Does a company owe sales tax when it has customers' VHS tapes converted to DVD by a third party and hands over the DVD for a fee—and can it buy the conversion from the third party tax-free?
Plain-English summary
Customers bring VHS tapes to a company to have them converted to DVD. The company doesn't do the conversion itself — it hires a third party, which converts the tape, transfers the finished DVD to the company, and bills the company. The company then hands the DVD to its customer for a fee. It asked: (1) should it charge customers sales tax on the DVDs, and (2) should it give the third party a resale certificate?
The Department found two sales:
- Third party → company: the sale of the finished DVD to the company is an exempt wholesale (sale-for-resale) transaction, because the company resells the DVD to its customer. So the company should give the third party a resale certificate — and it doesn't matter whether the third party separately states a service charge for the conversion, since that whole sale is exempt.
- Company → customer: this is a taxable retail sale of the DVD.
The company hoped the conversion might be a nontaxable service with the DVD only "incidental." The "true object" test (Special Regulation Sales 40) defeats that: here the true object is the DVD itself, so the transfer is taxable even though labor produced it. And the taxable price must include the cost of the services used to produce the property (§ 39-26-102(10) — sales price is the gross value of all materials, labor, service, and profit). Because the third party's conversion work is a necessary and inseparable part of producing the DVD (A.D. Stores), the company must collect tax on the full amount including that conversion charge — even if it separately states it on the customer's invoice.
Finally, the company is out-of-state. An out-of-state retailer must collect Colorado sales/use tax only if it is "doing business in this state" (§ 39-26-102(3)); the letter didn't have enough facts to decide that and pointed to FYI Sales 5 (out-of-state businesses) and FYI Sales 1 (documenting sales to retailers).
What this means for you
Businesses that sell a finished tangible product made by a subcontractor
If the customer is really buying a thing (a DVD, a printed item, a fabricated good), it's a taxable retail sale even though labor and a subcontractor produced it. Buy the finished item from your subcontractor tax-free for resale (give them a resale certificate), then collect tax from your customer on the whole price — including the production/conversion labor you paid for — because that labor is inseparable from making the product. Separately stating the labor doesn't carve it out of the tax base.
The "true object" line
A transfer of goods can escape tax when the true object is a service and the goods are merely incidental. That didn't apply here because the customer's real objective was the DVD. Ask what the customer is actually paying for; if it's the tangible item, expect tax on the full amount.
Out-of-state sellers
Whether you must collect Colorado tax depends on whether you're "doing business in this state." If you have Colorado nexus, the rules above apply; if not, the obligation may shift. See FYI Sales 5.
Common questions
Q: Is converting a customer's VHS to DVD a taxable sale?
A: Yes. The true object is the DVD (tangible property), so handing it to the customer for a fee is a taxable retail sale, even though labor produced it.
Q: Is the conversion labor taxable if I list it separately?
A: Yes. The sales price includes the labor/service used to produce the DVD, and that conversion work is inseparable from making it — so it's in the tax base even if separately stated.
Q: Can I buy the conversion from my subcontractor tax-free?
A: Yes. The third party's sale of the finished DVD to you is an exempt sale for resale; give them a resale certificate.
Q: I'm an out-of-state company — do I collect Colorado tax?
A: Only if you're "doing business in this state." The Department didn't have enough facts to decide; see FYI Sales 5.
Q: Can I rely on this letter?
A: No. It's a General Information Letter — general guidance only, not binding on the Department.
Citations and references
Statutes, cases, and rules:
- § 39-26-104(1)(a), C.R.S. — sales/use tax on retail sales
- § 39-26-102(9), C.R.S. — retail sales do not include wholesale (resale) sales
- § 39-26-102(10), C.R.S. — sales price includes materials, labor, service, and profit
- § 39-26-102(3), C.R.S. — out-of-state retailer "doing business in this state"
- A.D. Stores v. Department of Revenue, 19 P.3d 680 (Colo. 2001) — inseparable service folded into the taxable price
- Department Special Regulation Sales 40 — "true object" of the transaction
- Department publications FYI Sales 5 (out-of-state businesses) and FYI Sales 1 (documenting sales to retailers)
True-object / separability cousins: [[gil-08-001-telecommunications-computer-software-freight-training-repair]], [[gil-09-018-taxability-of-services]], [[gil-09-011-xxxxxxxxxx]].
