When were marketing-strategy reports and related expenses nontaxable even if the consultant also produced brochures?

Plain-English summary

A marketing firm assessed clients' needs and objectives, delivered written strategy reports, and sometimes went on to create brochures and other marketing materials.

If the firm supplied only a text report, the Board treated the transaction as a nontaxable service with the paper transfer merely incidental. Supervision, consultation, research, telephone, travel, and similar expenses incurred in providing that service were also nontaxable.

When the firm also sold brochures, the brochures were taxable tangible personal property and services that were part of producing and selling them entered taxable gross receipts. The Board nevertheless analogized a pre-approval strategy report to preliminary art: the report charge could remain nontaxable when the report was produced before a contract or client approval for the final product and was separately billed.

Expenses followed the work they supported. Costs tied to a nontaxable strategy report or qualifying preliminary art were nontaxable; costs tied to taxable final marketing materials were taxable. When a transaction mixed both, the firm needed documentation supporting which passed-through costs related to the nontaxable services.

What controlled the result

• The strategy report was assumed to contain text only.
• It had to precede the contract or approval for producing the final product.
• Its charge had to be separately stated or separately billed.
• Preliminary work physically incorporated into finished art did not receive the same treatment under the quoted rule.
• Expense reimbursements took the tax character of the underlying taxable or nontaxable work.

Citations and references

• California Revenue and Taxation Code section 6051, described as imposing retailer sales tax measured by gross receipts from tangible-personal-property retail sales (as cited)
• California Revenue and Taxation Code section 6012, described as including sale-related services and materials, labor or service cost, interest, losses, and other expenses in gross receipts (as cited)
• California Sales and Use Tax Regulation 1501, cited for treating a text-only report as incidental property in a service transaction (as cited) — enclosed copy not reproduced in the official PDF
• California Sales and Use Tax Regulation 1540(b)(4), quoted for preliminary-art definition, pre-contract or pre-approval timing, title retention, separate-charge treatment, and finished-art incorporation exception (as cited) — enclosed copy not reproduced in the official PDF
• California Sales and Use Tax Annotation 295.1690 dated August 16, 1978, quoted for catalog preproduction and postproduction services that were required to produce and sell property or were purchase conditions (as cited)
• December 14, 1993 firm letter asking about itemized strategy-report charges and interview-transcript, photocopy, courier, proofreading, design-material, parking, and long-distance telephone expenses across three work phases — request, contracts, approvals, reports, art, brochures, invoices, expense records, and cost-allocation documentation not reproduced in the official PDF
• Staff counsel's express assumption that the report contained text only and no photographs or artwork, and statement that the preliminary-art question was unclear — no report or art supplied in the official PDF
• February 1, 1994 Staff Counsel Sukhwinder K. Dhanda response, Regulations 1501 and 1540 enclosures, and blind copy to a redacted district administrator — no enclosures, firm reply, implemented billing, return, audit, assessment, refund claim, appeal, or later outcome supplied
• Official Annotation 295.1536's report, consultation, brochure, pre-contract, and single-contract rules and February 1, 1994 date — annotation's categorical single-contract formulation compresses the source's separate pre-contract-or-pre-approval and separate-billing tests; it omits the text-only assumption, preliminary-art uncertainty, specified expenses, statutes, regulation and prior-annotation authorities, absent records and enclosures, later outcome, and reliance status and supplies no 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/295-1536.pdf

Original ruling text

295.1536

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 322-2976

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego
MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

BURTON W. OLIVER
Executive Director

February 1, 1994

Mr. M--- K---, Principal
M--- K--- and Associates
XXX --- Street, Suite XXX
--- ---, CA XXXXX
Re: SR - - XX-XXXXXX
Dear Mr. K---:
This is in response to your letter of December 14, 1993 in which you request advice as to the application of tax to charges made in connection with the production of marketing materials. Your company provides consulting services and produces marketing materials such as brochures for its clients. Your charges for producing the brochures are itemized. You ask whether the following itemized charges are subject to sales tax: "Marketing strategy; i.e., assessing a client's marketing needs and objectives and recommending how to achieve them. This service results in a written report prepared solely for the purpose of recommending a corporate positioning and/or thematic direction for acceptance by a client before approval is given to commence creative services." Revenue and Taxation Code section 6051 imposes a sales tax on all retailers measured by their gross receipts from retail sales of tangible personal property. If all you provide is the report1, we would regard that as the providing of a service with the transfer of any tangible personal property (i.e., paper) as being merely incidental to the service. (Regulation 1501 (copy 1

We assume that the report consists of text only and contains no photographs or artworks.

