Were costume-design fees taxable when costumes were later fabricated and sold under separate contracts?

Plain-English summary

A costume designer separately contracted to design wardrobes for motion pictures and television series. The contracts did not require the customers to buy costumes from the designer, and the designer was not required to fabricate them, although customers usually placed later costume orders.

The Board treated the design work and later costume sales as separate transactions. The design fees therefore were not services that were part of the costume sales, and the recommendation called for deleting them from the taxable measure.

There was an exception for customers who used another fabricator and received the designer's sketches or patterns: the portion of the design fee allocable to those transferred items was taxable. The decision also warned that unrealistically low costume prices could show that design and costumes were actually sold as a package, but found no such evidence here.

Source-date note

The official decision repeatedly states May 16, 1991 and is signed 5/16/91. The later May 31 date came from annotation metadata rather than the decision itself.

Citations and references

• California Revenue and Taxation Code sections 6012(a)(2), 6012(b)(1), and 6051 (as cited and quoted or described concerning retail-sale gross receipts, nondeductible costs, and services that are part of a sale)
• California Sales and Use Tax Annotations 515.0440 dated February 27, 1964 and 515.0460 dated April 16, 1970 (as cited for separately contracted design and production) — annotation texts and supporting sources not reproduced in the official PDF
• Two redacted petitions, account numbers, liability periods, protested amounts, and November 28 redacted-year Culver City hearing before James E. Mahler, with no petitioner appearance and Department appearances by George Ito and Harry Rutta — petitions, notices, period years, liability computations, transcript, exhibits, and appearance records not reproduced in the official PDF
• Limited partnership, successor sole proprietorship effective March 1 of a redacted year, motion-picture and television costume-design work, sample contracts in audit workpapers, periodic design bills, separate costume invoices, customer budgets, differing design and costume purchasers, employee-withholding instances, costume-sale tax reporting, and interstate exemptions — formation and succession records, contracts, workpapers, invoices, budgets, payroll and withholding records, returns, exemption support, and costume records not reproduced in the official PDF
• Audit staff's assumption that sketches and patterns would have been transferred when another person fabricated costumes and admission that staff did not know how often this occurred — transfer records, sketches, patterns, fabrication orders, frequency evidence, valuations, and allocation calculations not reproduced in the official PDF
• May 16, 1991 hearing-officer recommendation signed by James E. Mahler to reaudit and delete design fees except amounts allocable to transferred patterns and sketches — no reaudit schedules, allocation, reviewer action, final Board decision, payment, refund claim, appeal, or later outcome supplied
• Official Annotation 295.1503's generalized custom-property rules, separate-contract treatment, sketch-and-pattern sale, unrealistically-low-price warning, package conclusion, and May 31, 1991 date — supporting recommendation is a costume-specific matter repeatedly dated and signed May 16, 1991; annotation omits the two petitioners, hearing, redacted periods and amounts, audit assumptions and unknown frequency, cited annotations, recommendation-only posture, ordered reaudit, missing records, final outcome, and reliance status and supplies no date-reconciliation or additional proceeding 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/295-1503.pdf

Original ruling text

STATE OF CALIFORNIA

295.1503

BOARD OF EQUALIZATION
APPEALS DIVISION

In the Matter of the Petitions
for Redetermination Under the
Sales and Use Tax Law of:
N--- M--- LTD.
N--- -. M--Petitioner

)
)
)
)
)
)
)
)

HEARING
DECISION AND RECOMMENDATION

No. SR -- XX-XXXXXX-XXX
No. SN -- XX-XXXXXX-XXX

The above-referenced matters came on regularly for hearing before Hearing Officer James E. Mahler on November 28, 19XX in Culver City, California. Appearing for Petitioners: Appearing for the Sales and Use Tax Department:

None

George Ito
Supervising Tax Auditor
Harry Rutta
Supervising Tax Auditor
Protested Items

The protested tax liabilities for the periods July 1, 19XX, through February 28, 19XX (SR -- XX XXXXXX), and March 1, 19XX, through June 30, 19XX (SN -- XX XXXXXX), are measured by: State, Local County & LACT

