Are the parts and the machinery a company buys to build an experimental aircraft prototype for its own research and development exempt from Colorado sales and use tax?

Plain-English summary

A company developing a new commercial passenger aircraft wanted to build a full-size prototype to fly-test the design, and eventually maybe sell the prototype (though not as a commercial aircraft) or keep it for marketing. Building it required buying lots of aircraft parts plus machinery and machine tools. The company asked Colorado whether all of that was exempt from sales and use tax. The Department's bottom line: the parts are exempt, and so is the machinery — but the reason the parts are exempt matters.

Why the obvious exemption doesn't apply. Colorado has an exemption for components bought to manufacture goods for sale (an anti-pyramiding rule, so tax isn't charged twice on the same value). The Department said that exemption does not cover these parts, because the company isn't building the prototype primarily to sell it — it's building it to use for its own research, development, and marketing. When a manufacturer is the primary user/consumer of what it builds, the resale-based exemption falls away. Colorado case law backs this: extensive use of a product before any sale is a taxable use by the maker (the Department cited the General Motors test-vehicle case and AB Hirschfeld).

Why the parts are exempt anyway. Colorado has a separate aircraft-parts exemption for "tangible personal property that is to be permanently affixed or attached as a component part of an aircraft." The prototype's parts are permanently attached aircraft components, so they qualify on their own terms — independent of whether the prototype is ever sold. (This is distinct from buying a whole build-your-own airplane kit, which the Department treats as buying an airplane, not parts.)

The machinery is exempt too. Machinery and machine tools used to manufacture tangible personal property are exempt under Colorado's manufacturing-machinery exemption, and building an aircraft is manufacturing. That exemption applies regardless of whether the finished prototype is later sold or just used internally. (The Department only decided that building the aircraft is manufacturing; it did not verify every other requirement of § 39-26-709.)

The remaining questions (issues 2 and 3 — what happens if the prototype's cost exceeds its sale price, or no buyer is found) were moot once the parts were held exempt. And the company's plan to claim federal R&D depreciation on the prototype was consistent with the conclusion that it is using and consuming the prototype.

What this means for you

Aerospace and aircraft manufacturers

Parts permanently attached to an aircraft can be exempt under Colorado's dedicated aircraft-parts exemption even when your project is R&D rather than production-for-sale. Don't rely solely on the manufacturing-for-resale exemption for prototypes you'll use yourself — it may not apply — but check the product-specific aircraft-parts exemption, which doesn't require a downstream sale.

Manufacturers building prototypes or test units (any industry)

The key trap: if you build something and use it (testing, R&D, marketing) before any sale, that use is generally a taxable use, and the "purchased for resale / components for manufacture-for-sale" exemptions can evaporate. The favorable result here came from a separate, product-specific exemption (aircraft parts) plus the manufacturing-machinery exemption — not from the resale theory. Map your facts to a specific exemption rather than assuming "it'll be sold eventually" protects you.

R&D-intensive companies and their tax advisors

Claiming federal R&D depreciation signals that you're using the property — which can undercut a "held for resale, not used" position for sales/use tax. The two were consistent here. Note also that the manufacturing-machinery exemption (§ 39-26-709) applies even when the manufacturer consumes what it makes, but it has its own set of requirements the Department didn't fully adjudicate in this letter.

Accountants and tax professionals

The analysis layers three doctrines: (1) the manufacture-for-sale/anti-pyramiding exemption (§ 39-26-102(20); § 39-26-713(2)(e)(I)) fails where the maker is the primary user (Carpenter v. Carman; AB Hirschfeld (1991); General Motors (1999)); (2) the standalone aircraft-parts exemption (§ 39-26-711) for permanently affixed components, which the Department reads as separate from the interstate-commerce-limited aircraft exemption; and (3) the manufacturing-machinery exemption (§ 39-26-709), which doesn't require a subsequent taxable sale. Watch the home-rule-city caveat.

Common questions

Q: Are parts for an aircraft prototype exempt from Colorado sales and use tax?
A: Yes, here — but under the aircraft-parts exemption (for property permanently affixed as a component of an aircraft), not the components-for-resale exemption. The result is the same for the buyer: the parts are exempt.

