Does a coating company that processes its customers' tools and precision components for them qualify as a 'producer' entitled to New York's production exemption on its own machinery, tools, and utilities?

Plain-English summary

A company (referred to as XYZ) applies ultra-thin, hard, low-friction coatings to tools and precision components that its manufacturer-customers send it, then returns the finished parts. An accountant asked, on XYZ's behalf, whether XYZ counts as a "producer" for purposes of New York's production exemption, and whether its machinery, tools, supplies, and utility purchases qualify.

The Department confirmed XYZ's coating work is a taxable "processing" service under Tax Law § 1105(c)(2) -- it genuinely changes the nature of the customer's property (harder, more wear-resistant, less friction). But the more important question is whether XYZ's own purchases can be exempt as production equipment. Since XYZ is performing a service on someone else's property rather than manufacturing its own goods for direct sale, it only counts as engaged in "production for sale" to the extent its coating work is really an extension of its customer's manufacturing process -- meaning the coated part is, or becomes a component of, tangible personal property the customer itself manufactures for sale. When that link exists, XYZ's machinery, tools, supplies, and utilities qualify for the production exemption to the extent (over 50%) they're used directly in that processing. But the Department drew a sharp line on when production begins: simply counting incoming parts isn't enough to make the unloading process "production," but inspecting and testing incoming material for composition and surface condition is an administrative step -- so equipment used only for that initial inspection/testing doesn't qualify, even though equipment used in the actual coating application does. XYZ must document, customer by customer, that the property being coated is or becomes part of something the customer manufactures for sale (a written statement or a Resale Certificate from the customer helps), and separately track production-phase use from administrative and distribution-phase use of each piece of equipment.

What this means for you

Coating, plating, and other processing subcontractors

You can claim New York's production exemption on your own machinery, tools, supplies, and utilities, but only for equipment used in genuinely production-phase work that's part of your customer's manufacturing for sale -- get a written confirmation (ideally a Resale Certificate) from each customer that the item you're processing becomes part of something they sell, and keep records showing over 50% of the relevant equipment's use is in that qualifying production activity.

Manufacturers who outsource a processing step

If you send components out for coating, plating, galvanizing, or similar processing before selling the finished product, that outside processing service is itself excluded from sales tax if you hold the components for resale (as your own manufacturing inventory) -- give your processor a Resale Certificate to confirm this.

Accountants and tax professionals

The key distinguishing line the Department drew: mere counting of incoming parts doesn't trigger "administrative" status, but inspecting/testing for composition and surface condition does -- so equipment used only for that testing step doesn't qualify for the exemption even though equipment used in the actual coating application does. This matters for allocating exempt vs. taxable use of dual-purpose equipment.

Common questions

Q: Does a company that processes someone else's goods (rather than manufacturing its own) qualify for the production exemption?
A: Yes, if its processing work is really an extension of its customer's own manufacturing for sale -- meaning the processed item is or becomes part of tangible personal property the customer manufactures for sale.

Q: What proof does a processing subcontractor need to claim the exemption?
A: A written statement from the customer (or a Resale Certificate, Form ST-120) confirming the processed property is or becomes part of goods the customer manufactures, processes, or assembles for sale.

Q: Does initial inspection and testing of incoming materials count as "production"?
A: No -- inspecting and testing incoming material for composition and surface condition is an administrative activity, so equipment used only for that step doesn't qualify for the exemption, even though mere unloading/counting might still be treated as part of production depending on the plant's procedure.

Q: Is the subcontractor's processing service itself taxable to its customer?
A: Yes, generally, unless the customer holds the processed property for resale (in which case the service charge is excluded from tax) -- this is a separate question from whether the subcontractor's own equipment purchases are exempt.

Citations and references

Statutes and guidance:

• Tax Law § 1101(b)(4) (retail sale)
• Tax Law § 1105(a), (c)(2) (retail sales; producing/fabricating/processing services)
• Tax Law § 1105-B (production parts, tools, and supplies exemption)
• Tax Law § 1115(a)(12) (production machinery and equipment exemption)
• Tax Law § 1115(c)(1) (production utilities exemption)
• 20 NYCRR 527.4(a), (d), (f) (processing services; resale exclusion)
• 20 NYCRR 528.13(a)-(c) (production machinery and equipment; production phase definitions)
• TSB-A-88(17)S (Burn Brite Metals Company, Inc., Feb. 29, 1988)
• TSB-A-04(22)S (O. W. Hubbell & Sons, Inc., Sept. 2, 2004)
• TSB-A-02(17)S (Henry & Henry Inc., June 26, 2002)
• TSB-M-82(25)S (Determining Electricity Used in Production, Sept. 7, 1982)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2005.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a05_25s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-05(25)S
Sales Tax
June 22, 2005

Office of Tax Policy Analysis
Technical Services Division
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S041221A

On December 21, 2004, the Department of Taxation and Finance received a Petition for
Advisory Opinion from David E. Werth, CPA, Tronconi Segarra & Associates LLP, 6390 Main
Street, Suite 200, Williamsville, New York, 14221.
The issues raised by Petitioner, David E. Werth, CPA, are:
1.

