Does a retailer owe Colorado use tax when it withdraws items from inventory to assemble and display them before selling, and can it credit that use tax against the tax collected on the later sale?

Plain-English summary

A retailer withdraws items from inventory, assembles them, and displays them on the sales floor for several weeks or longer, then sells the display unit and replaces it. The representative asked: (1) does pulling the item for display create a use tax obligation; (2) if so, is there a credit for that use tax against the tax collected when the display unit is later sold; and (3) does the same apply to Colorado cities with a use tax? The Department gave a framework but declined a specific determination.

The resale exemption tolerates only "incidental" use. Colorado levies use tax on the use, storage, or consumption of tangible personal property (§ 39-26-202). A retailer normally owes no use tax on inventory because it bought the goods at wholesale for resale — but only if it makes no more than incidental use before resale. If the use is more than incidental, that use is a taxable transaction separate from the eventual retail sale, and the once-exempt wholesale purchase is recast as a retail sale to the retailer (American Multi-Cinema; A.B. Hirschfeld Press; IBM v. Charnes).

Ordinary display is usually incidental — no use tax. A retailer that puts a product on display while also holding it out for sale has only incidentally used it (the Department's example: a bookstore displaying a book it's also selling). Most retail display items are held primarily for resale, so no use tax.

But "primary own-use" triggers use tax. If the retailer's primary purpose is its own use rather than sale, use tax is due (Hirschfeld). Examples: samples used to market goods, or products significantly consumed in demonstrations. The Department weighs a four-factor "primary purpose" test: (1) any contractual obligation to use/alter/consume the property; (2) how essential the items are to performing those obligations; (3) how much the retailer controls the items' use before transfer; and (4) how much the items' form/character differs when transferred vs. when purchased. It also considers how long goods sit on display (so long they can't be sold as new), and notes that treating the goods as other than inventory — e.g., capitalizing and depreciating a display unit — is, by itself, usually a sufficient basis for use tax. (It cited Maine's Mathews Bros. display-cabinet case and others.)

Two firm rules when use tax does apply:

• Measured on the full purchase price. Use tax is computed on the full price the retailer paid the supplier — not prorated for partial use before resale. It doesn't matter that the retailer intends to resell the used item later.
• No credit at resale. Because the use and the later sale are separate transactions, the retailer gets no credit for the use tax it paid against the sales tax it later collects from the customer.

Home-rule cities: the Department doesn't administer self-collected home-rule city/county taxes — those jurisdictions set their own rules (see DRP 1002); contact them directly.

What this means for you

Retailers using floor models, demos, and display units

Displaying an item you're also selling is fine — that's incidental use, no use tax. The danger zone is when the item becomes primarily your own tool: long-term demo units, samples, or anything you capitalize and depreciate. If you depreciate a display unit, expect use tax on its full cost, with no credit when you eventually sell it. Keep display goods in inventory (not on the fixed-asset ledger) if you want to preserve the resale treatment.

Accountants and bookkeepers

The accounting treatment can decide the tax: capitalizing/depreciating a display item is usually enough on its own to create use tax. Apply the four-factor primary-purpose test, watch display duration, and remember the tax is on full cost with no resale credit. Check home-rule city rules separately.

Common questions

Q: Do we owe use tax just for putting inventory on display? A: Generally no, if you're also holding it out for sale — that's incidental use. Use tax arises only if your primary purpose is your own use (samples, consumed demos, depreciated display units).

Q: If we paid use tax on a display item, can we credit it when we sell the item? A: No. The use and the sale are separate transactions; there's no credit. And the use tax is on the full price you paid your supplier, not prorated.

Q: Does depreciating a display model matter?
A: Yes. Capitalizing and depreciating a display item is, by itself, usually a sufficient basis for the Department to find a taxable use.

Q: Do these rules apply to city use taxes?
A: For state-administered jurisdictions, yes. Self-collected home-rule cities/counties set their own rules — check DRP 1002 and contact them.