Q: Why didn't the "components used to manufacture goods for sale" exemption apply?
A: Because the company's primary purpose was to use the prototype for its own research, development, and marketing, not to sell it. When the manufacturer is the primary user/consumer of what it builds, that resale-based exemption doesn't apply.

Q: Is the machinery used to build the prototype taxable?
A: No. Machinery and machine tools used to manufacture tangible personal property are exempt, and building an aircraft is manufacturing. That holds whether or not the prototype is later sold — though the machinery still has to meet the other requirements of the manufacturing-machinery exemption.

Q: Does it matter if the prototype is sold at a loss or never sold at all?
A: No. Once the Department concluded the parts were exempt, the questions about selling at a loss or failing to find a buyer were moot.

Q: Does claiming the federal R&D credit/depreciation affect my sales tax position?
A: It can. Claiming depreciation implies you're using the property, which is consistent with treating it as used/consumed for sales and use tax — and inconsistent with a "purchased only for resale, never used" position.

Q: Can another company rely on this ruling?
A: No. A private letter ruling binds the Department only for the taxpayer and facts it was issued to, and explicitly cannot be relied on by anyone else. It shows the Department's reasoning, but your facts may differ.

Q: Does this cover city tax too?
A: No. The Department administers state and state-administered local sales and use tax only. Self-collected home-rule cities set their own rules. Check each home-rule city.

Citations and references

Statutes and rules:
- § 39-26-104(1), C.R.S. (sales tax on retail sales of tangible personal property)
- § 39-26-202, C.R.S. (use tax on storage, use, or consumption)
- § 39-26-102(20), C.R.S. (wholesale sale; component-part definition)
- § 39-26-713(2)(e)(I), C.R.S. (exemption for components used to manufacture property for sale)
- § 39-26-711, C.R.S. (exemption for property permanently affixed as a component part of an aircraft)
- § 39-26-709, C.R.S. (manufacturing machinery and machine-tools exemption)

Cases:
- Carpenter v. Carman Distributing Co., 144 P.2d 770 (Colo. 1943)
- AB Hirschfeld v. City and County of Denver, 806 P.2d 917 (Colo. 1991)
- General Motors Corp. v. City and County of Denver, 990 P.2d 59 (Colo. 1999)

Related guidance:
- Colorado PLR 15-002 and PLR 14-003; FYI Sales 85; GIL 13-027 (cited by the Department; private rulings cannot be relied on by other taxpayers)

Subject

Sales and use tax on parts and machinery for an R&D aircraft prototype

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/PLR-18-003.pdf

Original ruling text

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

PLR-18-003
May 23, 2018
XXXXXX
Attn: XXXXXX
XXXXXX
XXXXXX
Re: XXXXXX
Dear XXXXXX,
You submitted a request for a private letter ruling on behalf of your client XXXXXX
(“Company”) to the Colorado Department of Revenue (“Department”) pursuant to
Department Rule 24-35-103.5. This letter is the Department’s private letter ruling. This
ruling is binding on the Department to the extent set forth in Department Rule 24-35103.5. It cannot be relied upon by any taxpayer other than the taxpayer to whom the
ruling is made.
Issue
1. Is Company’s purchase of parts, materials, and consumables that are
incorporated into the Prototype exempt from sales and use tax?
2. If the cost of the Prototype exceeds the proceeds from the sale of the
Prototype, would the Department treat the costs related to manufacturing
the Prototype subject to sales or use tax?
3. If a buyer cannot be found for the sale of the Prototype and the Department
determines that Company’s purchase of the materials incorporated into the
Prototype are subject to tax, when is the use tax due on the cost of the
Prototype?
4. If the Prototype is used for internal purposes at the end of testing, would
the Department consider the machinery and equipment used to build the
Prototype to be taxable?
a. If taxable, when is the use tax due on such materials?
b. Would the date the use tax is due on the machinery and equipment
follow the date that use tax is due on the materials used to build the
Prototype?