Whether Petitioner’s client is a person engaged in the production
for sale of tangible personal property for purposes of section
1115(a)(12) of the Tax Law.

2.

Whether Petitioner’s client's purchases of machinery, equipment,
tools, supplies and utilities used to apply coatings to its customers’
property, as described below, qualify for exemption from sales and
use tax pursuant to section 1115(a)(12) of the Tax Law

Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner’s client (XYZ) applies coatings that improve the performance of tools and
precision components. The coatings are extremely thin, harder than steel and reduce friction and
wear. XYZ develops the coatings and coating processes, markets systems and equipment to
produce the coatings and provides a contract coating service in a network of coating centers that
includes a facility in New York State.
XYZ’s customers are typically manufacturers of tools and precision components. XYZ
applies these coatings to its customers’ tools or components (hereinafter “tangible personal
property”). The typical process at a coating center begins with inspection of incoming tangible
personal property to be coated. Upon receipt by XYZ, the tangible personal property to be
coated is counted and inspected for material composition and surface condition. The tangible
personal property is then cleaned using various specialized techniques which prepare the
property’s surfaces for application of the specific coating desired by the customer. Some
additional pre-treatment may be required for certain applications. Then, using various methods,
the coatings are applied to the customer’s tangible personal property.
Once the coatings have been applied to the customer’s tangible personal property, the
coatings are inspected to ensure their proper application. In many cases, XYZ carries out a post­
treatment where, for example, the coated tangible personal property is demagnetized. The coated
tangible personal property is usually returned to the customer in the packaging in which it was
delivered.

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Applicable law and regulations
Section 1101 (b)(4) of the Tax Law provides, in part:
Retail sale. (i) A sale of tangible personal property to any person for any purpose,
other than (A) for resale as such or as a physical component part of tangible personal
property, or (B) for use by that person in performing the services subject to tax under
paragraphs (1), (2), (3), (5), (7) and (8) of subdivision (c) of section eleven hundred five
where the property so sold becomes a physical component part of the property upon
which the services are performed or where the property so sold is later actually
transferred to the purchaser of the service in conjunction with the performance of the
service subject to tax. . . .
Section 1105 of the Tax Law provides, in part:
Imposition of sales tax On and after June first, nineteen hundred seventy-one,
there is hereby imposed and there shall be paid a tax . . . upon:
(a) The receipts from every retail sale of tangible personal property, except as
otherwise provided in this article.
*

*

*

(c) The receipts from every sale, except for resale, of the following services:
*

*

*

(2) Producing, fabricating, processing, printing or imprinting tangible personal
property, performed for a person who directly or indirectly furnishes the tangible
personal property, not purchased by him for resale, upon which services are performed.
Section 1105-B of the Tax Law provides:
(a) Receipts from the retail sales of parts with a useful life of one year or less,
tools and supplies for use or consumption directly and predominantly in the production of
tangible personal property, gas, electricity, refrigeration or steam for sale by
manufacturing, processing, generating, assembling, refining, mining or extracting shall be
exempt from the tax imposed by subdivision (a) of section eleven hundred five of this
article.
(b) Receipts from every sale of the services of installing, repairing, maintaining or
servicing the tangible personal property described in paragraph twelve of subdivision (a)
of section eleven hundred fifteen of this article, including the parts with a useful life of

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one year or less, tools and supplies described in subdivision (a) of this section, to the
extent subject to such tax, shall be exempt from the tax on sales imposed under
subdivision (c) of section eleven hundred five of this article.
(c) Parts with a useful life of one year or less, tools and supplies described in
subdivision (a) of this section and services described in subdivision (b) of this section
shall be exempt from the compensating use tax imposed by section eleven hundred ten of
this article.
Section 1115 of the Tax Law provides, in part:
(a) Receipts from the following shall be exempt from the tax on retail sales
imposed under subdivision (a) of section eleven hundred five and the compensating use
tax imposed under section eleven hundred ten:
*

