Could a drill-bit maker exclude a credit for industrial diamonds recovered from a customer's old bit when the new bit used commingled diamonds?

Plain-English summary

A drill-bit manufacturer removed usable diamonds from customers' returned bits, sorted them by size, and commingled them with equivalent diamonds in inventory. New bits were made from the common inventory rather than from the particular stones recovered from each customer's old bit.

The memorandum still allowed the customer credit to reduce taxable gross receipts. The industry made no commercial distinction between new and used industrial diamonds of the same size and quality, so the stones were fungible and the carat-weight credit could be treated as return of the customer's own diamond value.

The new bit was not an exchange under the cited ruling because it was regarded as completely new, but fungibility independently supported excluding the credit.

Citations and references

• California Sales and Use Tax Ruling 26 (as cited)
• Out-of-state audit staff's question about invoice credits labeled “less customers dias. set” on “reset and return your own diamond bit” transactions — facts and question supplied; audit request, attachments, taxpayer and customer identities, invoices, and complete credit terms not reproduced in the official PDF
• Returned used drill bits, salvaged diamonds, size sorting, inventory commingling, new-bit manufacture, industry treatment of comparable new/used diamonds, and customer diamond credits — facts supplied; bits and stones, receiving and salvage records, grading and quality evidence, inventory records, manufacturing records, industry materials, credit calculations, customer accounts, sales records, returns, and tax computations not reproduced in the official PDF
• Official Annotation 295.0260's new/used-diamond fungibility, salvage, customer-account credit by carat weight, commingling, subsequent new-bit sale, and gross-receipts exclusion summary, dated May 29, 1969 — annotation adds carat-weight and subsequent-sale details not stated in the supporting opinion, prints “caret weight,” and omits the audit-question provenance, invoice wording, Ruling 26 exchange distinction, source wording defects, and missing records and supplies no additional transaction record
• Possible later returned bit, diamond salvage or commingling, credit calculation or use, new-bit sale, return filing, audit adjustment, assessment, payment, refund claim, appeal, or other agency action — not supplied in the official PDF

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/295-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/295-0260.pdf

Original ruling text

State of California

Board of Equalization

Memorandum

To:

Out-or-State - Auditing

From:

Tax Counsel (PRD) - Headquarters

295.0260

Date:

May 29, 1969

Subject:

This is in ·reply to your question whether the credit for “less customers dias. set” on transactions specified as “reset and return your own diamond bit” operations on the invoices of the taxpayer must be included in the taxable measure for the sale of the new diamond bits. It appears that the diamonds in the returned, used bits are the only things salvaged from those bits. After removal they are sorted according to size and commingled with simarily sized diamonds in the taxpayer’s inventory. No effort is made to reset a new bit going for that particular customer with the diamonds recovered from the old bit received from that customer. The new bits are made from diamonds of appropriate size taken from the taxpayer's inventory. Industrial diamonds of the same size are regarded as fungible goods in these transactions. Apparently, the industry makes no distinction between “new” and "used” industrial diamonds of similar size and quality. Since the bits which are sold are properly regarded as completely new bits because there is no commercial distinction between the “new” and “used” diamonds in them, the transactions are not included within the exchange provisions of ruling 26. Yet because the diamonds are treated as fungible goods, it is appropriate to regard the diamond credit allowed on the new bits as a record of the return of the customer's own diamonds, and for that reason the credit may be excluded from the taxable gross receipts from the sale of the bit.

PRD: smb

cc:

San Francisco - Dist. Admin.
San Mateo - Subdist. Admin.