5. Are the federal income tax credits and sales and use tax treatment
exclusive of each other? If Company claims the research and development
credit, can Company purchase the materials exempt from sales and use
taxes for resale?
Conclusion
1. Company’s purchases of parts that are incorporated into the Prototype are
exempt from sales and use tax.
2. This issue is moot because the Department determines that Company’s
purchases of the parts are exempt.
3. This issue is moot because the Department determines that Company’s
purchases of the parts are exempt.
4. Machinery and machine tools used to manufacture the Prototype are
exempt from sales and use taxes, regardless of whether the subsequent
sale of the Prototype is subject to sales or use taxes.
5. Company’s anticipated claim for federal depreciation expense for the
Prototype is consistent with the Department’s conclusion that Company is
using the Prototype for sales and use tax purposes.
Background
Company proposes to engage in the manufacture of commercial aircraft capable
of carrying XXXXXX passengers and intends to sell such aircraft to third parties
that operate commercial passenger airline service. Company is currently in the
research and development stage for its aircraft and intends to build a prototype
XXXXXX version of the aircraft (“Prototype”) that Company will use to perform
flight testing. Company expects flight tests to be rated at XXXXXX hours and the
initial useful life of the Prototype is expected to be XXXXXX hours, which can be
extended several times by normal maintenance and refurbishment.
Company may sell the Prototype to raise revenue after it completes testing the
Prototype. Company would not sell the Prototype as a commercial passenger
aircraft. Company may not be able to find a buyer for the Prototype. If a buyer
cannot be found, then Company may use the Prototype for marketing the fullscale versions of the aircraft. The cost to build the Prototype is expected to
exceed the price at which Company can sell the Prototype. Company will
purchase machinery and machine tools to manufacture the Prototype.
Discussion
1. Are Company’s purchases of parts that are incorporated into the Prototype
exempt from sales and use tax?

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DR 4010A (06/11/14)

Colorado levies sales and use tax on the retail sale, use, storage and
consumption of tangible personal property.1 Colorado provides a number of
exemptions from these taxes and two of those exemptions are pertinent here.
The first exemption applies to the purchase and use of components used in the
manufacture of tangible personal property for sale.2 This exemption was enacted
to avoid pyramiding of taxes for manufactured and compounded goods
subsequently sold as a taxable retail transaction.3
Company’s purchase of components used to manufacture the Prototype do not
fall within this exemption. This exemption does not apply if the manufacturer is
the primary user and consumer of the manufactured good.4 In this case, the
primary purpose for building the Prototype is not to sell the Prototype as a
commercial product but, rather, to use it to conduct research and development for
the development of a full-scale version of the aircraft. The sale of the Prototype
after that use is secondary to this purpose and is itself, a separate transaction.
Company cites to Department PLR 15-002 in support of its contention that its
purchase of components are exempt from tax. In that ruling, the Department
ruled that a company was not liable for sales or use tax on manufacturing
components, even though the company engaged in extensive testing of the
manufactured final product prior to its sale to a third-party buyer. The Department
concluded that a manufacturer’s testing of its goods that are ultimately sold is part
of the manufacturing process and is not, in and of itself, a taxable use. PLR 15002 is not applicable to this case because Company’s primary purpose in building
the Prototype is for its own research and development and not to ensure that the
Prototype will operate properly when sold.
The ruling here is consistent with Colorado case law. In AB Hirschfeld v. City and
County of Denver, 806 P.2d 917 (Colo. 1991), the court held that whether a
purchase of tangible personal property is a nontaxable purchase for resale or a
taxable purchase depends on whether the purchaser’s primary purpose was to
resell the property or to use the property prior to resale. A similar analysis was
applied in General Motors Corporation v. City and County of Denver, 990 P.2d 59
(Colo 1999), in which the court held that the manufacturer’s use of motor vehicles
in extensive testing was a taxable use by the manufacturer even though the
manufacturer later sold the vehicles. Although the Prototype will be ultimately
resold, Company will extensively use the Prototype for research, development,
1 39-26-104(1) and 202, C.R.S.

2 39-26-102(20) and 713(2)(e)(I), C.R.S.

3 Carpenter v. Carman Distributing Co., 144 P.2d 770 (Colo. 1943)

This is consistent with the similar tax principle that a buyer cannot claim a purchase is a nontaxable wholesale purchase for resale if the buyer uses the product prior to resale. See, e.g., GIL 13027 (taxpayer not entitled to claim purchases are non-taxable wholesale purchases for resale when
the taxpayer uses the product prior to reselling it.).

