Did selecting high-reliability resistors from a production run for unusually rigorous testing create taxable self-use?

Plain-English summary

A manufacturer removed high-reliability resistors from a production run for testing. The testing went beyond ordinary quality control: it occurred in the buyer's resident engineer's presence, followed United States standards, and reflected the resistors' intended use in the missile industry.

California still treated the samples as production loss with no tax consequence. Its stated policy treated ordinary quality-control samples and defective items removed and destroyed the same way because production naturally involves losses and those items are not truly self-consumed by the manufacturer.

The letter recommended deleting the protested audit item, but said formal Board action and notice would follow.

Common questions

Did unusually rigorous testing change the result?

No. The source applied the same production-loss treatment even though the testing required greater reliability and care.

Did title passage or who benefited from testing control?

No. The letter focused on the fact that the tested resistors were selected from a production run.

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/570-1400.pdf

Original ruling text

570.1400

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

June 4, 1964

“U”
This is to inform you of our recommendation to the Board with respect to the above named taxpayer’s petition for redetermination. We will recommend that the protested item be deleted from the audit. This item involved high reliability resistors removed from a production run for test purposes. The testing was more than quality control on the part of the petitioner in that the testing was done in the presence of the buyer’s resident engineer, and the testing was done according to United States’ standards. It has been the Board’s policy in the past to treat quality control test samples as a production loss which incurs on tax consequences. This is also true of defective items which are removed from production and destroyed. The theory is simply that production entails certain losses and items removed from a production run are not really self-consumed by the taxpayer. While the testing in this case involved a higher degree of reliability and care because the items will be used in the missile industry, we feel the same rule should apply. The important thing here is not whether title passes prior to testing or who is ultimately benefited by the testing, but the fact that the testing was of resistors selected from a production run. The Board will act upon our recommendation at its regular meeting, and you will receive official notice of the redetermined amount in due course. We appreciate your cooperation in answering our inquiries. Very truly yours,

John H. Knowles
Associate Tax Counsel

JHK:md

[1b]