Could a California-built computer-system prototype be bought for resale when it was used locally as a test bed before shipment to a foreign customer?

Plain-English summary

A California computer consultant planned to build and install a larger system abroad. It would fabricate a smaller prototype in Los Angeles and use that model as a test bed for hardware-software integration and problem correction throughout development, installation, testing, and support.

California rejected the claim that the prototype was intangible. It was tangible personal property, and its local integration and correction work was use beyond demonstration or display for resale. The materials and labor bought to fabricate or assemble it therefore were taxable retail purchases.

The later sale of the completed prototype to the foreign customer was a second retail sale. It could qualify for exemption only if the seller's sale and common-carrier shipment complied with Regulation 1620(a)(3)(B) or (C).

The company also planned to test other components bought for resale before overseas shipment. Because the request did not explain that testing, counsel expressly gave no opinion on whether California use tax applied to those components.

What this means for you

Technology developers

Using a physical prototype for local development and troubleshooting can defeat resale treatment for its inputs.

Export sellers

Foreign destination alone did not establish exemption; the sale and shipment had to meet Regulation 1620.

Accountants and tax professionals

Separate retained equipment, resale components, prototypes, development use, demonstration use, title passage, and common-carrier delivery.

Common questions

Q: Was the prototype intangible property?

A: No. It was tangible personal property.

Q: Were its materials and fabrication labor bought for resale?

A: No. The prototype's California development use made that purchase taxable.

Q: Was the later foreign sale exempt?

A: Only if the sale and shipment met Regulation 1620(a)(3)(B) or (C).

Q: Did the opinion decide whether testing other resale components was taxable use?

A: No. The testing facts were insufficient.

Citations and references

• California Revenue and Taxation Code § 6016
• California Sales and Use Tax Regulation 1620(a)(3)(B) and (C)
• Business Taxes Law Guide Annotation 210.0560, cited for comparison

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 515.0725
• Original supporting opinion: 515.0725 PDF

Original ruling text

515.0725

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

May 3, 1993

GRAY DAVIS
Controller, Sacramento

BURTON W. OLIVER
Executive Director

Mr. R--- J. A--Law Offices of
---, --- & --XXX --- --- ---, Suite XXX
--- ---, CA XXXXX
Re:

T--- P--- S--SR -- XX-XXXXXX

Dear Mr. A---:
This is in reply to your February 10, 1993 letter regarding the application of sales tax to charges to and by T--- P--- S---, Inc. (TPS), for the purchase and sale of computer hardware and peripherals under the following facts you provided: “T--- P--- S--- Inc. (‘TPS’) is a California corporation engaged in a computer consulting business, consisting of the assembly of hardware and peripherals in the creation of custom software. TPS is contemplating a contract to develop and install a system in a foreign country for a foreign entity. “Some tangible personal property (hardware, peripherals and supplies) will be purchased by TPS for the development of the system and retained by TPS after the completion of the contract. On those items, TPS will pay the applicable sales tax to its vendors or use tax as appropriate. Other items of tangible personal property, which are to become component parts of the system, will be purchased for resale and shipped overseas by TPS after testing and packaging in Los Angeles. It is our understanding that such items are exempt as sales in foreign commerce. “The taxpayer is requesting the State Board of Equalization’s advice on a separate item of intangible personal property, namely a prototype to serve as a model or a ‘test-bed’ for the larger system which will be assembled and developed in the

Mr. R--- J. A---

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May 3, 1993
515.0725

foreign country. The prototype will be a ‘scale model’ of the larger system and will remain in Los Angeles until the completion of the contract overseas. The prototype will be used to perform such tasks as hardware and software integration (during the development phase of the contract) and system problem correction (during the installation, testing and support periods of the contract). On completion of the assembly and development of the system overseas, the prototype will be shipped to the customer via common carrier in foreign commerce. “Title to the prototype will be maintained by TPS until delivery to the common carrier for shipment.” Given this information, you asked for the taxability of the sale to TPS of the materials used in constructing the prototype and the sale of the prototype itself when it is shipped at the end of the contract. You note that TPS will purchase for resale the items of tangible personal property which will become components parts of the systems but will test the items in California. Since you have not described the type of testing, we do not provide an opinion as to whether tax may apply to the use of the component parts in California. (Cf. Bus. Taxes Law Guide Annot. 210.0560.) We disagree with your characterization of the prototype as an “intangible.” We believe it clear that the prototype is “tangible personal property” as that term is defined at Revenue and Taxation Code section 6016. Based on the facts you provide, TPS will use the prototype in this state to integrate hardware and software and to correct system problems. That use is a use in California other than for demonstration and display for the purpose of resale. The sale to TPS of the materials and labor to fabricate or assemble the prototype is a retail sale. TPS’ sale of the prototype to the customer is exempt from tax if TPS’ sale and shipment of the prototype is made in accordance with Sales and Use Tax Regulation 1620, Interstate and Foreign Commerce, subdivision (a)(3)(B) or (a)(3)(C)2. We hope this answers your questions; however, if you need further information, feel free to write again. Very truly yours,

Ronald L. Dick
Senior Tax Counsel

Mr. R--- J. A---

RLD:sr

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May 3, 1993
515.0725