The Supreme Judicial Court ruled today that Skechers is a "manufacturing company" and so owes more in state taxes than it would otherwise, even if all of its footwear products are made in third-party factories in Asia.
At issue was roughly $190,000 in excise taxes and interest assessed for 2020 after the state Department of Revenue concluded Skechers, based in California, was engaged in manufacturing, which typically means a higher tax bill for manufacturers not based in Massachusetts under the way the state calculates excise taxes. The company appealed to the state Appellate Tax Board, which ruled against it, so it then appealed in court.
"Skechers contends that its business is to design and market footwear, but that it plays only an 'incidental' role in the actual production of its shoes," the state's highest court noted, before giving a very detailed explanation of how Skechers footwear goes from its designs to physical objects, a process in which Skechers designers are involved at every step to ensure the final product meets their exacting standards. For example:
The third-party factories then conduct initial production runs. Skechers personnel confirm that each size is produced in accordance with the specifications and standard operating procedures and conduct quality checks. If these are satisfactory to Skechers, the factories may go forward with production. Skechers quality assurance personnel also perform visual inspections of equipment and verify that machinery operates within required specifications. If deficiencies are identified, Skechers directs corrective action, and production does not proceed until the issues are resolved. Skechers's overseas personnel remain present at the factories, and samples are sent to Skechers employees in the United States for inspection.
In Massachusetts, the court said:
To qualify as manufacturing, the taxpayer's activities must play an "essential and integral" part in the total manufacturing process, even if those activities do not produce a finished product for the consumer. ... This test has been phrased as whether the taxpayer's contribution "is a sine qua non of the produced items' ultimate salability." ...
In Skechers's case:
Applying these principles, the record amply supports the board's conclusion that Skechers is engaged in manufacturing. Skechers's activities extend far beyond the creation of concepts or designs. Skechers designers prepare specifications that set forth the parameters of nearly all aspects of the proposed product, including materials, dimensions, stitching, colors, and technological features. Its involvement continues beyond prototyping into the preproduction process, in which Skechers designers and product technicians review and revise prototype pullovers, marking changes directly on the pullover and requiring further refinements. Skechers reviews and revises molds and requires that lasts conform to its specifications. Skechers's requirements govern the third-party manufacturers' selection of materials used in production. Although factories may independently purchase raw materials, they must comply with those requirements, and Skechers may require the use of specific suppliers. Skechers conducts or reviews testing to ensure that materials meet required performance standards.
Skechers's role continues through production. Before full production begins, factories conduct test runs and prepare standard operating procedures, which are submitted to Skechers for review and approval. During production, Skechers employees present at factories confirm that products are manufactured in accordance with specifications and perform inspections, including verification that machinery operates within required parameters. Skechers conducts final inspections and designs the packaging for final sales.
And so, Skechers gets to join a long line of companies in other industries that tried the same argument and lost:
Skechers's involvement in the manufacture of Skechers brand footwear by third-party factories is comparable to that of Houghton Mifflin in the development of content to be produced by third parties as printed books or compact discs, see Houghton Mifflin Co., 423 Mass. at 48, 50-51; more extensive than Onex Communications' design and development of prototype computer chips, see Onex Communications Corp., 457 Mass. at 421, 430-432; and more transformative than the scrap metal repurposing conducted in William F. Sullivan & Co., 413 Mass. at 577-578, or the produce packaging in Noreast Fresh, Inc., 50 Mass. App. Ct. at 353-354.