Item
Taxable Measure Understated
Designer fees not reported

SR -- XX XXXXXX
$XXX,XXX

SN -- XX XXXXXX
$XXX,XXX

N--- M--- LTD., SR -- XX XXXXXX-XXX
N--- -. M---, SN -- XX XXXXXX-XXX

-2-

May 16,1991
295.1503

Petitioner’s Contention
No costume designer has ever been required to pay sales tax on his services. Summary N--- M--- Ltd. was a limited partnership engaged in the business of designing and manufacturing women’s clothing. N--- -. M--- took over operation of the business as a sole proprietor effective March 1, 19XX. For convenience, we hereinafter use the term “petitioner” to refer to both the partnership and the proprietorship collectively. As part of the business, petitioner contracted to design costumes for motion pictures and television series. Sample copies of numerous such contracts are included in the audit workpapers. These contracts required petitioner to design, but did not require petitioner to fabricate or sell costumes. The design contracts sometimes required petitioner to loan the design services of Mr. M--- to the customer for a fee. More typically, however, petitioner simply contracted to perform the design services for a set fee (for motion pictures) or for a set fee per episode (for television series). Petitioner billed the customers periodically for these design fees. If the customers later ordered petitioner to fabricate costumes (as they almost invariably did), petitioner’s charges for the costumes were billed on invoices separate from the invoices for design fees. According to the audit staff, petitioner’s customers were usually on budgets, and the amounts of those budgets may have limited the prices that petitioner could charge for costumes. In a few cases, it appears that the entity with which petitioner contracted to perform design services was different from the entity which ordered costumes. For example, the design contract for the television series “D---” was between petitioner and “The O--- Company”, and petitioner’s bills for design fees were sent to that entity. The bills for costumes, on the other hand, were sent to A--- S--- P---. According to the audit staff, the customers were not required to order costumes from petitioner and could have the costumes fabricated by someone else if they so desired. The audit staff assumes that petitioner would have transferred sketches and patterns to the customers in those cases, so that the customer could have the clothing fabricated in accordance with petitioner’s designs, but the staff does not know how often that might have occurred. Petitioner reported and paid tax on all billings for costumes, unless otherwise exempt. It did not report tax on the design fees. The audit staff found that the design services were sometimes performed by Mr. M--- as an employee of the customer (when the customer deducted withholding taxes from petitioner’s billings) and did not assert tax on the design fees in those cases. In all other cases, however, the design fees were found to be part of the sale of

N--- M--- LTD., SR -- XX XXXXXX-XXX
N--- -. M---, SN -- XX XXXXXX-XXX

-3-

May 16,1991
295.1503

costumes, and tax was assessed unless the sales of costumes were otherwise exempt (such as sales in interstate commerce). Analysis and Conclusions Sales tax is assessed on the “gross receipts” from the retail sales of retailers. (Rev. & Tax. Code § 6051.) “Gross receipts” means the total amount of the sale price, without deduction on account of the “cost of the materials used, labor or service cost, interest paid, losses, or any other expense.” (Rev. & Tax. Code § 6012(a)(2).) The total sale price includes charges for any “services that are a part of the sale.” (Rev. & Tax. Code § 6012(b)(1).) There is no general exemption for sales of custom-made property. Although the manufacture or production of custom-made property necessarily involves design work or similar types of created services, the services are required to product the property in the form desired by the customer and are therefore generally taxable as “part of the sale” of the property. The Board has nonetheless recognized a limited exemption to this rule in cases where the design and sale of the property are performed under separate contracts. If the customer contracts solely for design services, tax does not apply (assuming there is no associated transfer of tangible personal property). If the customer then contracts separately for production of the property in accordance with the design, charges for the property might well be taxable, but the charges for design work remain nontaxable. (See Sales and Use Tax Annots. 515.0440 [2/27/64] and 515.0460 [4/16/70].) The contracts in question required petitioner to design costumes, but did not mention fabrication or sale of the costumes. The customers were not required to purchase costumes from petitioner and petitioner was not required to fabricate or sell costumes to the customers. We therefore conclude that the design services and the subsequent fabrication and sale of costumes were performed under separate contracts. The design services were thus not “part of the sale” of the costumes. We would reach a different conclusion if petitioner’s charges for the costumes were unrealistically low. We would view that as evidence that a portion of the design fees was in fact being paid for the costumes, which would lead us to conclude that the design services and costumes were being sold together as a “package deal.” There is no evidence to indicate that such is the case here, however. According to the audit staff, petitioner sometimes transferred sketches and patterns to customers who had elected not to purchase costumes from petitioner. Unless otherwise exempt, tax would apply to these transactions measured by the portion of the design fees allocable to the sketches and patterns transferred. The tax applies not because the design is part of the sale of costumes, but because the transfer of sketches and patterns is itself a sale of tangible personal property.

N--- M--- LTD., SR – XX XXXXXX-XXX
N--- -. M---, SN – XX XXXXXX-XXX

-4-

May 16,1991
295.1503

Recommendation
Reaudit to delete design fees from the measure of tax, except to the extent the design fees are allocable to patterns and sketches transferred to customer who elected to have the costumes fabricated by other persons.

________
James E. Mahler, Hearing Officer

5/16/91
________
Date