employees were involved with compliance and quality control at the third‑party manufacturers’ factories.  Macau placed purchase orders with the third‑party manufacturers and also acted as a liaison for Deckers.

Each Deckers brand was assigned a “product team” including a product line manager, designers, and product developers, plus marketing and sales people.  A Deckers product line manager created a product brief that established parameters necessary for the designer to design the shoes, defined the product’s goals and attributes, specified the customers to whom the product was directed, and described the product’s desired use.

Next, a Deckers product designer translated the product brief into a sketch.  A more elaborate drawing followed, with detailed renderings of materials, colors, and specifications as to height, width, length, and thickness of shoes.  These more detailed drawings were then sent to Guangzhou, which would work with third‑party manufacturers to create an actual shoe from the drawings.

The resulting three-dimensional sample products were sent back to Deckers for the next step in the process, the initial line review.  The initial line review took place in California and typically involved a large team of Deckers employees.  They reviewed every aspect of the sample, from its look and feel to its functionality.  At this point, Deckers could drop a proposed shoe from a line altogether or make significant changes to the proposed design elements.

The changes desired by Deckers following the initial line review were communicated back to Guangzhou and, in turn, the third‑party manufacturers, which produced a second set of samples incorporating those changes.  A final line review of the footwear samples was then conducted by Deckers employees.

Finally, Deckers employees would create a tech pack, a multi-page document containing detailed information about the footwear item to which it relates, including drawings, materials, precise measurements of the features, and colors.  The tech pack was e-mailed by Deckers to the third‑party manufacturers.  The third‑party manufacturers used the tech pack to create three-dimensional renderings of the shoe.  The factories then engaged a mold-maker to create the molds and other items necessary for mass production of the shoe.  Because the molds contained valuable Deckers trademarks, title to them did not pass to third-party manufacturers, only possession.

Quality control was conducted throughout the production process.  Guangzhou personnel were present in the third‑party manufacturers’ factories to facilitate quality control.  A final quality control inspection took place at Deckers distribution centers in California.

The Opinion

In the Board’s view, the evidence demonstrated that Deckers was continuously involved in the creation of its footwear products, from the conception of an idea for a shoe in an initial product brief to its ultimate mass production.  The Board, therefore, concluded that the activities undertaken by Deckers amounted to the transformation of “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.” G.L. c. 63, § 38(l)(1).  Thus, Deckers was a manufacturer required to use a single-factor apportionment formula in calculating its corporate excise.

The Board did, however, abate the penalties assessed against Deckers.  In determining that Deckers’ understatement of tax was due to reasonable cause, the Board relied on the fact that Deckers had engaged national accounting firms to assist in the preparation and filing of its tax returns.

The Board’s decision relied heavily on similar decisions previously issued by the Massachusetts Supreme Judicial Court (Commissioner of Revenue v. Houghton Mifflin, 666 N.E.2d 491 (Mass. 1995); Onex Communications Corporation v. Commissioner of Revenue, 930 N.E.2d 733 (Mass. 2010)) and the Appellate Tax Board (The First Years Inc. v. Commissioner of Revenue, No. C267626, MA St. Tax. Rep. (CCH) ¶ 401-104 (App. Tax Bd. 2007); Random House, Inc. v. Commissioner of Revenue, No. C303502, MA State ARD (CCH) ¶ 401-413 (App. Tax Bd. 2012)).  Nevertheless, the Board’s detailed factual recitation confirms that the determination of manufacturing under Massachusetts law is a fact‑driven question, decided on a case-by-case basis.