Does a manufacturer owe sales tax when it buys a service contract that it passes through, as part of the product's price, to the end user?

Plain-English summary

Encode, Inc., manufactures computer programming systems for numerically controlled machine tools and sells them only to machine-tool distributors, who resell to end users (Encode invoices the distributor and takes a Resale Certificate). To ensure proper initial performance, Encode includes a 60-day service contract (with Data General Corporation) with each system. Encode pays for the contract, and its cost is passed on to the end user as part of the system price — invoiced by Encode to the distributor, and by the distributor to the end user. Encode asked whether its purchase of those service contracts is taxable.

The Department held the service-contract purchase is not taxable — Encode buys it for resale.

• Service contracts are normally a taxable purchase. Section § 1105(c)(3) taxes the service of "servicing or repairing tangible personal property not held for sale," except for resale, and the regulations make the purchase of a maintenance or service contract itself a taxable transaction (20 NYCRR §§ 527.5(c)(1), 527.5(d)(4)).
• But this one is bought for resale. Because Encode buys the contract and passes it through — reselling it as part of the system to the distributor and ultimately the end user — its purchase is a purchase for resale, so no tax is due on Encode's purchase.
• How to claim it. Encode avails itself of the exclusion by giving the contract provider (Data General) a properly completed Resale Certificate (Form ST-120) at the time of purchase.

What this means for you

A service or maintenance contract is taxable — unless you resell it. Buying a service contract for your own equipment is a taxable purchase. Buying one you fold into a product and resell to your customer is a purchase for resale.

Pass-through billing supports resale treatment. The key facts were that Encode paid for the contract but billed its cost through to the distributor and end user as part of the price — it wasn't consuming the coverage itself.

Document it with Form ST-120. Give your provider a Resale Certificate to buy the contract without tax; the tax is then collected downstream when the covered product is sold to the end user.

Common questions

Q: I bundle a service contract into the product I sell. Do I pay tax when I buy the contract?
A: No, if you're reselling it as part of the product — that's a purchase for resale. Give the provider a Resale Certificate (Form ST-120).

Q: When would a service contract be taxable to me?
A: When you buy it for your own equipment and consume the coverage yourself, rather than reselling it. The purchase of a service/maintenance contract is otherwise a taxable transaction.

Q: Who collects the tax then?
A: It's collected downstream when the product (with the contract folded in) is sold to the end user, in the ordinary way.

Citations and references

Statutes:

• Tax Law § 1105(c)(3) — tax on the service of servicing or repairing tangible personal property, except for resale

Regulations / forms:

• 20 NYCRR §§ 527.5(c)(1), 527.5(d)(4) — the purchase of a maintenance or service contract is itself a taxable transaction
• Form ST-120 — Resale Certificate (given to the contract provider to claim the resale exclusion)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1982.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a82_10s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-82(10)S
Sales Tax
March 9, 1982

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S811207C

On December 7, 1981, a Petition for Advisory Opinion was received from Encode, Inc., 112
Parker Street, P.O. Box 924, Newburyport, Massachusetts 01950.
The issue raised is whether Petitioner's purchases of certain service contracts on behalf of the
end users of its computer programming systems are subject to tax under Article 28 of the Tax Law.
Petitioner is a manufacturer of computer programming systems for numerically controlled
machine tools. Petitioner sells these systems, exclusively to machine tool distributors, who resell the
systems to end users. Petitioner invoices the distributor, from whom it receives a properly executed
Resale Certificate.
To insure proper initial performance of its systems, Petitioner includes a 60 day service
contract with Data General Corporation. Petitioner pays for the contract, the cost of which is passed
on to the end user as part of the price of the system. The cost of the contract is invoiced by Petitioner
to the distributor and by the distributor to the end user.
Section 1105(c)(3) of the Tax Law imposes a sales tax on the "receipts from every sale,
except for resale, of the service of "servicing or repairing tangible personal property not held for sale
in the regular course of business." The Sales and Use Tax Regulations provide that the purchase of
a maintenance or service contract is itself such a taxable transaction. 20 NYCRR §§527.5(c)(1);
527.5(d)(4). In the present instance, however, inasmuch as the contract is purchased by Petitioner
for resale, no tax is due on its purchase. Petitioner may avail itself of this exclusion by supplying
Data General Corporation with a properly completed Resale Certificate (Form ST-120) at the time
of purchase.

DATED: February 22, 1982

JAMES H. TULLY., COMMISSIONER
TP-8 (4/80)

s/LOUIS ETLINGER
Deputy Director
Technical Service Bureau

LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR