Was a per-foot payment to a highway-barrier machine seller taxable as a royalty, and were tax-paid materials used out of state exempt?

Plain-English summary

A highway contractor bought a concrete-barrier machine and agreed to pay the seller $1 per linear foot of barrier. The seller also supplied an expert operator because the machine required precise skills.

The hearing officer concluded that the per-foot amounts were not taxable royalties or part of the machine's sales price. They paid for the skilled work of the seller's personnel, not for the right to use the machine or another incident of ownership. The recommendation directed the audit staff to remove those payments from the deficiency measure.

The contractor lost on a separate materials issue. It withdrew materials from tax-paid inventory for a real-property contract outside California but had not given its vendor the written certification required by the cited statute. Because it did not meet that condition, the source applied tax to the materials.

Citations and references

• California Revenue and Taxation Code sections 6385 and 6386 (as cited)
• Santa Fe Transportation Co. v. State Board of Equalization, 51 Cal. 2d 531 (as cited)
• The petition summary associates the written vendor certification with section 6386, while the analysis states section 6385 — unresolved source citation conflict preserved verbatim below
• Petition for redetermination and Sept. 30, 1975 Pasadena hearing concerning $18,854 of per-foot payments and $20,391 of tax-paid inventory materials for April 1, 1971–Dec. 31, 1974 — petition, determination, audit workpapers, hearing notice, taxpayer appearance, exhibits other than A, and transcript not reproduced in the official PDF
• June 7, 1972 machine-purchase letter agreement reproduced as Exhibit A, including equipment and screed prices, $5,000 assistance, operator and expense terms, $1 per lineal foot, and title transfer — acceptance signature, returned copy, invoices, payments, job records, and contract identified only as the “simi job” not supplied
• Hearing officer's discussion with an unidentified recognized highway-construction expert and allegation that the machine price approximated a new machine's cash price — expert identity, discussion record, appraisal, comparable sale, and price evidence not supplied in the official PDF
• Oct. 29, 1975 recommendation for a district reaudit deleting per-foot payments from the deficiency measure — recommendation only; audit-review signature and date are blank, and no completed reaudit, final Board action, refund, collection, appeal, or later outcome is supplied
• Official Annotation 295.0462's highway-barrier equipment, seller assistance, per-foot rate, skilled-workmen, nonroyalty, equipment-price exclusion, nontaxability, and Oct. 29, 1975 date — annotation omits the petition, audit period and amounts, hearing, Exhibit A and other price terms, expert discussion, price allegation, out-of-state materials issue, certification-section conflict, case, reaudit recommendation, blank review, missing records, and final outcome and supplies no additional audit record

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/295-0462.pdf

Original ruling text

STATE OF CALIFORNIA
BOARD OF EQUALIZATION

In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Laws:

Petitioner

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295.0462
10/29/75

DECISION AND RECOMMENDATION
No. ----

The above entitled matter came on regularly for hearing in Pasadena, California on September 30, 1975 before W. E. Burkett, Hearing Officer.

Appearing for Taxpayer:

Appearing for the Board:

Mr. Hodder, Supervising Auditor

Protested Item
(Period 4/1/71 to 12/31/74)

1. Royalty payments subject to use tax not reported (audit item D)

$18,854

2. Materials withdrawn from tax-paid inventory claimed exempt (audit item E)

20,391

Taxpayer's Contentions

1. The royalty payments were made to secure the services of the seller's expert equipment
   operator.
2. The material was actually used in the performance of a contract to improve realty at an out-ofstate location.
   Summary of Petition
   The taxpayer is a specialty contractor performing highway construction and fence installation contracts. The first protested item is made up of a $1.00 per linear foot royalty payment paid pursuant to the letter agreement attached hereto as Exhibit A.

The audit staff determined that the royalty payment represented a part of the purchase price of the concrete barrier machine. The taxpayer's representative explained that the machine was purchased for use in the performance of a previously awarded highway construction contract. The seller's operator was secured because the operation of the machine requires very precise skills. The hearing officer has confirmed this by discussions with a recognized expert in the highway construction field. The purchase price of the machine exclusive of the royalty payment is alleged to approximate the cash price of a new machine of the same type and size. The second protested item consists of a disallowed deduction for material withdrawn from the taxpayer's tax-paid yard inventory and utilized in the performance of a construction contract at an out-of-state site. While the taxpayer held a seller's permit, it concededly did not certify to its vendor that the particular materials were acquired for use in the manner indicated (per Revenue and Taxation Code Section 6386). Analysis and Conclusions It is our conclusion that the royalty payments are not a part of the sales price of the machine. Royalty payments made for the right to use the proper t y or to acquire any other right incident; to the ownership of property are properly a part of the sales price. However, in this instance it is quite apparent that the payments were made to secure the skilled performance of the seller's skilled workmen and not for the right of use or any other incident of ownership of the property. Contrawise, we conclude that the taxpayer is not entitled to any exemption for the material withdrawn from its merchandise inventory and used at an out-of-state location. This utilization of property would customerily result in the application of the sales or use tax. Accordingly, any exemption or exclusion must be strictly construed and limited to its precise terms (see Santa Fe Transportation Co. v. State Board of Equalization, 51 Cal. 2d 531). Here the taxpayer failed to meet the requirement specified by the legislature in Section 6385 that the purchaser certify in writing to his vendor that the property was being specifically acquired for use in the performance of a contract to improve real property located outside of this state. Having failed to do so, the tax is applicable. Recommendation The district audit staff should conduct a reaudit deleting the royalty payments from the audited measure of tax deficiency.

10/29/75
W. E. Burkett, Hearing Officer

Date

REVIEWED FOR AUDIT:

Principal Tax Auditor

Date

Preliminary Hearing
Exhibit A

June 7, 1972

Attention:
Dear
This will confirm our agreement for the purchase of your --- Machine, as Modified to time 10 ft. width, with 5 ft. height capacity.
--Shipping allowance to Los Angeles
One screed for --- to-your latest design
One variable screed, with each side
varying automatically, at the estimated
cost of $5,000.00 to $7,000.00, based on
your actual cost of Fabrication.

$40,000.00
2,500.00
1,250.00

A payment of $5,000.00 for you and --- to come to the job, to be sure of the complete satisfactory operation of all of the equipment, as well as such advice you may be able to give us, the air fare of one of your operators, and the loan of one of your top operators for the duration of the job. We will pay the operator and also such of his expenses as we agree is fair. We will also pay you $1.00 per lineal foot for every foot of barrier poured with the machine on the simi job. Other jobs, where variable heights are concerned we will negotiate as required. All of the above equipment will become the property of ---. We are enclosing an advance payment of $5,000.00 as discussed with you. We wish to thank you for the help you have given, and if this agreement is per your understanding, would you kindly sign one copy and return it to us for our records.

Yours truly,