*

*

(12) Machinery or equipment for use or consumption directly and predominantly
in the production of tangible personal property, gas, electricity, refrigeration or steam for
sale, by manufacturing, processing, generating, assembling, refining, mining or
extracting. . . .
*

*

*

(c)(1) Fuel, gas, electricity, refrigeration and steam, and gas, electric, refrigeration
and steam service of whatever nature for use or consumption directly and exclusively in
the production of tangible personal property, gas, electricity, refrigeration or steam, for
sale, by manufacturing, processing, assembling, generating, refining, mining or extracting
shall be exempt from the taxes imposed under subdivisions (a) and (b) of section eleven
hundred five and the compensating use tax imposed under section eleven hundred ten of
this article.
Section 527.4 of the Sales and Use Tax Regulations provides, in part:
Sale of services of producing, fabricating, processing, printing or imprinting.
(a) Imposition. (1) Section 1105(c)(2) of the Tax Law imposes a tax on the
receipts from services of producing, fabricating, processing, printing or imprinting
tangible personal property, performed for a person who directly or indirectly furnishes
the property.
(2) The enumerated services are not taxable when:

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(i) purchased for resale; or
(ii) performed on property intended for resale.
*

*

*

(d) Processing. Processing is the performance of any service on tangible personal
property for the owner which effects a change in the nature, shape, or form of the
property.
*

*

*

(f) Resale. (1) When the services enumerated in this section are rendered on
property held for resale, the services are not taxable.
Example 1: A manufacturer of home appliances has certain of the component
appliance parts galvanized by a plating firm. The service of galvanizing is not
taxable since it is being performed on a product which will be sold by the
manufacturer.
(2) Where a person performing a service subject to tax purchases tangible
personal property, which becomes a part of the property on which the services are
performed or which is later transferred to the purchaser of the service in conjunction with
the service performed, the purchase of the property is for resale and is not subject to the
sales tax.
Example 2: A plating company purchases zinc for galvanizing steel which is
furnished by its customer. The zinc becomes part of the steel. The purchase of the
zinc by the plating company is a purchase for resale which is not subject to tax.
Section 528.13 of the Sales and Use Tax Regulations provides, in part:
Machinery and equipment used in production; telephone and telegraph
equipment; parts, tools and supplies.
(a) Exemption. (1) Exemption from statewide tax. An exemption is allowed from
the tax imposed under subdivisions (a) and (c) of section 1105 of the Tax Law, and from
the compensating use tax imposed under section 1110 of the Tax Law, for receipts from
sales of the following:
(i) Machinery or equipment (including parts with a useful life of more than one
year) used or consumed directly and predominantly in the production for sale of tangible

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personal property, gas, electricity, refrigeration or steam, by manufacturing, processing,
generating, assembling, refining, mining or extracting. . . .
*

*

*

(iii) (a) Parts with a useful life of one year or less, tools or supplies for use or
consumption directly and predominantly in the production of tangible personal property,
gas, electricity, refrigeration or steam for sale by manufacturing, processing, generating,
assembling, refining, mining or extracting.
*

*

*

(iv) The services of installing, repairing, maintaining or servicing the exempt
machinery, equipment, apparatus, parts, tools or supplies identified in subparagraph (i),
(ii) or (iii) of this paragraph.
*

*

*

(b) Production. (1) The activities listed in paragraph (a)(1) of this section are
classified as administration, production or distribution.
(i) Administration includes activities such as sales promotion, general office work,
credit and collection, purchasing, maintenance, transporting, receiving and testing of raw
materials and clerical work in production such as preparation of work, production and
time records.
(ii) Production includes the production line of the plant starting with the handling
and storage of raw materials at the plant site and continuing through the last step of
production where the product is finished and packaged for sale.
(iii) Distribution includes all operations subsequent to production, such as storing,
displaying, selling, loading and shipping finished products.
(2) The exemption applies only to machinery and equipment used directly and
predominantly in the production phase. Machinery and equipment partly used in the
administration and distribution phases does not qualify for the exemption, unless it is
used directly and predominantly in the production phase.
(3) The determination of when production begins is dependent upon the procedure
used in a plant. If on receiving raw materials, the purchaser weighs, inspects, measures
or tests the material prior to placement into storage, production begins with placement
into storage, and the prior activities are administrative. If the materials are unloaded and

