Is a leased CAD/CAM system exempt from New York tax when it's used partly for research and development and partly for product design and manufacturing?

Plain-English summary

Peerless-Winsmith, Inc., a manufacturer of power-transmission equipment (speed reducers), electric motors, fans, and blowers, leases a CAD/CAM system it uses in New York to design new products, redesign existing ones, model designs for trial-and-error engineering, design tooling and fixtures, and generate the numerical-control (CNC) tapes that run its manufacturing equipment. It asked, use by use, whether the leased system qualifies for the research-and-development exemption (Tax Law § 1115(a)(10)) or the production-machinery exemption (§ 1115(a)(12)).

Both exemptions require the property to be used directly and predominantly in the exempt activity (Regulations §§ 528.11 and 528.13). The Department sorted the uses:

• Qualifies as R&D (§ 1115(a)(10)). Using the CAD/CAM to design and develop new products, improve existing products, and develop products (including for a single customer) is R&D "in the experimental or laboratory sense." Of the listed uses, all qualified except expanding a product line into "market-driven areas," which the Department found administrative and failing the "direct" test (and it likewise excepted the use where only the design is sold).
• Qualifies as production machinery (§ 1115(a)(12)). Equipment used to produce the CNC (numerical-control) tapes that operate manufacturing equipment qualifies (citing Buffalo Forge, TSB-A-86(26)S).
• Does NOT qualify. CRTs placed in the manufacturing area that merely provide information to shop-floor personnel fail the direct test. And using the CAD to design or redesign tools and fixtures — whether for R&D or for manufacturing — does not meet the "direct" test of either exemption.
• Leased property: measure each billing period. Because the CAD/CAM is leased (tax due monthly), the Department compares exempt-use time versus taxable-use time within each billing period to decide whether tax is due for that period.
• Documentation. Regulation § 533.2(c) sets the recordkeeping rules: the purchaser must keep records detailed enough to independently determine the taxable status of each purchase (categorizing purchases as fully taxable, exempt for resale, exempt for other reasons, or subject only to certain state/local taxes). No specific form of records is mandated — only that they prove any claimed exemption.

What this means for you

"Directly and predominantly" is the whole ballgame

Both the R&D and production-machinery exemptions demand direct and predominant (more than 50% of the time) use in the exempt function. Activities that merely support production or R&D — displaying data to workers, designing the tools and fixtures used to make the product, or administrative product-line expansion — are collateral, not direct, and don't qualify. Map each use of shared equipment against the "direct" test individually.

R&D vs. administrative: watch the "market-driven" trap

Genuine experimental/laboratory design — new products, product improvements, trial-and-error modeling — is R&D. But expanding a product line into "market-driven areas" is treated as administrative (like a market study), not R&D. The label "product development" doesn't carry the exemption if the activity is really business/market planning.

Producing CNC tapes is production machinery; displaying data isn't

Equipment that generates the control tapes driving CNC machines is part of production (per Buffalo Forge) and exempt under § 1115(a)(12). But a CRT that just shows information to manufacturing staff is one step removed from production and fails the direct test. Proximity to the actual production step matters.

Leased equipment: re-test every billing period

For a lease, you don't decide taxability once. Each billing period, compare exempt-use time to taxable-use time to determine whether that period's rental is taxable. Mixed-use leased equipment needs ongoing usage tracking — which ties directly to the § 533.2(c) recordkeeping duty. Keep records good enough to prove each exemption you claim.

Common questions

Q: Is a leased CAD/CAM system exempt in New York?
A: Only for its qualifying uses. Designing/developing and improving products is exempt R&D, and producing CNC tapes is exempt production machinery; other uses (administrative expansion, tool/fixture design, data-display CRTs) are taxable.

Q: Why doesn't designing tools and fixtures qualify?
A: The Department found that use doesn't meet the "direct" test of either the R&D or production-machinery exemption, even though the tools and fixtures are later used in manufacturing.

Q: How is tax handled since the system is leased?
A: Taxability is determined each billing period by comparing exempt-use time to taxable-use time for that period.

Q: What records are required?
A: Under § 533.2(c), records detailed enough to independently determine each purchase's taxable status and to prove any exemption claimed. No specific form is mandated.

Citations and references

Statutes, regulations, and authorities:

• Tax Law § 1115(a)(10) (exemption for property used directly and predominantly in R&D in the experimental or laboratory sense; excludes quality-control testing, efficiency surveys, management studies, consumer surveys, advertising/promotions)
• Tax Law § 1115(a)(12) (exemption for machinery used directly and predominantly in producing tangible personal property for sale)
• Sales and Use Tax Regulations § 528.11 (R&D exemption; definitions; direct, predominant (over 50%) tests)
• Sales and Use Tax Regulations § 528.13 (production-machinery exemption)
• Sales and Use Tax Regulations § 533.2(c) (purchase recordkeeping requirements)
• Buffalo Forge, TSB-A-86(26)S (equipment producing numerical-control tapes qualifies under § 1115(a)(12))

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a92_10s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-92 (10)S
Sales Tax
February 19, 1992

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S910805B

On August 5, 1991 a Petition for Advisory Opinion was received from Peerless-Winsmith,
Inc., 1301 W. Sandusky Avenue, Bellefontaine, Ohio 43311.
The issue raised by Petitioner, Peerless-Winsmith, Inc., is whether its lease of a CADCAM
software and hardware system used partially for research and development and partially for redesign
of existing products to fit a customer's application is subject to sales tax.
In particular Petitioner asks if the following uses qualify the CADCAM for exemption under
Section 1115(a)(10) of the Tax Law.
1)

Research and development.

