Could a federal contractor performing qualified production services buy overhead materials for resale because its contract passed title to the United States?

Plain-English summary

Audit staff asked whether a redacted federal contractor could buy overhead materials tax-free for resale to the United States. The supplied contract documents were unclear about whether the contractor performed qualified production services; the memorandum assumes that status based on the author's conversations with Audit Review and Refund staff.

The memorandum explained that Regulation 1529 ordinarily made the service provider the consumer of property used to perform qualified production services. Aerospace Corporation v. State Board of Equalization had allowed resale treatment where a progress-payment clause passed title to overhead materials before the contractor used them.

This contract incorporated FAR 52.245-2, which accelerated title only for direct-cost items, but did not incorporate FAR 52.232-16, the progress-payment clause relevant to overhead materials. It also incorporated a DFARS clause described as making the contractor the consumer of software whose transfer was restricted.

Because no contract clause passed title to the overhead materials before use, the contractor consumed them and could not purchase them for resale to the United States.

The memorandum says it did not need to reach whether Aerospace overrides Regulation 1529 under the facts. Its last sentence calls the consumer “TSD,” although the earlier taxpayer name is redacted and the source does not explain that label.

Source and live-annotation limits

The source does not reproduce the April 24, 1996 audit memorandum or its attached contract excerpts. It does not identify the taxpayer, federal customer, or Air Force base, or supply the full contract, qualified production services, overhead or direct-cost property, software, restriction on transfer, purchase, title-passage record, invoice, tax return, completed transaction, audit workpaper, assessment, refund, or later outcome. The source does not resolve whether “TSD” identifies the redacted taxpayer or is an error.

The live annotation preserves the assumed qualified-service premise, Regulation 1529 consumer rule, Aerospace contract-clause approach, missing accelerated-title clause, and no-resale conclusion. It omits the named audit staff, April 24 request and attachments, direct federal service and Air Force base, uncertainty behind the qualified-service assumption, FAR and DFARS clause numbers and software rule, direct-cost distinction, issue expressly not reached, unexplained “TSD” label, absent records, and later-outcome gap.

What this means for you

Federal contractors and tax professionals

Review the complete executed contract clause by clause. Government ownership in general is not enough; identify when title passes for direct-cost items, overhead materials, and restricted software. Do not treat an assumed service classification based on undocumented conversations as proof of your own classification.

Common questions

Q: Did qualified-production-service status permit resale purchases?

A: No. It ordinarily made the provider the consumer.

Q: Why did the Aerospace case not change the result?

A: This contract omitted the progress-payment clause that accelerated title to overhead materials.

Q: Could the contractor buy the overhead property for resale?

A: No.

Q: Did the memorandum decide whether Aerospace overrides Regulation 1529?

A: No. It said the missing accelerated-title clause made reaching that issue unnecessary.

Q: Was qualified-production-service status established by the contract documents?

A: No. The documents were unclear; the memorandum assumed it based on staff conversations.

Citations and references

• California Sales and Use Tax Regulation 1529(a)(1)
• FAR 52.245-2, including subsection (c)
• FAR 52.232-16 — cited but not incorporated into the contract
• DFARS 252.227-7013
• Aerospace Corp. v. State Board of Equalization, 218 Cal. App. 3d 1300, 1311, 1313 (1990)
• April 24, 1996 audit memorandum and attached contract excerpts — described but not included
• Services, property, software, purchases, title passage, and tax records — described or assumed but not documented

Verbatim support

From the official memorandum:

Although it is not clear from the documents, the conversations I have had with Mr. Kitchen on this indicate that the taxpayer is providing “qualified production services” under Regulation 1529. We will assume for the purposes of this discussion that it is.

We find under the facts of this case, however, that we do not need to reach this issue.

As FAR 52.232-16 is not incorporated into this contract, no clause in this contract provides for accelerated passage of title to overhead materials to the United States prior to its use by ---.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 375.0957
• Original supporting opinion: 375.0957 PDF

Original ruling text

375.0957

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

Board of Equalization
Legal Division-MIC:82
Telephone: 324-3828
Date: July 29, 1996

To:

Mr. William R. Pitts
Supervising Tax Auditor,

From:

John L. Waid
Senior Tax Counsel

Subject:

United States Government Service Contracts -- Title Clauses

At the request of Mr. Michael P. Kitchen of the Audit Review and Refund Section, I am responding to your memorandum to him dated April 24, 1996. You ask if --- may buy overhead materials ex tax for resale to the United States under the ruling in Aerospace Corporation v. State Board of Equalization (1990) 218 Cal.App.3d 1300. Attached to your memorandum are excerpts from its contract with the United Stated that contain the title clauses and describe certain aspects of the work. According to the contract documents, --- is providing its services directly to the --- at --- AFB. Although it is not clear from the documents, the conversations I have had with Mr. Kitchen on this indicate that the taxpayer is providing “qualified production services” under Regulation 1529. We will assume for the purposes of this discussion that it is. As a result, it would normally be the consumer of any tangible personal property it purchases for use in providing such services. (Reg. 1529(a) (1).) As I understand it, the issue is whether or not Aerospace overrides the regulation and permits the taxpayer to buy the property for resale. We find under the facts of this case, however, that we do not need to reach this issue. Section I of the Contract is the part which incorporates by reference FAR contract clauses. FAR 52.245-2 is specifically incorporated, but 52.232-16 is not. We note that DFARS 252.227-7013, which provides that the contractor remains the consumer of any software it purchases that contains a restriction on transfer, is also incorporated. OPINION The Aerospace case construed two title clauses that are substantially similar to those contained in FAR 52.232-16 and FAR 52.245-2. The first, which provides for progress payments, was the clause which the court held passed title to overhead materials to the government prior to use by the contract, thus permitting the contractor to buy such materials free of tax for resale. (Ibid. at 1311.) FAR 52.245-2(c) provides for accelerated title passage to items of direct cost only.

Aerospace held that the resolution of this issue is determined by the clauses of the contract. (Ibid. at 1313.) As FAR 52.232-16 is not incorporated into this contract, no clause in this contract provides for accelerated passage of title to overhead materials to the United States prior to its use by ---. Therefore TSD is the consumer of the items that it purchases to perform qualified production services and may not purchase such property for resale to the United States.

JLW: sr
cc: Mr. Michael Kitchen (MIC:39)