Mr. M--- K---

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February 1, 1994
295.1536

enclosed).) Charges and expenses incurred in the rendering of such nontaxable services, such as supervision, consultation, research, telephone and travel expenses, are likewise nontaxable. However, if you are providing tangible personal property (such as brochures) in addition to the report, then sales tax applies to the sale of that tangible personal property. As stated above, the sales tax is measured by the gross receipts from a sale of tangible personal property. Section 6012 of the Revenue and Taxation Code defines "gross receipts" to include the cost of any services that are a part of the sale of the tangible personal property. "Services that are a part of the sale" are defined in Sales and Use Tax Annotation 295.1690 (8/16/78) which states: "'Services that are a part of the sale' include any the seller must perform in order to produce and sell the property, or for which the purchaser must pay as a condition of the purchase and/or functional use of the property, even where such services might not appear to directly relate to production or sale costs. Thus, charges described by a seller of catalogs as for preproduction research and consultation services and for postproduction merchandising consultation services are part of the taxable sales price of the catalogs, whether separately stated or not. The first 'service' is a necessary prelude to catalog production; and the second is furnished only to catalog purchasers who are required to pay for the service when they purchase the catalogs, whether or not it is desired or used." In order to determine your taxable gross receipts from the sale of the brochures, it is first necessary to determine whether the written report you provide is a "service that is a part of the sale" or not. Your letter states that this report is used by the client to decide whether or not to contract with your firm for creative services as well as for the production of marketing items such as brochures. Given the fact that the client may reject the recommendations made in the report, there may not be a transfer of any tangible personal property other than the report itself. This fact situation appears to be analogous to preliminary art. "Preliminary art" is defined in Regulation 1540(b)(4) (copy enclosed) which states: "'Preliminary art' means roughs, visualizations, layouts and comprehensives, title to which does not pass to the client, but which are prepared by an advertising agency, commercial artist or designer solely for the purpose of demonstrating an idea or message for acceptance by the client before a contract is entered into or before approval is given for preparation of finished art to be furnished by the agency, commercial artist or designer to its client. Tax does not apply to separate charges for preliminary art except where the preliminary art becomes physically incorporated into the finished art ...." As noted above, if you contract to provide only the report, your charges would be regarded as nontaxable service charges. Similarly, charges for preliminary art are regarded as nontaxable service charges when the customer does not purchase any tangible personal property.

Mr. M--- K---

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February 1, 1994
295.1536

Further, charges for preliminary art are regarded as nontaxable service charges when meeting the requirements quoted above. By analogy, we believe the same rules apply here. That is, the charges for the written report will not be subject to tax if it was produced prior to any contract or before approval by the client for the production of the final product. The charge for the report must be billed separately to the client, either on a separate billing or separately charged for on the billing. You also ask whether the following charges are subject to tax: "Out-of-pocket expenses incurred a) during the marketing strategy phase; b) during the preliminary art phase; or c) during the copywriting and mechanical art phase:
-

interview transcripts
photocopy costs
courier services
proofreading services
design materials
automobile parking charges
long-distance telephone charges."

Revenue and Taxation Code section 6012 states that "gross receipts" include "the cost of the materials used, labor or service cost, interest paid, losses or any other expense." During the "marketing strategy" phase, if all you are providing is a non-taxable report, then your charges to your customer for expenses incurred in rendering that service are likewise nontaxable. Your question is unclear as to whether you are providing "preliminary art", as defined above. The application of tax to preliminary art is as discussed above. When you charge your customer for your expenses related to nontaxable preliminary art, your charges are not taxable. If, however, the preliminary art does not qualify as nontaxable as discussed above, all charges related to the preliminary art are likewise subject to tax. Similarly, your charges for expenses related to production of the final marketing product, which is subject to tax, are also included in the measure of tax. If you are making a taxable sale together with providing services which qualify as nontaxable, you should retain documentation to support your treatment of costs passed on to your customer as related to the nontaxable services rather than the taxable sale.

Mr. M--- K---

-4-

If you have any further questions, please do not hesitate to write again. Sincerely,

Sukhwinder K. Dhanda
Staff Counsel
SKD:plh

Enclosures - Regulations 1501 and 1540
bc:

--- --- District Administrator - --

February 1, 1994
295.1536