Is electricity used to power computers that write and test software exempt from Colorado sales tax as manufacturing or industrial use?

Plain-English summary

A company builds a finished system combining tangible parts (bought from vendors) with software it designs, develops, and tests to each customer's specs. It asked whether the electricity used to power the computers that write and test that software is exempt as electricity used in manufacturing or industrial use.

The framework: Colorado taxes electricity sold for commercial purposes but exempts (as a wholesale sale) electricity for manufacturing and industrial use (§§ 39-26-104(1)(d.1), 102(21)). So the question is whether powering computers to do programming is a commercial use (taxable) or a manufacturing/industrial use (exempt).

The Department's nuanced reasoning:
- Manufacturing means "[o]peration of producing a new product … different from and having a distinctive name, character, or use from raw or prepared materials," and machinery used for "managerial, sales, research and development, or other non-operational activities is not manufacturing." "Industrial" has no statutory definition; the Department reads it as "the business of producing goods." "Commercial" use (taxable) means business activities meant to produce a profit — e.g., the Department has said electricity for desktop computers is a commercial, not industrial, use.
- Standing alone, computer programming may not qualify as manufacturing or industrial (the NAIC classifies programming as a service, and software isn't tangible personal property for sales tax unless it meets certain criteria, § 39-26-102(15)). But the Department said viewing one activity in isolation is too strict. "Manufacturing involves multiple activities, some of which, if viewed in isolation, may be characterized as services" (like energy to power equipment that cleans manufacturing machinery).
- The line it drew: electricity powering computers used in a manufacturing/industrial process can be exempt, but electricity powering computers used for administrative purposes (record keeping, communications) is not.
- Bottom line — undecided on these facts. The Department "cannot tell whether the assembling Company performs is a relatively minor assemblage … or is more akin to … an industrial or manufacturing process." "If the activities … did qualify as manufacturing or as an industrial purpose, then the electricity used to program software that is included in the finished goods would likely be viewed as exempt."

This is a General Information Letter — guidance and a framework, not a determination; the Department invited a private letter ruling for a fact-specific answer.

What this means for you

Manufacturers that also develop embedded software/firmware

The key insight: don't assume the electricity powering your software/firmware development is taxable just because programming, in isolation, looks like a service. If that programming is one step in a genuine production process that yields a new, distinct finished good, the electricity for it can fall within the manufacturing/industrial electricity exemption. Conversely, electricity for purely administrative computers (records, email, sales) is taxable commercial use. The exemption hinges on whether your overall operation is real manufacturing/industrial production versus minor assembly — a fact-intensive question worth a private letter ruling if the dollars are significant.

Software-only companies

Software development on its own typically reads as a service/commercial use, so the electricity powering it is generally taxable. The exemption analysis here depended on the software being integrated into a tangible finished product as part of a production process.

Accountants and tax professionals

Authorities: exemption for manufacturing/industrial electricity as a wholesale sale (§§ 39-26-104(1)(d.1), 102(21)); manufacturing definition (§ 39-26-709(1)(c)(III)) and Reg 39-26-709.1(B)(2) excluding managerial/sales/R&D; software-as-TPP criteria (§ 39-26-102(15)); cf GIL 16-014, 14-009. The Department's "don't view activities in isolation" stance plus the administrative-vs-production line is the takeaway. No determination was made.

Common questions

Q: Is electricity taxable in Colorado?
A: Electricity for commercial purposes is taxable; electricity for manufacturing or industrial use is exempt as a wholesale sale.

Q: Is electricity used to write and test software exempt?
A: Only if the programming is part of a genuine manufacturing or industrial production process that creates a finished good. Programming in isolation usually looks like a taxable commercial/service use.

Q: Why wouldn't programming count as manufacturing?
A: The NAIC classifies computer programming as a service, and software generally isn't tangible personal property unless it meets certain criteria. But the Department warned against judging a single step in isolation — within a larger production process, it can still be part of manufacturing.

Q: So is my electricity exempt or not?
A: The Department couldn't decide on the facts given. If the company's overall activity qualifies as manufacturing/industrial, the electricity used to program software included in the finished goods would likely be exempt. A private letter ruling can resolve a specific case.

Q: Is this letter binding?
A: No. A General Information Letter is general guidance and is not binding on the Department; it makes no specific determination.

Q: Does this cover city sales tax?
A: No. The Department administers state and state-collected local taxes only; self-collected home-rule cities and counties set their own rules.

Citations and references

Statutes and rules:
- § 39-26-104(1)(d.1), C.R.S. (sales tax on electricity for commercial purposes)
- § 39-26-102(21), C.R.S. (wholesale sale; electricity for manufacturing/industrial use treated as a wholesale sale)
- § 39-26-709(1)(c)(III), C.R.S. (definition of "manufacturing")
- § 39-26-102(15), C.R.S. (software is tangible personal property only if it meets certain criteria)
- 1 CCR 201-4, Reg 39-26-709.1(B)(2) (machinery for managerial/sales/R&D is not manufacturing); GIL 16-014; GIL 14-009