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placed in storage for production without such activities, the unloading is the beginning of
production.
Example 1: A crane is used to unload raw materials, which are immediately
placed in storage at a plant. From the storage site, the material is placed on an
assembly line without testing. The crane is being used in production.
*

*

*

(4) Production ends when the product is ready to be sold.
*

*

*

(c) Directly and predominantly. (1) Directly means the machinery or equipment
must, during the production phase of a process:
(i) act upon or effect a change in material to form the product to be sold,
or
(ii) have an active causal relationship in the production of the product to
be sold, or
(iii) be used in the handling, storage, or conveyance of materials or the
product to be sold, or
(iv) be used to place the product to be sold in the package in which it will
enter the stream of commerce.
(2) Usage in activities collateral to the actual production process is not deemed to
be used directly in production.
*

*

*

(4) Machinery or equipment is used predominantly in production, if over 50
percent of its use is directly in the production phase of a process.
Example 11: A fork lift is used 60 percent of the time on an assembly line and 40
percent of the time for loading finished products onto railroad cars for delivery.
The fork lift is used predominantly in production.

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Opinion
XYZ is engaged in the processing of its customers’ tangible personal property by
applying specialized coatings to its customers’ tangible personal property. This application
creates tangible personal property which is superior to the original tangible personal property by
virtue of its increased hardness, increased resistance to wear and reduced friction. XYZ’s
customers then either sell the processed tangible personal property to others or use it themselves.
Since XYZ sells a service performed on its customers’ tangible personal property rather than
making direct sales of tangible personal property to its customers, a threshold question in this
case is whether XYZ is a person engaged in the production of tangible personal property for sale
by manufacturing, processing, generating, assembling, refining, mining or extracting for
purposes of section 1115(a)(12) of the Tax Law.
Publication 852, entitled Sales Tax Information For: Manufacturers, Processors,
Generators, Assemblers, Refiners, Miners and Extractors, and Other Producers of Goods and
Merchandise (12/97) provides that “The purchase of machinery and equipment used by a
subcontractor to perform part of a production process may also be entitled to exemption as
production machinery and equipment.”
XYZ’s application of its coatings to its customers’ tangible personal property effects a
change in the nature of the tangible personal property by increasing its hardness and resistance to
wear, and reducing its friction coefficient. XYZ’s services to its customers’ tangible personal
property clearly fall within the meaning of processing as provided under section 1105(c)(2) of
the Tax Law. See section 527.4(d) of the Sales and Use Tax Regulations.
Sections 1105-B and 1115(a)(12) of the Tax Law provide exemptions for machinery,
equipment, parts, tools and supplies used or consumed directly and predominantly in the
production for sale of tangible personal property by processing. If XYZ’s customer is a
manufacturer of tangible personal property for sale and XYZ’s finished product (i.e., the coated
tangible personal property) is, or becomes a component of, the tangible personal property
manufactured for sale by XYZ’s customer, then XYZ is performing a part of a production
process for its customer. In such cases, XYZ’s services are, in effect, performed as an extension
of its customer’s manufacturing process. See Burn Brite Metals Company, Inc., Adv Op Comm
T&F, February 29, 1988, TSB-A-88(17)S; O. W. Hubbell & Sons, Inc., Adv Op Comm T&F,
September 2, 2004, TSB-A-04(22)S. Accordingly, XYZ’s purchases of machinery, equipment,
parts, tools and supplies qualify for exemption from sales and use tax pursuant to sections
1105-B and 1115(a)(12) of the Tax Law to the extent that XYZ’s machinery, equipment, parts,
tools and supplies are used directly and predominantly (more than 50% of their use) to process
tangible personal property which is, or becomes a component of, tangible personal property
manufactured for sale by XYZ’s customers. XYZ must maintain records documenting that such
exempt machinery, equipment, parts, tools and supplies are used directly and predominantly in
the production of tangible personal property for sale.