2)

development of new products,

3)

expansion of a product line into market driven areas

4)

design and development of a product solely for one customer

5)

design and development of a product for one customer then adding that product to
Petitioner's catalog

6)

design and development of a product but only the design is sold

7)

redesign of a product to fit a customer's application

8)

redesign of an existing product to fit a customer's application where its redesign
requires calculations to insure proper alignment and operation.

9)

design and development of a product which will be used outside of New York State

In addition, Petitioner asks if the following equipment qualifies for exemption under Section
1115(a)(12) of the Tax Law.
10)

equipment used to create CAM tapes for CNC manufacturing equipment

11)

CRT's located in a manufacturing area to provide CADCAM information to
manufacturing personnel

12)

software used exclusively to create CAM tapes for CNC manufacturing equipment

-2­
TSB-A-92 (10)S
Sales Tax
February 19, 1992
Finally Petitioner asks the following:
13)

As the CADCAM is on a lease, and the sales/use tax is due on a monthly basis, is the
determination for taxable use versus exempt use made on a monthly basis or some
other period of time.

14)

Is the use of CAD for design of tools and fixturing for research and development
projects subject to sales tax.

15)

Is its use of the CAD for design of tools and fixtures for customer driven
development projects subject to tax.

16)

Is the use of the CAD for design or redesign of tools and fixtures for existing
products subject to tax.

17)

What type of documentation is required to support taxable versus exempt use.

Petitioner is a manufacturer of power transmission equipment (speed reducers) electric
motors, fans and blowers. Petitioner has plants in New York as well as outside New York.
Petitioner is leasing a CADCAM which will be used in New York in the following manner:
1)

Aid in the design of new products;

2)

Aid in the design of fixtures and tool;

3)

Aid in the redesign of existing products both to improve the product and to
conform to customer requests,

4)

Provide three dimensional graphic models on the CADCAM for trial and
error use; and,

5)

Directly generate numerical control machine tapes that are used to operate
CNC manufacturing equipment.

Petitioner's CADCAM is used in product design for both new and existing products. In this
application, Petitioner designs the product for overall dimensions and configurations. With a new
product, the system is used to view the entire product and review angles for proper operation. With
existing products, the system is used to: (1) Customize the product to a customer's needs, or (2) to
expand the product line, into market driven areas.
The CADCAM is used for tooling and fixture design for new and existing products. These
toolings and fixtures are necessary for the manufacturing of new products or to improve the
manufacturing process of existing products. Tooling and fixtures designed by the CADCAM are
used directly in the manufacturing process.

-3­
TSB-A-92 (10)S
Sales Tax
February 19, 1992
The three dimensional graphic models on the CADCAM are for trial and error purposes. The
CADCAM performs scientific calculations in order to produce a three dimensional graphic model
which can be examined on a CRT (Cathode Ray Tube) from numerous angles as a whole and from
cutaway view points. From this model, calculations are then made by the CADCAM to determine
if performance, function and reliability requirements can be met. If these requirements are met, it is
then determined if the design is economically feasible for commercial production. If not, the product
is redesigned on the CADCAM.
The numerical control tapes are used to provide operating instructions for CNC
manufacturing equipment. The tapes provide instructional information to programmable
manufacturing equipment, thereby, insuring consistent manufacturing and reducing scrap due to
human error.
Section 1115(a)(10) of the Tax Law provides an exemption from sales and use tax for:
Tangible personal property purchased for use or consumption directly
and predominantly in research and development in the experimental
or laboratory sense. Such research and development shall not be
deemed to include the ordinary testing or inspection of materials or
products for quality control, efficiency surveys, management studies,
consumer surveys, advertising, promotions or research in connection
with literary, historical or similar projects.
Section 1115(a)(12) of the Tax Law provides in part for an exemption from sales and use tax
for:
Machinery or equipment for use or consumption directly and
predominantly in the production of tangible personal property,. . .for
sale, by manufacturing, processing, generating, assembling, refining,
mining or extracting,. . .but not including parts with a useful life of
one year or less or tools or supplies used in connection with such
machinery, equipment or apparatus. . . .
Section 528.11 of the Sales and Use Tax Regulations provides that:
(a) Exemption. (1) The sale of tangible personal property purchased for use or consumption
directly and predominantly in research and development in the experimental or laboratory
sense is exempt from the sales and use tax.
(2) The exemption does not extend to installation and repair services for such
property.
(3) An exemption is allowed for the sale of gas, electricity, refrigeration and
steam, and gas, electric, refrigeration and steam service of whatever nature for use
or consumption directly or exclusively in research and development in, the
experimental or laboratory sense.

