Were speculative advertising sketches sold for sales presentations taxable in California even when the final directory ad was recreated?

Plain-English summary

A graphics business created computer-designed "spec ads" before advertising space was sold. It printed each ad and transferred it for use in a sales presentation. After a customer approved the concept, an internal graphics department recreated the final yellow-pages advertisement.

The Board's tax counsel said the transferred spec ads were taxable retail sales even though they were only sketches or guidelines and might not be used in the final directory version. Regulation 1540 applied tax to the entire charge for transferred drawings, designs, and sketches, whether or not they were display-ready or usable for actual reproduction.

The quoted rule separately excluded qualifying preliminary-art charges, but the letter treated these transferred spec ads as taxable and did not find that exception applicable to them.

The business also asked about paper, printer supplies, and other production materials. Tax applied to materials the business used to create the advertisement. Only property purchased for incorporation into the advertisement sold could be bought for resale or support a tax-paid-purchase-resold deduction.

What this means for you

Graphic artists and advertising vendors

A sketch can be taxable even when the buyer uses it only as a sales tool or creative guide. Whether another team later recreates the final advertisement did not change the transferred sketch's treatment.

Businesses commissioning speculative ads

Do not assume a pre-sale mockup is nontaxable merely because it precedes the final ad. The opinion focused on the transfer of tangible drawings or sketches to the client.

Accountants and tax professionals

Separate consumed production supplies from material incorporated into the delivered product. The former were taxable to the artist; the latter could qualify for resale treatment.

Common questions

Q: Were the spec ads taxable even if the final layout was different?

A: Yes. The transferred sketches were taxable even when used only as guidelines.

Q: Did it matter that the ads were created on a computer?

A: No. The opinion focused on the printed sketch transferred to the customer.

Q: Were all preliminary-art charges taxable?

A: No. The quoted regulation allowed a separate exception for qualifying preliminary art, but the letter did not apply it to these transferred spec ads.

Q: Could the artist buy paper and printer supplies for resale?

A: Only to the extent the property was purchased for incorporation into the advertisement sold. Supplies used or consumed in production were taxable to the artist.

Citations and references

• California Revenue and Taxation Code § 6051
• California Civil Code § 1656.1
• California Sales and Use Tax Regulations 1525(a)–(b) and 1540(c)

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 100.0010
• Original supporting opinion: 100.0010 PDF

Original ruling text

100.0010

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
PO BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001
TELEPHONE (916) 445-6450

March 4, 1993
Ms. A--- W--Bookkeeper
P--- G--XXXX --- ---, Studio XXX
---, CA XXXXX
Dear Ms. W---:
This is in reply to your September 28, 1992 letter regarding the application of sales tax to your charges to P--- for advertisements under the following facts you provided: “When asked to create an ad for P---, our graphic artists use computers and their talent to create the ad. It is printed at our establishment and sent to P---, and of course we charge them a fee. This advertisement is called a ‘Spec Ad’ and is produced prior to the sale of advertising space to the customer. “The P--- sales people then use our ad in presentation to the customer; on approval from their customer P---’s internal graphics department then recreates the ad for the yellow pages, using the guidelines from our ad. “Camera ready art is produced by P--- and placed in the yellow page directory . . .
.”
Given this information, you asked the following specific questions: “Since our ad is only a guideline, should we charge sales tax based on the fact that the ad itself is not used, and sometimes not even our layout is used for the final version of the directory?” We first note that the sales tax is imposed on retailers at the applicable rate of the gross receipts of the sale of all tangible personal property sold at retail in this state. (Rev. & Tax. Code § 6051.) Whether or not you collect reimbursement for the tax from your customer is a matter of contract between you and the customer. (Civ. Code § 1656.1.) Sales tax applies to your retail sale of advertisements to Pacific Bell even though the advertisements may be only in the form of sketches. Sales and Use Tax Regulation 1540, Advertising Agencies, Commercial Artists and Designers, provides at subdivision (c):

Ms. A--- W---

-2-

March 4, 1993
100.0010

“The tax applies to the entire amount charged by commercial artists or designers for items of tangible personal property such as drawings, paintings, designs or sketches transferred to the client, whether or not the property is suitable for display or is useful for actual reproduction by photo-mechanical or other processes. “Tax does not apply to separate charges for preliminary art as defined in (b)(4)(A).” Enclosed is a copy of this Board’s Pamphlet 38, Tax Tips for Advertising Agencies, for your further information. “If so, are we then allowed credit for the materials used to produce the ad such as paper, printer supplies, etc.?” Tax applies to the sale to you of tangible personal property which you use in creating the advertisement you sell. We are enclosing a copy of Sales and Use Tax Regulation 1525, Property Used in Manufacturing. As noted in subdivision (a), tax applies to the sale to you of tangible personal property you use in producing the product you sell. As noted in subdivision (b), you may purchase for resale or take a tax-paid purchase resold deduction only for the sale to you of tangible personal property you purchase for the purpose of incorporating into the advertisement. We hope this answers your question; however, if you need further information, feel free to write again. Very truly yours,

Ronald L. Dick
Senior Tax Counsel
RLD:sr
Encs.