Could preliminary art remain nontaxable if the client was allowed to dispose of the roughs after review instead of returning them to the agency?

Plain-English summary

An advertising business proposed separate purchase orders for roughs, visualizations, layouts, and comprehensives used only to present ideas before a separate finished-art order. Its proposed clause said title remained with the business but allowed the client either to return the materials or dispose of them when directed.

The Legal Division said that disposal option defeated the intended treatment. If the business did not require the client to return the layouts after review, it had sold them to the client and tax applied.

The opinion recommended deleting the disposal clause and retrieving the artwork after review. The other regulatory requirements still mattered: separate and clearly identified preliminary-art charges, proof that the work preceded finished-art approval, no physical incorporation into finished art, and retained hard copies for computer-prepared materials.

What this means for you

Advertising agencies and designers

Temporary client review should end with return of the physical preliminary art to the creator.

Clients

Possession for review is not the same as ownership, but keeping or disposing of the materials can change the result.

Accountants and tax professionals

Compare purchase-order language with actual return practices; a paper reservation of title is weak if the client controls final disposal.

Common questions

Q: Could the client destroy the preliminary art at the agency's direction?

A: Not under the proposed nontaxable arrangement. The opinion said the agency should retrieve it.

Q: Was a separate finished-art purchase order helpful?

A: Yes, but it did not cure the failure to require return of the preliminary materials.

Q: Did title need to remain with the agency?

A: Yes.

Q: Could preliminary art become taxable for other reasons?

A: Yes, including physical incorporation into finished art or failure to meet the separate-billing and record requirements.

Citations and references

• California Sales and Use Tax Regulation 1540(b)(4)(A), as quoted in the opinion
• California Sales and Use Tax Regulation 1698(d)

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 100.0163
• Original supporting opinion: 100.0163 PDF

Original ruling text

100.0163

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

JOHAN KLEHS
First District, Hayward

LEGAL DIVISION - MIC 82
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
Telephone No.: (916) 445-6450
Fax No.: (916) 445-4326

DEAN ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles
KATHLEEN CONNELL
Controller, Sacramento

February 14, 1995

BURTON W. OLIVER
Executive Director

Mr. J--- -. V---, esq.
---, --- & --Attorneys at Law
Suite XXX --- Square
XXXXX East --- Street
---, CA XXXXX
Re:

S--- A---, Inc.
Account No. SR -- XX-XXXXXX

Dear Mr. V---:
This is in reply to your October 20, 1994 letter regarding the application of sales tax to your client's charges for preliminary art. You provided us with the following statement which your client proposes to incorporate into its purchase orders relating to preliminary art: "The roughs, visualizations, layouts and/or comprehensives which The S--- A--Group will prepare according to this purchase order will be for the purpose of demonstrating the ideas of The S--- A--- Group. These ideas are being presented to the client in order to gain its acceptance of our ideas before entering into a contract for finished art. If the client determines that it wishes The S--- A--Group to prepare finished art, such work will be the subject of a separate purchase order. "The title to all ideas prepared pursuant to this purchase order remains the property of The S--- A--- Group. These roughs, visualizations, layouts and/or comprehensives must be returned to The S--- A--- Group after the client has had

Mr. J--- -. V---

-2-

February 14, 1995
100.0163

sufficient time to review them, or the client may dispose of them if directed to do so by The S--- A--- Group."

You ask for our confirmation that, if your client incorporates the proposed statement into its purchase order forms for preliminary art and your client requires separate purchase orders for the finished art, then sales tax would not apply to the client's charges for tangible personal property transferred to its customers pursuant to the purchase order for preliminary art. As you know, the application of sales tax to charges for preliminary art is provided at subdivision (b)(4)(A) of Sales and Use Tax Regulation 1540, Advertising Agencies, Commercial Artists and Designers: "'Preliminary art' means roughs, visualizations, layouts and comprehensives, title to which does not pass to the client but which is prepared by an advertising agency, commercial artist or designer solely for the purpose of demonstrating an idea or message for acceptance by the client before a contract is entered into or before approval is given for preparation of finished art to be furnished by the agency, commercial artist or designer to its client. Tax does not apply to separate charges for preliminary art except where the preliminary art becomes physically incorporated into the finished art, as, for example, when the finished art is made by inking directly over a pencil sketch or drawing, or the approved layout is used as camera copy for reproduction. If the preliminary art is prepared on data processing equipment, the advertising agency, commercial artist, or designer shall produce a hard copy of each of the roughs, visualizations, layouts or comprehensives presented for client approval and retain such copies in accordance with subdivision (d) of Regulation 1698. "The charge for preliminary art must be billed separately to the client, either on a separate billing or separately charged for on the billing for the finished art. It must be clearly identified on the billing as preliminary art. Proof of ordering or producing the preliminary art, prior to the date of the contract or approval for finished art, shall be evidence by purchase orders of the buyer, or by work orders or other records of the agency, commercial artist or designer. No other proof shall be required." Essential to the nontaxability of preliminary art is that the agency does not pass title to the preliminary art to the customer. Under the language of the proposed statement, if S--- does not require the client to return the layouts, S--- has sold them to the client, and tax applies to the charge for the sketches or layouts.

Mr. J--- -. V---

-3-

February 14, 1995
100.0163

Therefore, we suggest you delete the last clause of the last sentence of the proposed statement. When S--- provides preliminary art to clients, it should retrieve the artwork after the client reviews it. We hope this information answers your questions; however, if you need further information, feel free to write again. Very truly yours,

Ronald L. Dick
Senior Staff Counsel
RLD:sr
cc: --- --- District Administrator - --