Citations and references

Statutes, cases, and publications:

• § 39-26-202, C.R.S. (use tax)
• American Multi-Cinema, Inc. v. City of Westminster, 910 P.2d 64 (Colo. 1995); A.B. Hirschfeld Press, Inc. v. City & County of Denver, 806 P.2d 917 (Colo. 1991) (primary-purpose test); International Business Machines v. Charnes, 601 P.2d 622 (Colo. 1979)
• DRP 1002 (state-administered vs. self-collected home-rule jurisdictions)

Related rulings

• [[plr-10-006-private-letter-ruling]] — primary-purpose / use-before-resale; acceptance testing as incidental use
• [[gil-09-002-colorado-sales-and-use-tax]] — wholesale purchase recast; use tax measured on cost (IBM)

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-09-019.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-09-019
June 30, 2009
XXXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXX
Re: use tax / display items
Dear XXXXXXXXXXXX,
This letter is in response to your inquiry regarding use tax. The Department issues general information letters and private letter rulings. A general information letter provides a general overview of the applicable tax law, does not provide a specific determination, and is not binding on the department. A private letter ruling is a determination of the applicability of tax to a specific set of circumstances and is binding in the department. A party requesting a private letter ruling must provide certain information and remit a fee. For more information about general information letters and private letter rulings, please refer to the Department’s regulation 24-35-103.5, C.R.S., which is available on our web site at: www.colorado.gov/revenue/tax. I will initially treat your request as one for a general information letter because the request does not contain the information or fee necessary for a private letter ruling. You may resubmit this request as a request for a private letter ruling. Issue

1. Are your clients required to remit use tax upon withdrawal of products from inventory?
2. If they are required to remit use tax, are they allowed a credit for use tax paid when the
   product is ultimately sold?
3. Should the answers for questions one and two also apply to the Colorado cities that
   have use tax?
   Background
   You represent a client that will withdraw items from its inventory, assemble the product and displays it on the sales floor. After several weeks or longer of being on display, the client will sell the display product and replace it with another item.

Discussion
Colorado levies use tax on the use, storage, or consumption of tangible personal property sold at retail. §39-26-202, C.R.S. A retailer generally does not incur use tax on its inventory because it purchases the inventory at wholesale (purchase for resale), not retail. However, in order to come within this exemption, the retailer cannot make any use, other than incidental use, of the product prior to resale. If a retailer’s use of goods from its inventory is more than incidental, then that use is a taxable transaction separate and distinct from the retailer’s subsequent taxable retail sale of the goods to customers. See, e.g., American Multi-Cinema, Inc. v. City of Westminster and Susan S. Stubbs, as Finance Director for the City of Westminster., 910 P2d 64 (Colo.1995); A.B. Hirschfeld Press, Inc. v. City and County of Denver, et al, 806 P2d 917 (Colo. 1991). Thus, what was originally an exempt wholesale sale from the wholesale supplier to the retailer is recast as a retail sale to the retailer. See, International Business Machines v. Charnes, 601 P.2d 622 (Colo. 1979). Importantly, the use tax owed by the retailer is calculated on the full price the retailer paid the supplier (i.e., use tax is not calculated on a prorated schedule based on the retailer’s partial use of the product prior to resale). For this reason, it does not matter that, at the time the retailer pulls goods from inventory its own use, the retailer intends to resell the used inventory to its customers at some future date. See, e.g., A.B. Hirschfeld Press, Inc. v. The City and County of Denver; 806 P2d 917 (Colo. 1991) (court rejected retailer’s argument that it was not liable for use tax because it intended to resell goods that it used prior to resale). And because these are separate transactions, the retailer is not entitled to a credit for use tax it pays when the retailer sells the goods to a customer. The principal issue presented in your letter is whether the use of inventory for a marketing display is more than an incidental use that would subject the retailer to use tax liability. In general, a retailer who places product on display while also holding the same out for sale has only incidentally used the product and is not liable for use tax. For example, a bookstore that withdraws a book from inventory for purposes of display and sale has not created a use tax obligation. The department generally views most retail display items as items held primarily for resale and not primarily for use by the retailer. If, however, the “primary purpose” of the retailer is to put the goods to its own use rather than for sale, then the retailer owes use tax. A.B. Hirschfeld Press, supra. A common example of a retailer using inventory primarily for its own use and not for resale is the retailer’s use of samples to market its goods. Similarly, products consumed to some significant degree in the course of a product demonstration are considered primarily used by the retailer and not primarily for resale. The department will consider a number of factors in applying this “primary purpose” test, including: (1) the nature of the retailer’s contractual obligations, if any to use, alter or consume the property to produce goods or perform services; (2) the degree to which the items in question are essential to the retailer’s performance of those obligations; (3) the degree to which the retailer controls the manner in which the items are used, altered or consumed prior to their transfer to third parties; and (4) the degree to which the form, character or composition of the items when transferred to third parties differs from the form, character or composition of those items at the time they were initially purchased.

