We frequently receive questions about the differences between contract brewing and alternating proprietorships, as well as questions concerning the key details the Alcohol and Tobacco Tax and Trade Bureau (TTB) and other regulators will be looking for in either approving the proposed structure or, more importantly, during a company audit. Here we discuss the primary considerations for businesses utilizing other premises for production.
Alternating Proprietorship. The TTB allows two or more proprietors with different federal employer identification numbers (FEINs) to operate their respective businesses at the same premises by alternating and sharing space and/or equipment. How does it work? Typically, each proprietor obtains its own federal and state licenses and permits and operates and produces on its own behalf; these latter tasks include maintaining its own reports, records, excise tax payments, label approvals, and bond changes once approved. One proprietor is the “host,” and another is a “tenant” paying rent to the host. The rent can be a fixed monthly rate or based on equipment-hour usage. Other shared-cost arrangements are possible, as well.
During its review of an alternating proprietor’s application for a federal basic permit, the TTB will evaluate the written agreement between the alternating proprietor and the host. The TTB’s primary concern is to ensure the protection of each proprietor’s revenue. As such, the separation and movement of each proprietor’s products, payment of taxes, etc., will likely face the most scrutiny by TTB in an alternating proprietorship agreement. Accordingly, the alternating proprietorship agreement should expressly state that the alternating proprietor is responsible for its own production, recordkeeping, reporting, labeling, and payment of taxes. The agreement should provide that the alternating proprietor will pay the host directly for its floor space, equipment use, and, where applicable, personnel time and material consumed if the host is to provide additional services or materials. Payment to the host should not be based on volume rates (e.g., tons, gallons, or cases). The TTB reviews all of these factors to determine if the arrangement is a true alternating proprietorship and not a contract manufacturing relationship in disguise.
Entities engaging in alternating proprietorships frequently use a combination of direct employees and independent contractors to maintain their operations. In this highly specialized industry, independent contractors are in high demand due to their extensive knowledge and experience. Utilizing these workers enables producers to meet higher production targets with a shorter learning curve, while allowing direct employees to learn the process with limited downtime. However, it should be clear in the alternating proprietorship agreement that these employees are acting solely at the alternating proprietor’s direction, or they should be hired directly by the alternating proprietor.
Contract Manufacturing. Also known as co-packing, contract manufacturing is an operational methodology that differs from an alternating proprietorship. With contract packaging, a co-packer entity produces and/or packages product(s) on behalf of their customers, with all operations occurring under the co-packer’s license or permit and often under the customer’s trade name. In a co-packing situation, the co-packer also may be producing or packaging for multiple customers at the same time. Since these operations all occur under the co-packer’s permit, the co-packer handles all related reporting, records management, tax payments, and label approvals. From an excise tax perspective, this type of operation generally results in the application of the TTB’s single-taxpayer rule, which aggregates all production of the co-packer, regardless of the number of customers, for purposes of eligibility for reduced excise tax rates under the Craft Beverage Modernization Act. For this reason – and to avoid excessive tax liability in future audits for both the co-packer and its customers – it is imperative to understand these implications.
Key Considerations. When assessing whether to engage with a third party under an alternating proprietorship or contract manufacturing arrangement, it is important to keep in mind the key differences between these two options. These methods of operation are quite distinct: An alternating proprietorship is made up of multiple separate permittees sharing space and/or equipment and operating on their own behalf with only one entity operating in the alternating areas at any given time, whereas co-packing is a single entity operating on behalf of other entities, with operations able to occur simultaneously throughout the premises since the premises are controlled by a single permittee. For this reason, the TTB will thoroughly analyze each of these operations during the audit process, from ingredient acquisition and production to sales and recordkeeping, to assure that the operations and ways of working do in fact mirror the chosen model.
In conclusion, there are advantages and disadvantages to the contract manufacturing arrangement and alternating proprietorship arrangement. Industry members, new and seasoned, must carefully consider a number of factors before deciding which structure to use. This can be a complex and confusing process; if you are interested in learning more, contact one of the members of McDermott’s alcohol beverage team.
