Is the software a manufacturer uses to run its computerized milling machines exempt from Connecticut sales tax as manufacturing machinery?

Plain-English summary

A company makes architectural models and industrial prototypes. It takes customer plans (drawings or disc data), uses one software program to break them into images of individual parts, and a second program to write the instructions that tell its computerized milling machines how to cut the parts. Both programs are prewritten. DRS was asked whether the software qualifies for a manufacturing exemption.

The starting point: the manufacturing-machinery exemption, § 12-412(34), covers "machinery used directly in a manufacturing production process," including "equipment or devices used or required to control, regulate or operate the machinery." A CAD/CAM setup — a computer used to design a product and control/monitor the manufacturing, directly linked to the production machinery — counts as such machinery (Conn. Agencies Regs. § 12-412(34)-1(f)(3)). And software, without which the machinery won't run, can be an exempt "device … used or required to … operate the machinery." But there's a same-transaction limit.

DRS pulled in the software classification from Ruling No. 93-1:

• Prewritten ("canned") software = tangible personal property (taxable as TPP).
• Custom software = a nontaxable license of intangible property + taxable computer and data processing services.
• Customized software = a prewritten base with significant modifications = a mix of both.

Because the § 12-412(34) manufacturing exemptions apply only to sales of tangible personal property, only prewritten software can qualify on its own. Then the same-transaction rule (§ 12-412(34)-1(b)) kicks in: component parts/devices are exempt only if purchased in the same transaction as the basic machine. So:

• Software bought with the machine (same time, same vendor) — prewritten, custom, or customized — can be fully exempt under § 12-412(34). Even taxable custom/customized-software charges get in, because "sales price"/"gross receipts" include "services which are part of the sale" (§ 12-407(8)(a), (9)(a)).
• Prewritten software bought separately from the machinery is not exempt under § 12-412(34) — but it may qualify for the partial exemption under the Manufacturing Recovery Act of 1992 (§ 12-412i), whose "machinery" definition also covers operating devices and is not limited to same-transaction purchases.

What this means for you

Manufacturers buying CAD/CAM or machine-control software

How you buy it drives the tax. Buy the software bundled with the machine and the full manufacturing-machinery exemption (§ 12-412(34)) can cover all of it — even custom/customized-software charges. Buy prewritten software later, on its own, and you fall back to the MRA partial exemption (§ 12-412i), not the full exemption.

Watch the prewritten-vs-custom line for separate purchases

When you buy software apart from the machine, only prewritten software (treated as TPP) can reach the manufacturing exemptions. Custom and customized software bought separately is a license plus taxable computer services, which don't independently qualify.

Time your bundling deliberately

If a machine and its controlling software are both needed, purchasing them in a single transaction from the same vendor can maximize the exemption. Splitting the purchase can cost you the full § 12-412(34) exemption and leave only the partial MRA relief.

Common questions

Q: Is manufacturing software exempt from Connecticut sales tax?
A: It can be. Bought in the same transaction as the machine it runs, software (prewritten, custom, or customized) can be fully exempt under § 12-412(34). Bought separately, only prewritten software qualifies — and then only for the Manufacturing Recovery Act partial exemption (§ 12-412i), not the full one.

Q: Why does buying software with the machine matter so much?
A: Because § 12-412(34) exempts a machine's component devices only when purchased in the same transaction as the basic machine. The Manufacturing Recovery Act exemption (§ 12-412i) has no such same-transaction limit, but it's only a partial exemption.

Q: Can custom software ever be exempt here?
A: Yes, but generally only when bought together with the machinery — its otherwise-taxable charges get folded into the § 12-412(34) exemption because they're "services which are part of the sale." Bought separately, custom software is a license plus taxable computer services and doesn't independently qualify.

Q: What makes a computer/CAD system "machinery" at all?
A: Under Conn. Agencies Regs. § 12-412(34)-1(f)(3), a computer used to design a product and to control or monitor the manufacturing process, directly linked to the production machinery (a CAD/CAM machine), is machinery used directly in the manufacturing production process.

Citations and references

Statutes and regulations:

• Conn. Gen. Stat. § 12-412(34) (manufacturing-machinery exemption); Conn. Agencies Regs. § 12-412(34)-1(f)(3) (CAD/CAM machinery), -1(b) (same-transaction requirement for component parts/devices)
• Conn. Gen. Stat. § 12-412i (Manufacturing Recovery Act of 1992 partial exemption)
• Conn. Gen. Stat. § 12-407(8)(a), 12-407(9)(a) (sales price/gross receipts include services that are part of the sale)

Related guidance (described in prose, not linked):

• Ruling No. 93-1 (prewritten vs. custom vs. customized software classification)
• Special Notice SN 93(1) (Manufacturing Recovery Act details)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 94-3

Original ruling text

Ruling 94-3, Sales and Use Taxes / Manufacturing Machinery / Manufacturing Recovery Act of 1992

Ruling 94-3

Sales and Use Taxes

Manufacturing Machinery

Manufacturing Recovery Act of 1992

FACTS:

A Connecticut company (the "Company") manufactures architectural models and industrial prototypes which it sells to its customers. The Company receives plans for the finished products from its customers either as drawings or as data on computer discs. The Company then edits the plans, using a software program on a computer, to break them down into computer images of the individual parts that will eventually be cut out on its computerized milling machines. The Company then uses another software program to write programs to "instruct" the computerized milling machinery how to cut out the parts, based on the analysis of the individual parts performed by the first program.

