Were custom trial exhibits and laser disks taxable products or nontaxable production services?

Plain-English summary

A litigation-support company produced videos, computer animations, charts, illustrations, scanned and coded documents, and other visual aids on a laser disk for attorneys to use in a specific trial. It billed labor time and project expenses such as materials, mileage, transportation, copies, and meals.

California treated the customer as buying the completed tangible exhibits, not production services. Tax applied to the full charge without deductions for labor, materials, mileage, transportation, copies, meals, or other expenses.

Materials used or consumed in production were taxable to the exhibit company. A source photograph used to make a larger print was a taxable manufacturing aid because only its image was reproduced. The finished larger print actually transferred to the customer could be purchased for resale, and tax applied to the exhibit company's entire customer price.

What this means for you

Litigation-support firms

Custom, one-case use did not make the completed physical trial exhibits nontaxable services.

Law firms

Time-based creative billing did not prevent tax on the full tangible-deliverable charge.

Accountants and tax professionals

Separate consumed manufacturing aids from property incorporated into or resold as the actual customer deliverable.

Common questions

Q: Were the trial exhibits taxable?

A: Yes. The laser disk and other completed exhibits were the contract's true object.

Q: Could labor and project expenses be deducted?

A: No. The taxable receipts included labor and expenses such as mileage, transportation, copies, and meals.

Q: Was a source photograph bought for resale?

A: No, when it was used only to reproduce its image; it was a manufacturing aid consumed by the producer.

Q: Could the finished enlarged print be purchased for resale?

A: Yes, because it was the same property transferred to the customer.

Citations and references

• California Revenue and Taxation Code §§ 6012 and 6051
• California Sales and Use Tax Regulations 1501, 1540(e), and 1701

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 515.0026
• Original supporting opinion: 515.0026 PDF

Original ruling text

515.0026

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-6450

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

August 22, 1994

GRAY DAVIS
Controller, Sacramento
BURTON W. OLIVER
Executive Director

REDACTED TEXT
This is in reply to your June 28, 1994 letter regarding the application of sales tax to charges to create trial exhibits. You provided the following facts: “Our client is engaged in the business of creating demonstrative exhibits for attorneys to use in trial presentation. The services provided by our client are the production of videos, computer animation, charts and illustrations, scanning and coding documents and other visual aids onto a laser disk for access and display during the trial. It should be noted that these exhibits are produced for a single use in a specific case. “The work is billed based on the time spent by video producers, artists, art directors, graphic consultants and project managers, in producing the exhibits. Charges are also billed for expenses related to the project. These charges include materials incorporated into the exhibits as well as other expenses such as mileage, transportation, charges for copies, and meals.” Given this information, you ask whether we believe that your client provides a nontaxable service pursuant to Sales and Use Tax Regulation 1501, Service Enterprises Generally. No, although your client probably expends significant labor to create the exhibits, we believe that under the test provided in Regulation 1501, the true object of the contract between your client and its customer is the tangible personal property the client transfers to its customer. The sales tax is imposed upon all retailers at the applicable rate of the gross receipts of the retailer from the sale of all tangible personal property sold at retail in this state. (Rev. & Tax. Code § 6051.) The law defines “gross receipts” to mean the total amount of the sale price of the retail sales of retailers, without any deduction on account of the cost of the property sold, the cost of the materials used, labor or service cost, or any other expense. (Rev. & Tax. Code § 6012.) Therefore, all expenses your client incurs in producing the tangible personal property such as expenses for mileage, transportation, copies, and meals, are includible in the gross receipts of your client’s sale.

515.0026
You note your client pays sales tax reimbursement on its purchase of all materials your client uses in performing its work. Sales tax properly applies to sales to your client of tangible personal property the client uses or otherwise consumes in producing the tangible personal property your client sells. Tax does not apply to sales of tangible personal property to your client when your client either sells that very same tangible personal property to its customer prior to use or physically incorporates that tangible personal property into the tangible personal property your client sells to its customer. For example, let us assume your client contracts to furnish its customer with a poster size photograph of a building for $60. Your client purchases a 5” x 7” picture of the building for $10. Your client contracts with a photography laboratory to make the poster size print, and the laboratory charges your client $15. Under those facts, the sale of the 5” x 7” picture to your client is a retail sale, and sales tax applies to the $10 charge. Your client would use the photograph as a manufacturing aid to produce the poster. As explained in Sales and Use Tax Regulation 1540, Advertising Agencies, Commercial Artists and Designers, at subdivision (e), “A photograph, for example, does not become an ingredient or component part of property sold merely because the image of the photograph is reproduced as part of the property sold. A photograph or art is regarded as having been used when a reproduction is made from the photograph or art.” See also Business Taxes Law Guide Annotations 385.0400 and 385.0420. Your client may issue a resale certificate to the photography laboratory to purchase the larger print extax, because the larger print is the very same tangible personal property the client provides to its customer. If the laboratory were to charge sales tax reimbursement to your client, your client would be eligible to take a “tax paid purchase resold deduction” in accordance with Sales and Use Tax Regulation 1701, “Tax-Paid Purchases Resold.” Under these facts, sales tax applies to your client’s entire $60 charge for the poster with no deduction for the cost of the 5” x 7” picture, the charge by the photography laboratory, nor any other expenses. again.

We hope this answers your questions; however, if you need further information, feel free to write Very truly yours, Ronald L. Dick Senior Tax Counsel

RLD:plh
cc: Out-of-State Chicago Area Office - OHA