-4­
TSB-A-92 (10)S
Sales Tax
February 19, 1992
(4) An Exempt use Certificate (form ST-121) is used to make purchases
eligible for this exemption, without payment of sales tax. (See section 532.4[e] of
this Title.)
(b) Research and development. (1) Research and development, in the experimental
or laboratory sense, means research which has as its ultimate goal:
(i) basic research in a scientific or technical field of endeavor;
(ii) advancing the technology in a scientific or technical field of
endeavor;
(iii) the development of new products;
(iv) the improvement of existing products; and
(v) the development of new uses for existing products.
(2) Research and development in the experimental or laboratory sense does
not include:
(i) testing or inspection of materials or products for quality control
(for machinery and equipment used for quality control in the
production of products for sale, see section 528.13 of this Part);
(ii) efficiency surveys;
(iii) management studies;
(iv) consumer surveys, advertising and promotions; and
(v) research in connection with literary, historical or similar projects.
(c) Directly, predominantly, exclusively. (1) Direct use in research and development
means actual use in the research and development operation. Tangible personal
property for direct use would broadly include materials worked on, and machinery,
equipment and supplies used to perform the actual research and development work.
Usage in activities collateral to the actual research and development process is not
deemed to be used directly in research and development.
(2) Tangible personal property is used predominantly in research and
development if over 50 percent of the time it is used in such function.
(3) Tangible personal property is exempt only if it meets the tests of direct
and predominant use.

-5­
TSB-A-92 (10)S
Sales Tax
February 19, 1992
Section 528.13(a) of the Sales and Use Tax Regulations provides that:
(1) An exemption is allowed from the tax imposed under section 1105(a) of
the Tax Law, and from the compensating use tax imposed under section 1110 of the
Tax Law, for receipts from sales of:
(i) machinery or equipment used or consumed directly and
predominantly in the production for sale of tangible personal
property, gas, electricity, refrigeration or steam, by manufacturing,
processing, generating, assembling, refining, mining or extracting;
and
(ii) telephone central office equipment or station apparatus, or
comparable telegraph equipment for use directly and predominantly
in receiving at destination or initiating and switching telephone or
telegraph communication.
With the exception of Items "3" and "6", the use by Petitioner of its CADCAM as set forth
in Items "1" thru "9" to develop power transmission equipment (speed reducers), electric motors,
fans and blowers qualifies as use in research and development. The expansion of a product into
market driven areas as set forth in Item "3" is administrative in nature and does not meet the "direct"
test of the statute.
Equipment used to produce numerical control tapes as set forth in Item "10" qualifies for the
exemption under Section 1115(a)(12) (See: Buffalo Forge
TSB-A-86(26)S).
CRTs located in a manufacturing area which provide manufacturing personnel with
information as set forth in Item "11" do not meet the direct test of Section 1115(a)(12) and therefore
do not qualify for exemption.
The use of the CAD for design or redesign of tools and fixtures which are used for research
and development or manufacturing as set forth in Items "14", "15" and "16" does not qualify for the
exemptions provided by Sections 1115(a)(10) or (12) of the Tax Law since its use does not meet the
"direct" test required by the statute.
Where CADCAM is on a lease as set forth in Item "13", the amount of time it is used in an
exempt manner within the billing period versus the amount of time it is used in a taxable manner
determines whether or not a tax is due for that period.
As to what type of documentation is required to support taxable versus exempt use, Section
533.2(c) sets forth general guidelines as to what kind of records must be maintained in order to prove
exempt purchases as follows:

-6­
TSB-A-92 (10)S
Sales Tax
February 19, 1992
(c) Purchase records. Every purchaser must maintain documentation to
substantiate any exemption, exclusion or exception claimed on the purchase of any
tangible personal property or service. The purchase records must provide sufficient
detail to independently determine the taxable status of each purchase and the amount
of tax due, paid or remitted thereon. Purchase documents should be categorized as
follows:
(1) purchases that are subject to all taxes;
(2) purchases exempt from all taxes because for resale (inventory and raw
materials);
(3) purchases that are exempt from all taxes for reasons other than for resale;
e.g., purchases from an organization exempt from tax pursuant to section 1116(a)(4)
of the Tax Law:
(4) purchases that are subject only to the statewide sales tax or the New York
City sales tax, or a local tax; e.g., production machinery and equipment purchased in
New York City is exempt from the statewide tax but subject to the New York City
sales tax.
Neither the Tax Law or regulations mandate specific types of records to be kept, only that
the records kept must be able to prove any exemption claimed or that the tax was paid.

DATED: February 19, 1992

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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