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XYZ must be able to substantiate that its processing activities are a part of its customers’
production of tangible personal property for sale. XYZ should obtain a written statement or
information from its customer that the property upon which XYZ’s services are performed is, or
becomes a component part of, tangible personal property manufactured, processed or assembled
for sale by the customer. A properly completed Resale Certificate (Form ST-120) obtained by
XYZ from its customers in substantiation of the customer’s purchases of XYZ’s services without
payment of tax may be additional evidence that XYZ’s services are performed on property for
sale by XYZ’s customer.
Machinery, equipment, parts, tools and supplies used by XYZ to process a customer’s
tangible personal property are not used in the production of tangible personal property for sale
when the property upon which XYZ performs its services is not manufactured, processed or
assembled for sale by such customer or, when the property does not become a component part of
property manufactured, processed or assembled for sale by such customer.
Section 528.13(b)(3) of the Sales and Use Tax Regulations provides that the
determination of when production begins is dependent upon the procedure used in a plant. If,
upon receiving raw materials, XYZ weighs, inspects, measures or tests the material prior to
placement into storage or the production line, production begins with placement into storage or
onto the production line. In such instance, the activities prior to placement into storage or onto
the production line, such as unloading raw materials, are administrative. Petitioner states that
upon receipt, the tangible personal property to be processed is counted and inspected for material
composition and surface condition. The activity of counting incoming materials, by itself, does
not ascend to the level of handling required by section 528.13(b)(3) of the Sales and Use Tax
Regulations to make unloading raw materials an administrative activity. See Henry & Henry
Inc., Adv Op Comm T & F, June 26, 2002, TSB-A-02(17)S. However, the inspection and
testing of incoming tangible personal property to determine material composition and surface
condition are administrative activities as contemplated by section 528.13(b)(3) of the Sales and
Use Tax Regulations. Accordingly, machinery, equipment, parts, tools and supplies used by
XYZ to unload and count incoming tangible personal property and to inspect and test such
materials for composition and surface condition are used in the administrative phase and not
directly in the production process. The purchase of such machinery, equipment, parts, tools and
supplies by XYZ is, therefore, subject to the sales or use tax imposed by section 1105(a) of the
Tax Law unless such machinery, equipment, parts, tools and supplies are also used directly and
predominantly in the production process.
XYZ’s production line ends once the tangible personal property is packaged and ready to
be returned to its customer. Any use of XYZ’s machinery, equipment, parts, tools and supplies
subsequent to the packaging of the tangible personal property is a use in the distribution phase.
See sections 528.13(b)(1)(iii) and 528.13(b)(4) of the Sales and Use Tax Regulations.
Machinery, equipment, parts, tools and supplies used 50% or more in distribution activities are
not exempt from sales or use tax under section 1105-B or 1115(a)(12) of the Tax Law.

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Accordingly, in order to determine whether machinery, equipment, parts, tools or
supplies qualify for exemption from sales tax pursuant to sections 1105-B and 1115(a)(12) of the
Tax Law, XYZ must be able to document that 1) the machinery, equipment, parts, tools or
supplies are used directly in the production process as contemplated under section 528.13(c)(1)
of the Sales and Use Tax Regulations; and 2) more than 50% of the use of the machinery,
equipment, parts, tools or supplies is in the production of tangible personal property which is, or
becomes a component of, tangible personal property manufactured for sale by XYZ’s customers
(See section 528.13(b) of the Sales and Use Tax Regulations). It is noted that XYZ’s purchases
of the services of installing, repairing, maintaining or servicing machinery, equipment, parts,
tools or supplies which qualify for exemption from sales tax under section 1115(a)(12) of the
Tax Law are also exempt from sales or use tax under section 1105-B(b) of the Tax Law.
Section 1115(c) of the Tax Law provides an exemption from the sales and use tax for
fuel, gas, electricity, refrigeration and steam, and gas, electric, refrigeration and steam service of
whatever nature for use or consumption directly and exclusively in the production of tangible
personal property for sale by manufacturing, processing, assembling, generating, refining,
mining or extracting. Provided that XYZ maintains records showing the amount of utilities used
directly and exclusively in applying coatings to tangible personal property which is, or becomes a
component of, tangible personal property manufactured for sale by XYZ’s customers, XYZ may
purchase such utilities exempt from sales and use taxes. See Technical Services Bureau
Memorandum, entitled Determining Electricity Used in the Production of Tangible Personal
Property for Sale, September 7, 1982, TSB-M-82(25)S for additional information pertaining to
calculating the amount of utilities used directly and exclusively in the production of tangible
personal property for sale by manufacturing.
It is noted that XYZ also markets systems and equipment to produce the coatings. If
XYZ manufactures these systems and equipment for sale, the purchase by XYZ of machinery,
equipment, parts, tools or supplies used directly and predominantly (more than 50% of their use)
to produce these systems and equipment for sale will also qualify for exemption from sales and
use tax under sections 1105-B and 1115(a)(12) of the Tax Law. Utilities used directly and
exclusively in such production will also qualify for exemption under section 1115(c) of the Tax
Law.

DATED: June 22, 2005

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.