4 Ibid.

3

DR 4010A (06/11/14)

and marketing and, therefore, has engaged in a taxable use of the property and
does not qualify for exemption under this exception.
The second exemption at issue here is the exemption for aircraft parts.5
Specifically, this statute exempts from sales and use tax, “[t]he sale of tangible
personal property that is to be permanently affixed or attached as a component
part of an aircraft.”
The Department has previously given guidance that the purchase of fuselages
and other large components of an aircraft are exempt under this statute.6
Company represents that the aircraft components will be permanently affixed or
attached to an aircraft. These purchases satisfy the requirements of this
exemption and, therefore, the Department rules that Company’s purchase of such
parts are exempt from state sales and use taxes under the aircraft parts
exemption.7
2. If the cost of the Prototype exceeds the proceeds from the sale of the
Prototype, would the Department treat the costs related to manufacturing
the Prototype subject to sales or use tax?
This issue is moot because the Department determines that Company’s
purchases of parts are exempt.
3. If a buyer cannot be found for the sale of the Prototype and the Department
determines that Company’s purchase of the materials incorporated into the
Prototype are subject to tax, when is the use tax due on the cost of the
Prototype?
This issue is moot because the Department determines that Company’s
purchases of parts are exempt.
4. If the Prototype is used for internal purposes at the end of testing, would
the Department consider the machinery and equipment to be taxable?
Machinery and machine tools used to manufacture tangible personal property are
exempt from sales and use taxes, regardless of whether the subsequent use or

5 §39-26-711, C.R.S.

The Department considered whether this exemption is limited to aircraft used in
interstate commerce as is the exemption for the purchase of aircraft in 39-26-711(1)(a), C.R.S. but
determines that these are two separate exemptions.
6 See FYI Sales 85.
7 The Department has taken the position that the purchase of a build-your-own airplane kit is the
purchase of an airplane and not simply the purchase of airplane parts and, therefore, denied claims
that this exemption applied. In this case, Company is purchasing parts from a variety of suppliers and
no single purchase can be viewed as anything other than the purchase of a part.
4

DR 4010A (06/11/14)

sale of the manufactured product is subject to sales or use taxes.8 The building
of an aircraft is manufacturing. Company represents that the machinery and
machine tools are used to manufacture the Prototype and, thus, are exempt from
sales and use taxes.
5. Are the federal income tax credits and sales and use tax treatment
exclusive of each other? If Company claims the research and development
credit, can Company purchase the materials exempt from sales and use
taxes for resale?
The Internal Revenue Code allows taxpayers to claim depreciation expenses for
certain research and development products.9 This depreciation and the concept
of a useful life for property imply that the taxpayer is using the depreciated
property. In PLR 15-002, the Department ruled that, under the specific facts of
that case, taxpayer’s claim for depreciation expense was not inconsistent with
taxpayer’s claim that it was not using the manufactured product for purposes of
sales and use taxes. In this case, it is clear Company is using and consuming the
Prototype and Company’s anticipated claim for depreciation expense for the
Prototype is consistent with our conclusion.
Miscellaneous
This ruling is premised on the assumption that Company has completely and
accurately disclosed all material facts and that all representations are true and
complete. The Department reserves the right, among others, to independently
evaluate Company’s representations and assumptions. The ruling is null and void if
any such assumption or representation is incorrect and has a material bearing on the
conclusions reached in this ruling and is subject to modification or revocation in
accordance to Department Regulation 24-35-103.5.
This ruling is binding on the Department to the extent set forth in Department
Regulation 24-35-103.5. It cannot be relied upon by any taxpayer other than the
taxpayer to whom the ruling is made.
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.

8 See, PLR 14-003 (the exemption for manufacturing machinery applies even when the manufacturer

uses and consumes the manufactured goods). There are a number of requirements for
manufacturing machinery exemption. §39-26-709, C.R.S. The Department is not determining in this
ruling whether Company’s machinery satisfies all these requirements, but only that building an aircraft
is manufacturing and that this exempt does not require a subsequent taxable sale of the Prototype in
order for the exempt to apply.
9 See PLR 15-002 for discussion
5

DR 4010A (06/11/14)

Sincerely,

Office of Tax Policy
Colorado Department of Revenue
This ruling cannot be relied upon by any other taxpayer other than the
taxpayer to whom the ruling is made.

6

DR 4010A (06/11/14)