Source
- Landing page: Colorado Sales & Use Tax Letter Rulings
- Original PDF: GIL-08-008.pdf
Original ruling text
Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]
GIL-2008-8
XXXXXXXXXXXXX
Attn: XXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXX
February 28, 2008
Re: taxability of video format conversion
Dear XXXXXXXXXXXX,
This letter is in response to your letter to the Colorado Department of Revenue, dated January 9,
2008, re: the taxability of DVDs converted from VHS tapes.
Issues
1. Should the company charge sales tax to customers for the DVDs?
2. Should the company provide a resale certificate to a third-party that provides the company
with a service and DVD?
Background
You provide the following facts. Customers come to the company to have their VHS tapes converted
to DVDs. The company contracts with a third-party which converts the VHS to DVD. The third-party
bills the company for the conversion and transfers to the company the DVD. In turn, the company
transfers the DVD to its customer and charges a fee.
Discussion
Colorado imposes sales and use tax on the sale, use, storage, or consumption of tangible personal
property. §39-26-104(1)(a), C.R.S. There are two sales in the circumstances you describe. The first
is the sale of DVDs by the third-party to the [company]. However, Colorado exempts sales where the
purchaser intends to resell the property to another (i.e., wholesale sales). See, §39-26-104(1)(a) (tax
on retail sales) and 102(9) (retail sales do not include wholesale sales), C.R.S. Therefore, the sales
from the third-party to [company] are exempt because [company] resells the DVDs to customers.
The second sale is the sale of DVDs by the [company] to its customers. This sale is a retail sale of
the DVD and, therefore, is taxable.
I note that, in some cases, the transfer of tangible personal property is not taxable if the “true object”
of the transaction is the performance of a service and the transfer of tangible personal property is
only incidental to the sale. See, Department Special Regulation Sales 40. This exception, however,
does not apply here. In this case, the true object of the transaction is the DVD itself. In such cases,
the transfer of the property is taxable even though labor is used to produce the property. Other states
that have addressed this issue have reached similar conclusions. See, e.g., California Sales Tax
Counsel Rulings No. 435.0595; California Sales Tax Counsel Rulings No. 120.1220; Missouri Private
Letter Ruling No. LR 4151, 10/01/2007.
You ask whether the charge by the third-party for the service of making the conversion from VHS to
DVD is taxable. As noted above, the sale between the third-party and the [Company] is an exempt
sale. Therefore, it does not matter whether there is a separate charge for the service of converting
the VHS tape into a DVD. However, the sale between the [Company] and its customer is taxable, so
it is important to address whether the [Company] can separately state that service charge on its own
invoice to the customer and not collect tax on that amount. In general, the purchase price upon
which sales or use tax is calculated must include the cost of services incurred in producing the
tangible personal property. See, §39-26-102(10), C.R.S. (“Except as otherwise provided in this
subsection (12), the sales price is the gross value of all materials, labor, and service, and the profit
thereon, included in the price charged to the user or consumer.”). The services provided by the thirdparty are a necessary and inseparable part of the process to produce the DVDs. A.D. Stores v
Department of Revenue, 19 P3d 680 (Colo. 2001). Therefore, the sales tax collected from the
customer must include the third-party’s service charge, regardless of whether the [Company]
separately states the service charge on the customer’s invoice.
I also note that you are located out-of-state. An out-of-state retailer must collect Colorado sales or
use tax if it is “doing business in this state.” §39-26-102(3), C.R.S. You have not submitted an
inquiry on whether your activities constitute doing business in this state and there is not sufficient
information in the letter to allow me to provide guidance on that issue. However, the department has
a number of tax publications and other resources available on its web site regarding what constitutes
doing business in this state and other tax issues. Visit us on-line at: www.revenue.state.co.us and go
to Taxation > FYIs > Sales Tax > FYI Sales 5 (Sales Tax Information for Out-of-state Businesses).
See, also, FYI Sales 1 (Documenting sales to retailers).
Finally, the Department makes a good faith effort to provide accurate and complete answers to
questions posed to it by taxpayers. However, the information and answers provided here are not
binding on the Colorado Department of Revenue, nor do they replace, alter, or supersede Colorado
law and regulations. The Executive Director, who by statute is the only person having authority to
bind the Department, has not formally reviewed and/or approved this response.
Respectfully,
Office of Tax Policy
Colorado Department of Revenue