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Hirschfeld Press, 806 P.2d 921. See, also, Kaiser Steel Corp. v. State Bd. of Equalization, 24 Cal.3d 188 , 154 Cal.Rptr. 919 (1979); Laux Advertising, Inc. v. Tully, 67 A.D.2d 1066 , 414 N.Y.S.2d 53 (1979); Baltimore Foundry & Mach. Corp. v. Comptroller of State, 211 Md. 316 (1956). We note that in circumstances similar in a number of respects to the circumstances presented by your clients, Maine found that a retailer primarily used display cabinetry for the benefit of the retailer. In Mathews Bros. Co., v. Maine, CV-93-001, 03/04/1994, the superior court of Maine considered whether a cabinet maker incurred use tax when it fully assembled and then displayed cabinets for customers to view. The display cabinets were periodically sold to retail customers. The retailer also depreciated the cabinets over the period they were displayed. Applying the “primary purpose” test, the court concluded that the primary purpose of the goods was for use by the retailer and, therefore, an assessment of use tax was appropriate. See, also, Robert Philip Spudich, d/b/a Columbia Billiard Center, v. Director of Revenue, State of Missouri, 745 SW2d 677, 02/17/1988 (pool tables used for display and demonstration and sold only when inventory depleted created use tax because products primarily used by retailer rather than for sale); Foss Nirsystems, Inc. v. Comptroller, Md. Ct. of Special Appeals, (2003) 151 Md App 44, 822 A2d 1297, Dkt. No. 1428, 5-6-2003, aff'g Tax Court, Dkt. No. 98-SU-OO0272, 3-15-2001 (retailer’s use of product for demonstration purposes was a use “primarily for the benefit of the retailer and not primarily used to sell the product). The department will also consider the length of time that the retailer holds goods on display as an indication of whether the primary purpose of the goods were for resale or primarily for use by the retailer. See, e.g., Washington Tax Decisions 90-305, 10 WTD 107, 08/06/1990 (goods on display for such long periods of time that they cannot be sold as new). Although not a necessary basis for finding use tax liability, it is sufficient basis in most cases if the retailer treats the goods as other than inventory for tax purposes (e.g., capitalizing and depreciating a display item). Compare, J.C. MConville v. SBE, Calif. Ct. Appl. 3d Dist., (1978), 85 Cal App 3d 156, 149 Cal Rptr 194 (Inventory that is capitalized and depreciated will be treated as used for use tax purposes); Virginia Public Document Ruling No. 94-45, 03/09/1994. As I noted above, a general information letter provides a general discussion of the tax issue and we do not make rulings regarding a specific factual setting in these general information letters. You may resubmit your request as one for a private letter ruling if you would like a determination on the specific facts you have described. Miscellaneous Please note that the department does not collect sales and use taxes for “home-rule” cities and counties. You can find a list of these jurisdictions by visiting our web site at: www.taxcolorado.org (go to Tax Forms > DRP 1002) Contact those governments for information about their taxes. This general information letter represents the advice of experienced members of the Department’s staff. However, it is not binding on the department. Enclosed is a redacted version of this ruling. Pursuant to statute and regulation, this redacted version of the ruling will be made public within 60 days of the date of this letter. Please let me know in writing within that 60 day period whether you have any suggestions or concerns about this redacted version of the ruling. 3

Sincerely,

Office of Tax Policy
Colorado Department of Revenue

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