Which training, research, and quality-testing uses of machines withdrawn from finished-goods inventory were taxable?

Plain-English summary

A machine manufacturer withdrew finished goods for its training, application-research, and quality-assurance departments. The Board classified the uses by what the machine was actually doing.

Training service employees was taxable, including classes in which machines could be torn down and reassembled. Training owners of similar machines or prospective buyers in the machines' uses and applications was nontaxable demonstration and display.

Application research was taxable when machines were studied for improvements or new uses or were used to test other equipment. In quality assurance, testing a withdrawn machine to determine whether that machine met the manufacturer's own standards was nontaxable. Using one machine to test another, or to investigate problems reported in customers' machines, was taxable.

The memorandum separately reviewed a two-year lease with a purchase option and concluded it was not a lease in lieu of sale. Tax therefore applied to the monthly rental payments.

What this means for you

Manufacturers with training programs

Who is being trained and why matters. Customer-owner and prospective-buyer instruction promoted the machine itself; service-employee training served an internal operational purpose.

Research and quality-assurance teams

Distinguish the machine being evaluated from the machine used as test equipment. The former's own standards test was nontaxable here, while the latter's use to test other property was taxable.

Accountants and tax professionals

Track inventory withdrawals by department and specific function. Broad labels such as “training” or “quality assurance” did not determine the result.

Common questions

Q: Was training prospective buyers taxable?
A: No. The memorandum treated instruction about uses and applications for prospective buyers as demonstration and display.

Q: What about training employees who service the machines?
A: That was taxable use measured by the machines' cost.

Q: Could a machine be tested for its own quality standards without tax?
A: Yes, on the stated facts. But using that machine to test another machine was taxable.

Q: Were research activities exempt as demonstration?
A: No. Studying machines for improvements or new applications was taxable use.

Q: How were the lease payments treated?
A: The lease was not considered in lieu of sale, so tax applied to monthly rental payments.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 210.0560
• Original supporting opinion: 210.0560 PDF

Original ruling text

State of California

Board of Equalization

Memorandum

To:

San Jose - Auditing

From:

Tax Counsel (GAT) Headquarters

Subject:

B--- I---, Inc.
S--- Division
XXXX --- Avenue
--- ---, California

210.0560

Date:

July 21, 1967

SR -- XX-XXXXXX

This is in reply to your request for rulings concerning the application of use tax with respect to machines manufactured by B--- which are withdrawn from its finished goods inventories and charged to its Training, Application Research, and Quality Assurance Departments. It is our understanding that these departments use the machines in the following ways: (1) Training Department Machines charged to the training department are used in classes for training employees in servicing the machines. The machines are also used in other classes for training customers in their use. Machines may be used in classes for as long as 14 months. In the employee training classes, the machines may be completely torn down and reassembled. In the customer training classes, the trainees are instructed in the uses and possible applications of the machines. Customer trainees may be owners of machines or prospective buyers. In our opinion, the use of machines for training service employees is subject to tax measured by the cost thereof. On the other hand, it is our opinion that the use of machines to train owners of similar machines or prospective buyers constitutes demonstration and display. Accordingly, no tax is incurred with respect to such use. (2) Application Research Department New and standard models of machines are assigned to the Application Research Department for study to determine how they can be improved and whether they can be applied to uses other than those for which they were constructed. These machines are also used to test other instruments and accessories.

San Jose - Auditing
SR -- XX-XXXXXX

-2-

July 21, 1967
210.0560

In our opinion, the use of new and standard model machines by the Application Research Department to find new applications and to determine whether they can be improved and the use of the machines to test other machines are taxable uses. Therefore, the cost of such machines is subject to tax. (3) Quality Assurance Department Machines are assigned to the Quality Assurance Department to determine whether they meet the qualify and standards required by the manufacturer. In determining whether they meet such standards, other machines are used to test them. Machines are also used to check out problems which customers have complained of in their own machines. In our opinion, the testing of machines withdrawn from inventory to determine whether they meet company standards does not subject such machines to tax. On the other hand, it is our opinion that the use of machines to test other machines is subject to tax, and that the use of machines to check customer’s problems is likewise subject tot tax. We have examined the copy of the lease which you submitted. The lease is for a term of two years, renewable monthly thereafter. The lessee has the option to purchase the leased machine. If he then exercises the option within the first 60 days of the lease, he will be given credit for 100% of the rentals which he has paid toward the purchase price. If he exercises the option after 60 days, he will be given credit toward the purchase price for 75% of the rentals paid. In our opinion, this lease is not in lieu of sale. Accordingly, tax applies to the monthly rental payments.

GAT:ph