Were per-unit royalties taxable when an inventor sold one log peeler and retained usage rights in another peeler leased by a different owner?

Plain-English summary

An inventor sold one log peeler for $46,000 plus 20 cents per thousand board feet processed. A machinery company sold a second peeler to another owner, which leased it to a logger, while the inventor separately collected the same type of production royalty from the lessee.

Tax counsel concluded that the inventor retained absolute control over operational use and a right to compensation. Those rights were ownership interests in tangible property comparable to a lessor's interest.

For the first machine, the inventor owed sales tax on both the fixed sale amount and royalties. For the second, the owner owed use tax on rental receipts, and the inventor likewise owed use tax measured by royalties paid by the lessee.

Citations and references

• The official memorandum cites no statute, regulation, case, or prior ruling by number.
• Fabrication order placed with B for the first log-peeling machine and resale certificate used for the inventor's purchase — described as “apparently” placed; date, terms, certificate, and copies not provided in the official PDF
• Contract selling the first peeler to G for $46,000 plus twenty cents per thousand board feet for three years and, if issued, the patent's duration — described; date, complete terms, patent, and contract copy not provided in the official PDF
• B's fabrication and sale of the second peeler to O with the inventor's permission and a resale certificate, O's lease, and the inventor's separate twenty-cent royalty agreement with the lessee — described; dates, complete identities and terms, permission, certificate, agreements, and copies not provided in the official PDF
• Inventor's reported $46,000 taxable receipts, omitted first-machine royalties, O's reported rental receipts, and omitted second-machine royalties — reporting described; returns, royalty calculations, payments, audit workpapers, assessments, and account records not reproduced in the official PDF
• Official Annotation 295.0560's inventor, machinery-company fabrication, fixed-price sale and lease, board-feet royalties, taxable selling-price and rental-receipt conclusions, and Nov. 1, 1965 date — annotation omits the source's “apparently” qualification, $46,000 and twenty-cent amounts, three-year and patent-duration condition, resale certificates, inventor permission and retained-control analysis, reporting history, absence of numbered legal authority, missing agreements and records, and later outcome and supplies no additional transaction record
• Possible patent issuance, order fulfillment, sale, lease, royalty payment, amended return, audit, assessment, refund claim, appeal, or other later 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/295-0560.pdf

Original ruling text

State of California

Board of Equalization

Memorandum

To:

Santa Rosa – Auditing (ARD)

From:

Tax Counsel (GAT)

295.0560

November 1, 1965

It is our understanding that “S” was the inventor of a log peeling device. He apparently placed an order with “B” to fabricate a peeler which he purchased ex tax under a resale certificate. “S” sold the peeler to “G” under a contract, pursuant to which “G” agreed to pay $46,000 plus a royalty of 20 cents per thousand board feet of logs peeled. The royalty was to be paid for a period of three years and, providing “S” received a patent on the device, the royalty was to be paid for the duration of the patent. “S” reported the $46,000 as taxable gross receipts, but did not report tax on the royalties. “B” fabricated a second log peeler and, pursuant to permission granted by “S”, sold it ex tax under a resale certificate to “O”. “O” leased the peeler to a logging company for a stipulated rental. “S” then entered into an agreement with the lessee, pursuant to which the lessee agreed to pay “S” a royalty of 20 cents per thousand board feet of lumber peeled. “O” reported tax measured by its receipts from the rental of the peeler, but no tax was reported with respect to the royalties paid to “S”. Although both agreements, between “S” and “G” and “B” and “O”, were in form absolute sales, “S” retained the absolute right to control the operational use of the peelers and the right to compensation for such use. In our opinion, this interest was an ownership interest in tangible personal property, identical to an ordinary lessor’s interest in property which he leases. In view of the foregoing, it is our opinion that “S” became liable for sales tax measured by the receipts from the sale of the first peeler to “G:, and also became liable for tax measured by the royalty payments. It is further our opinion that “O” became liable for use tax measured by its receipts from the rental of the second peeler to its lessee, and that “S” likewise became liable for use tax measured by the royalties paid by lessees to “S”.

GAT:ls

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