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-17-011.pdf

Original ruling text

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

GIL-17-011

May 2, 2017
XXXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXXX
XXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXX
Re: Electricity to Produce Software
Dear XXXXXXXXXXXXXX,
You submitted a request for guidance on behalf of your company (“Company”) regarding
the application of sales and use taxes to electricity used in the production of software.
The Colorado Department of Revenue (“Department”) issues general information letters
and private letter rulings. A general information letter provides a general overview of the
relevant tax issues, but is not binding on the Department. A private letter ruling provides a
specific determination for a specific set of facts, is binding on the Department but not on
the Company, and requires payment of a fee. For more information about general
information letters and private letter rulings, please see Department Rule 1 CCR 201-1,
24-35-103.5.
The Department treats this request as a general information letter. It is important to
remember that general information letters, such as this one, are general discussions of tax
law and are not binding on the Department. If Company would like the Department to
issue a private letter ruling on the issue raised here, Company can submit a request and
pay the fee in compliance with Department Rule 1 CCR 201-1, 24-35-103.5.
Issues
1. Is the purchase of electricity for production of software (used to power the computers
on which the software is written and tested) exempt from sales tax?
2. Is electricity purchased for integration of the software with tangible personal property
exempt from sales tax as manufacturing?
Background
Company produces for sale at retail a finished system comprised of many parts. The parts
include tangible personal property as well as computer software designed specifically, and
exclusively, for use as part of the system. Company purchases from other vendors the
parts that are tangible personal property. However, Company designs, develops, and
tests the software to meet specifications of each purchaser of the finished system.

Company states that the electricity used to assemble the parts into different tangible
personal property is exempt from sales tax as manufacturing or industrial use.
Structure of Analysis
To determine whether Company’s transactions are exempt from sales and use tax, the
Department will examine the following question:
1. Does Company’s use of electricity qualify as electricity used in a commercial, industrial,
or manufacturing activity pursuant to §§39-26-104(1)(d.1) and 102(21), C.R.S.?
Discussion
Colorado imposes sales tax on the sale of electricity for commercial purposes but exempts
(as a wholesale sale) the sale of electricity for use in manufacturing and for industrial use
as wholesale sales.1 The principal issue raised in this request for guidance is whether
electricity used by Company to perform computer programming, which is integrated into
computer products assembled by Company or a third party, constitute a commercial,
manufacturing, or industrial use of electricity.
Manufacturing, in the context of the exemption for manufacturing machinery, is defined as
the,
[o]peration of producing a new product, article, substance, or commodity
different from and having a distinctive name, character, or use from raw or
prepared materials, ...2
Machinery used for managerial, sales, research and development, or other nonoperational activities is not manufacturing.3 There is no statutory definition of “industrial”
use. In the absence of statutory definitions, the Department generally looks to the
common meaning of terms. In general, “industrial” means the business of producing
goods.4 Finally, “commercial” use of electricity, which is taxable, generally refers to
business activities intended to produce a profit.5 For example, the Department has
provided guidance that electricity used for desktop computers is considered a commercial
use and not an industrial use of energy.
Although computer programming may not qualify as industrial or manufacturing6 if it were
the only activity engaged in by Company, we do not think this is dispositive.
Manufacturing involves multiple activities, some of which, if viewed in isolation, may be
characterized as services. For example, energy used to power equipment used to clean
manufacturing machinery may be part of the manufacturing process. This cleaning activity
may well be classified as a service if viewed in isolation from the other activities of
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4
5
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2

§§ 39-26-104(1)(d.1) and 102(21), C.R.S.
§ 39-26-709(1)(c)(III), C.R.S.
Department Regulation 39-26-709.1(B)(2) (1 CCR 201-4)
See, e.g., GIL 16-014 and 14-009. Merriam Webster Dictionary, “Industry” - “the process of
making products by machinery and factories.”.
“Commerce”- “relating to or used in the process of buying and selling of goods and services.”
The Department has not issued guidance on whether electricity used to power computers to
create computer software is manufacturing. We note that the North American Industrial Code
(NAIC) categorizes computer programming as a service. Consistent with this classification,
computer software is not classified as tangible personal property for sales tax purposes unless
it meets certain criteria. § 39-26-102(15), C.R.S.
DR 4010A (06/11/14)

manufacturing. However, we think viewing specific activities in isolation is an overly strict
view of the manufacturing / industrial process.
Moreover, we distinguish the exempt use of electricity to power computers used in
manufacturing and industrial processes from the taxable use of electricity to power
computers used in a commercial setting. Computers used for administrative purposes,
such as record keeping, communications, and other similar applications, are not part of the
manufacturing process and, therefore, the electricity used to power such computers is not
exempt as a manufacturing or industrial use of electricity.
In general, manufacturing and industrial use suggest fairly large, multi-stage production
processes. We cannot tell whether the assembling Company performs is a relatively
minor assemblage of finished computer components or is more akin to what is commonly
understood to be an industrial or manufacturing process. Similarly, we cannot determine
on the facts provided whether the development of firmware is a manufacturing or industrial
process.7 If the activities engaged in by Company did qualify as manufacturing or as an
industrial purpose, then the electricity used to program software that is included in the
finished goods would likely be viewed as exempt.
Miscellaneous
This letter represents the good faith opinion of Department personnel who are
knowledgeable on state taxes issues. However, the Department does not make a specific
determination here on any of the issues raised and the Department is not bound by this
general information letter.
The Department administers state and state-administered local sales and use taxes. This
letter does not address sales and use taxes administered by home-rule cities and homerule counties. You may wish to consult with local governments which administer their own
sales or use taxes about the applicability of those taxes. Visit our web site at
www.colorado.gov/tax for more information about state and local sales taxes.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this
redacted letter 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 letter.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

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3

A determination based on specific facts is outside the scope of a general information letter.
Company may request a private letter ruling that addresses the application of these rules to its
circumstances.
DR 4010A (06/11/14)