Can manufacturing production-control software be sold tax-free as machinery used directly in production or in research and development?

Plain-English summary

An Ohio software company sells manufacturing production-control / ERP software to New York manufacturers. The software (35+ integrated modules) lets users quote pricing, process orders, schedule jobs, control materials, track labor, and ship -- coordinating and monitoring the production process and surfacing ways to cut costs. It asked whether customers can buy it exempt as machinery used directly and predominantly in production, or as property used in research and development.

The Office of Counsel concluded the software qualifies for neither exemption, so the seller must collect tax:

• Prewritten software is taxable tangible personal property (Tax Law sections 1105(a), 1101(b)(6)).
• Not the production exemption (section 1115(a)(12)). "Directly" used machinery must act on or change the material, have an active causal role, or handle/convey/package the product (20 NYCRR 528.13(c)). This software doesn't interact with the item being produced; tracking, scheduling, costing, and shipping are administrative and distribution activities -- collateral to production -- so it isn't used directly and predominantly in production.
• Not the R&D exemption (section 1115(a)(10)). That covers experimental/laboratory work to advance science or develop new products (20 NYCRR 528.11(b)), not administrative order-processing.
• Because neither exemption applies, the seller cannot accept an exemption claim in good faith and must collect sales tax (20 NYCRR 532.4(b)(2)).

What this means for you

Software vendors to manufacturers

"Used in a factory" is not the test. The production exemption is for machinery that physically acts on the product. ERP/MRP, scheduling, costing, inventory, and shipping software is administrative/distribution -- taxable. Don't accept a production or R&D exemption certificate for it.

Manufacturers buying software

You generally owe tax on production-management software. The exemption is narrow -- it's for equipment that directly makes the product, not the systems that plan and track the making.

R&D is "laboratory sense"

The R&D exemption means experimental development of products/processes, not back-office automation.

Common questions

Q: Our software runs the whole shop floor -- isn't it production machinery? A: No. Coordinating, scheduling, and tracking jobs is administrative/distribution activity. The exemption requires acting directly on the material being produced.

Q: Could it qualify as R&D property?
A: No. R&D means experimental or laboratory work to advance science or develop new products, not order-processing and shipping tasks.

Q: Can the vendor accept a production exemption certificate to be safe? A: No -- since the software doesn't qualify, the vendor can't accept the claim in good faith and must collect tax.

Q: Can I rely on this opinion?
A: It binds the Department only as to the petitioner. Use it as guidance and confirm your own facts.

Citations and references

• Tax Law section 1105(a) (sales tax on tangible personal property, including prewritten software)
• Tax Law section 1101(b)(6) (tangible personal property includes prewritten software)
• Tax Law section 1115(a)(12) (machinery/equipment used directly and predominantly in production)
• Tax Law section 1115(a)(10) (property used in research and development)
• 20 NYCRR 528.13 (directly and predominantly used production machinery)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2015.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a15_44s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-15(44)S
Sales Tax
November 13, 2015

Office of Counsel
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S140708B

The Department of Taxation and Finance received a Petition for Advisory Opinion from REDACTEDREDACTED (“Petitioner”). Petitioner asks whether its customers can claim an exemption from sales tax on the purchase of its software as tangible personal property used directly and predominantly in the manufacturing of tangible personal property, or as tangible personal property used directly and predominantly in research and development. We conclude that the Petitioner’s software is not used directly and predominantly in manufacturing or in research and development. Therefore, Petitioner must collect tax on the sale of its software product. Facts Petitioner is a Limited Liability Company with headquarters in Ohio, and frequently sells to customers in New York. Its business includes producing software that enables manufacturing companies to track and control production and costs through every stage of a production process. Users can choose from over 35 fully integrated core and expansion modules that cover the full range of manufacturing and accounting requirements. After installation, the software is used to quote pricing, process the order, schedule the job, control materials, track labor, and ship the order. The software coordinates different stages of manufacturing in a way that streamlines the process and allows more control over monitoring the jobs. The software allows businesses to have more information on the status of each order or project and identify ways that costs can be reduced. Analysis Tax Law § 1105(a) imposes sales tax on “[t]he receipts from every retail sale of tangible personal property, except as otherwise provided in this article.” The definition of ‘tangible personal property” includes prewritten computer software. See Tax Law § 1101(b)(6). Tax Law § 1115(a)(12) provides an exemption from sales tax for “[m]achinery or equipment for use or consumption directly and predominantly in the production of tangible personal property, . . . for sale, by manufacturing, processing, generating, assembling, refining,

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TSB-A-15(44)S
Sales Tax
November 13, 2015

mining or extracting . . . .” Sales and Use Tax Regulation § 528.13(c) defines “directly” as follows: (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.

Machinery or equipment is used “predominantly” if more than 50% of its use is directly in the production phase of a process. See 20 NYCRR § 528.13(c)(4). Petitioner’s software cannot meet the definition of directly and predominantly used in production. Petitioner’s software does not directly interact with the item being produced. Rather, it provides information about tracking, scheduling, costs, and shipping. These activities are administrative and distribution activities, not production activities. See 20 NYCRR § 528.13 (b)(1). Thus, the software is not used directly in the production process. Accordingly, the software does not qualify for the exemption under Tax Law § 1115(a)(12). Similarly, Petitioner’s software would not qualify for exemption as tangible personal property used in research and development. See Tax Law § 1115(a)(10). This exemption applies to development in the experimental or laboratory sense. Research and development in the laboratory sense includes activities that are aimed at advancing science and technology, developing new products, or improving or developing new uses for existing products. See 20 NYCRR § 528.11(b). Petitioner’s software does not perform these types of functions. Rather, it performs administrative tasks such as processing and shipping orders, controlling materials and tracking labor. Accordingly, the software does not qualify for the research and development exemption. Because Petitioner’s software does not qualify for either the production or research and development exemptions, Petitioner cannot accept in good faith a claim for exemption on either

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TSB-A-15(44)S
Sales Tax
November 13, 2015

basis. Therefore, Petitioner must collect sales tax on its sales of software to its customers. See 20 NYCRR § 532.4(b)(2).

DATED: November 13, 2015

NOTE:

/S/
DEBORAH R. LIEBMAN
Deputy Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to the facts set forth therein and is binding on the Department only with respect to the person or entity to whom it is issued and only if the person or entity fully and accurately describes all relevant facts. An Advisory Opinion is based on the law, regulations, and Department policies in effect as of the date the Opinion is issued or for the specific time period at issue in the Opinion. The information provided in this document does not cover every situation and is not intended to replace the law or change its meaning.