Were royalties paid under a separate patent license included in taxable receipts from a retailer's equipment sale?

Plain-English summary

All quarterly patent royalties were included in the equipment retailer's taxable gross receipts, not merely the 15% commission the retailer retained for collecting them. The purchaser could not use the liquid-nitrogen injection equipment for its intended purpose without paying the royalties to the patent-holding manufacturer.

The separate license agreement and direct economic allocation did not sever the royalties from the equipment sale. For sales-tax purposes, the Board treated the total price paid for the right to use the equipment as part of its sale price. The retailer had to report the royalty payments in the quarter when they became due.

Citations and references

• California Revenue and Taxation Code sections 6012 and 6051 (as cited)
• Business Taxes Law Guide Annotations 295.0460 (July 8, 1955), 295.0480 (Sept. 21, 1966), 295.0520 (Feb. 19, 1954), 295.0540 (May 10, 1954), 295.0570 (Jan. 4, 1979), and 295.0575 (May 17, 1988) (as cited)
• March 28, 1996 letter asking about tax on a 15-percent collection commission and all royalties for liquid-nitrogen injection equipment used in canning — letter and supporting records not reproduced in the official PDF
• Equipment sale, manufacturer-held patent, separate manufacturer-purchaser license, quarterly royalty, retailer collection, and 15-percent commission — facts supplied; sale contract, patent, license, invoices, royalty calculations, collection records, payments, and commission records not reproduced in the official PDF
• Copies of all six cited Business Taxes Law Guide annotations — identified as enclosures but not reproduced in the official PDF
• Official Annotation 295.0557's manufacturing equipment, patent-holding supplier, separate license, quarterly royalties, retailer collection, 15-percent commission, 100-percent gross-receipts measure, due-quarter reporting, and June 20, 1996 date — annotation omits the March 28 request, liquid-nitrogen and canning facts, statutes, six prior annotations and missing enclosures, missing agreements and transaction records, and later outcome and supplies no additional license or payment 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/295-0557.pdf

Original ruling text

295.0557
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 94279-0082)
Telephone: (916) 324-2614
FAX: (916) 323-3387

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

June 20, 1996

KATHLEEN CONNELL
Controller, Sacramento
────────
E. L. Sorensen, Jr.
Executive Director

Mr. J--- M. S--Law Offices of J--- M. S---, Inc.
XXX N. --- --- Avenue
--- ---, California XXXXX-XXXX
Re: Royalty Payments
Dear Mr. S---:
This is in response to your letter dated March 28, 1996, regarding the application of tax on the sale of liquid nitrogen injection equipment by your client. You state that your client sells liquid nitrogen injection equipment for use by the canning industry. The equipment is supplied by a manufacturer who holds the patent on the equipment. After the sale of the equipment by your client, the manufacturer enters into a separate license agreement with the purchaser. Pursuant to that agreement, quarterly royalty payments for the use of the equipment are paid by the purchaser to the manufacturer. Your client collects the royalty payments on behalf of the manufacturer and is compensated for the collection work by retaining 15% of the royalty payment as a commission. You ask whether sales tax applies to the 15 percent commission received by your client. You also ask whether 100 percent of the royalties paid by the purchaser should be included in the gross receipts of your client as the retailer of the equipment. DISCUSSION Sales tax is imposed on a retailer’s gross receipts from the retail sale of tangible personal property in California unless the sale is specifically exempt from taxation by statute. (Rev. & Tax. Code § 6051.) Gross receipts include the total amount received with respect to a sale, with no deduction for the cost of the materials, service or expense of the retailer passed on to the purchaser unless there is a specific statutory exclusion. (Rev. & Tax. Code § 6012.) Royalty payments received in connection with a retail sale of a patented equipment are included in a retailer’s gross receipts. (See BTLG Annot. 295.0460 (7/8/55).)

Mr. J--- M. S---

-2-

June 20, 1996
295.0557

As you know, your client is liable for sales tax on its retail sales of liquid nitrogen injection equipment. For sales and use tax purposes, the total amount charged to the purchaser for the right to use the equipment is part of the sale price of the equipment and is included in gross receipts. (See BTLG Annots. 295.0520 (2/19/54); 295.0540 (5/10/54).) Based on the facts you have provided, our understanding is that the purchaser could not use the equipment for the purpose for which it is intended without paying royalties to the manufacturer who holds the patent on the equipment. (See BTLG Annot. 295.0480 (9/21/66).) Under such circumstances, sales tax is measured by the total amount of the sale price of the equipment, including 100 percent of the royalties paid by the purchaser of which 15 percent is retained by your client. As the retailer of the equipment, your client must report the royalty payments in the quarter in which the payments become due. (BTLG Annots. 295.0570 (1/4/79), 295.0575 (5/17/88).) For your information, I have enclosed a copy of each Business Taxes Law Guide Annotation cited above. If you have any further questions, please write again. Sincerely,

Sophia H. Chung
Tax Counsel
SHC:rz
Enclosures: Business Taxes Law Guide Annotations
cc:

--- --- District Administrator (--)