ISSUE:

Whether the Company may claim exemption under Conn. Gen. Stat. § 12-412(34) for the purchase of software programs it uses in the production of architectural models and industrial prototypes.

Whether the Company may claim exemption under the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i, for the purchase of software programs it uses in the production of architectural models and industrial prototypes.

DISCUSSION:

Conn. Gen. Stat. §12-412(34) exempts sales of "machinery used directly in a manufacturing production process." The statute defines "machinery" as:

... the basic machine itself, including all of its component parts and contrivances, such as belts, pulleys, shafts, moving parts, operating structures and all equipment or devices used or required to control, regulate or operate the machinery, but excluding office equipment or data processing equipment other than numerically controlled machinery used directly in the manufacturing process.

Conn. Agencies Regs. §12-412(34)-1(f)(3) elaborates on the type of property included within the scope of the exemption by stating that

[machinery ... (A) that is used exclusively to control or monitor an activity occurring during the manufacturing production process, or exclusively to design a product as well as to control or monitor an activity occurring during the manufacturing production process (e.g., a computer aided design/computer aided manufacturing machine), and (B) that is directly linked with machinery [other machinery used directly in a manufacturing production process], is used directly in a manufacturing production process.

Therefore, computers and computerized machinery used as described in Conn. Agencies Regs. §12-412(34)-1(f)(3) are considered "machinery" that may qualify for exemption under Conn. Gen. Stat. §12-412(34) if the remaining requirements for exemption are met. In addition, since such computers and computerized machinery will not function without software, software may be "equipment or [a] device used or required to control, regulate or operate the machinery..." that also qualifies for exemption under Conn. Gen. Stat. § 12-412(34) when purchased in the same transaction with the machinery.

In Ruling No. 93-1 , a distinction was made between the sale of prewritten (or "canned") software, which is taxable as the sale of tangible personal property, and the sale of custom software, which represents a combination of the sale of a nontaxable license of intangible personal property and the sale of taxable computer and data processing services. Customized software represents a combination of the characteristics of prewritten software and custom software, in that customized software is made up from a "base" of prewritten software to which significant modifications are made. The sale of customized software combines a taxable sale of computer and data processing services and the nontaxable sale of a license. Sales and use taxes are due on the purchase of prewritten software to be customized, whether such purchase is made by a customizer or its customer (resale treatment is not appropriate when prewritten software is purchased by a customizer because the software is used by the customizer in rendering a service).

The exemption under Conn. Gen. Stat. §12-412(34) applies only to sales of tangible personal property (in fact, the same is true for all of the exemptions from the sales and use taxes for items purchased in connection with manufacturing, such as in subsections (18), (34) and (73) of Conn. Gen. Stat. §12-412 and in Conn. Gen. Stat. § 12-412i). Under the distinction made in Ruling No. 93-1 between sales of prewritten software and sales of custom or customized software, only sales of prewritten software, as sales of tangible personal property, are able to qualify for any of the exemptions provided in the Sales and Use Taxes Act for items purchased for use in connection with manufacturing (except when software is purchased in the same transaction with the machinery on which it is to be used; see below). Both of the software programs used by the Company are prewritten, in that they are produced for a general class of users and need little if any modification to be able to function in the manner required by the Company, and so they may qualify for a manufacturing exemption.

Conn. Agencies Regs. §12-412(34)-1(b) provides that component parts and contrivances of machinery exempt under Conn. Gen. Stat. §12-412(34) (including equipment and devices used or required to control, regulate or operate machinery) are exempt only if they are purchased in the same transaction with the basic machine. Thus, prewritten software purchased in a separate transaction from the machinery on which it is to be used is not exempt under Conn. Gen. Stat. §12-412(34). However, the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i (the "MRA"), also includes in its definition of "machinery" "all equipment or devices used or required to control, regulate or operate the machinery," and it does not limit its exemption to such equipment or devices purchased in the same transaction as the machinery on which they are to be used. Therefore, prewritten software that does not qualify for exemption under Conn. Gen. Stat. § 12-412(34) may qualify for the partial exemption under the MRA. (See Special Notice SN 93(1).)

Taxable charges for custom or customized software that is purchased in the same transaction (i.e., at the same time and from the same vendor) with the machinery on which such software is to be used may be included in the exemption under Conn. Gen. Stat. §12-412(34). Such sales of custom or customized software may be exempted under Conn. Gen. Stat. §12-412(34), despite the fact that the software is not being sold as tangible personal property, by reason of Conn. Gen. Stat. §§12-407(8)(a) and 12-407(9)(a), which provide that "sales price" and "gross receipts" include "[any services which are part of the sale." Thus, since any charges for taxable computer and data processing services rendered in the creation or customization of software accompanying manufacturing machinery are included in the gross receipts and sales price, such charges must also be included in the exemption under Conn. Gen. Stat. §12-412(34).

RULING:

If the Company purchases software, whether it is prewritten, custom or customized, in the same transaction with the machinery on which it is to be used, all otherwise taxable charges for such software may qualify for exemption under Conn. Gen. Stat. §12-412(34). If the Company purchases prewritten software in a transaction separate from its purchase of the machinery on which the software is to be used, such software may be purchased under the partial exemption provided by the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i.

LEGAL DIVISION

Issued: February 8, 1994