Which uses of machines withdrawn from a manufacturer's resale inventory triggered California use tax?

Plain-English summary

California divided machines withdrawn from a manufacturer's finished-goods inventory according to what each department actually did with them.

Training service employees was taxable, even where machines were torn down and rebuilt. Training existing owners or prospective buyers was treated as demonstration and display, so that use was not taxable. Application research—finding improvements or new uses and testing other instruments—was taxable.

Quality-assurance testing of the withdrawn machine itself against the manufacturer's standards did not trigger tax. Using a machine to test other machines or investigate customer complaints did.

The memorandum also reviewed a two-year lease with a later purchase option and partial rent credits. It was not a lease in lieu of sale, so tax applied to monthly rental payments.

Common questions

Was every training use taxable?

No. Employee service training was taxable, while instruction for owners or prospective buyers was treated as demonstration and display.

Did quality-control testing trigger tax?

Testing the withdrawn machine to determine whether it met company standards did not. Using it to test other machines or diagnose customer problems did.

How was the submitted lease treated?

As a taxable lease rather than a sale, with tax on monthly rents.

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/570-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/570-0440.pdf

Original ruling text

State of California

Board of Equalization

Memorandum

To:

San Jose - Auditing

From:

Tax Counsel (GAT) Headquarters

Subject:

B--- I---, Inc.
S--- Division
XXXX --- Avenue
--- ---, California

570.0440

Date:

July 21, 1967

SR -- XX-XXXXXX

This is in reply to your request for rulings concerning the application of use tax with respect to machines manufactured by B--- which are withdrawn from its finished goods inventories and charged to its Training, Application Research, and Quality Assurance Departments. It is our understanding that these departments use the machines in the following ways: (1) Training Department Machines charged to the training department are used in classes for training employees in servicing the machines. The machines are also used in other classes for training customers in their use. Machines may be used in classes for as long as 14 months. In the employee training classes, the machines may be completely torn down and reassembled. In the customer training classes, the trainees are instructed in the uses and possible applications of the machines. Customer trainees may be owners of machines or prospective buyers. In our opinion, the use of machines for training service employees is subject to tax measured by the cost thereof. On the other hand, it is our opinion that the use of machines to train owners of similar machines or prospective buyers constitutes demonstration and display. Accordingly, no tax is incurred with respect to such use. (2) Application Research Department New and standard models of machines are assigned to the Application Research Department for study to determine how they can be improved and whether they can be applied to uses other than those for which they were constructed. These machines are also used to test other instruments and accessories.

San Jose - Auditing
SR -- XX-XXXXXX

-2-

July 21, 1967
570.0440

In our opinion, the use of new and standard model machines by the Application Research Department to find new applications and to determine whether they can be improved and the use of the machines to test other machines are taxable uses. Therefore, the cost of such machines is subject to tax. (3) Quality Assurance Department Machines are assigned to the Quality Assurance Department to determine whether they meet the qualify and standards required by the manufacturer. In determining whether they meet such standards, other machines are used to test them. Machines are also used to check out problems which customers have complained of in their own machines. In our opinion, the testing of machines withdrawn from inventory to determine whether they meet company standards does not subject such machines to tax. On the other hand, it is our opinion that the use of machines to test other machines is subject to tax, and that the use of machines to check customer’s problems is likewise subject tot tax. We have examined the copy of the lease which you submitted. The lease is for a term of two years, renewable monthly thereafter. The lessee has the option to purchase the leased machine. If he then exercises the option within the first 60 days of the lease, he will be given credit for 100% of the rentals which he has paid toward the purchase price. If he exercises the option after 60 days, he will be given credit toward the purchase price for 75% of the rentals paid. In our opinion, this lease is not in lieu of sale. Accordingly, tax applies to the monthly rental payments.

GAT:ph