Under RR 98-19, did South Carolina's manufacturing exemption cover computers and machines used in CAD, CAM, or integrated CAD/CAM systems?

Plain-English summary

South Carolina Revenue Ruling 98-19 drew the tax line between computer-aided design and computer-aided manufacturing.

Computers and machines used only in a CAD system were taxable. The Department treated product design as an operation preliminary or preparatory to producing the marketable product, not as manufacturing tangible personal property for sale.

Computers and machines used in CAM were exempt under S.C. Code Section 12-36-2120(17) when they operated or monitored production machines that directly manufactured goods for sale. The exemption did not reach work before manufacturing began or after it ended.

For an integrated CAD/CAM system, the result depended on each component's actual role. Design components were taxable and manufacturing components exempt. A single machine used for both functions qualified only if it was used substantially—not merely incidentally—in manufacturing.

The ruling's four answers

• CAD-only system: taxable because the equipment was used before production.
• CAM-only system: exempt when the equipment was used to manufacture tangible personal property for sale.
• Integrated CAD/CAM system: divided at the factual point where design ended and manufacturing began.
• One dual-use machine: exempt only when substantially used in manufacturing rather than merely incidentally used there.

Common questions

Q: Did calling a system "integrated" make every component exempt? No. The Department required a component-by-component and fact-specific analysis.

Q: Why was design equipment taxable? The ruling classified design as preliminary or preparatory to production rather than part of producing the marketable item.

Q: Did CAM equipment automatically qualify? Only when it was actually used in manufacturing property for sale and was not used merely before or after production.

Q: What controlled a machine used for both design and production? Substantial manufacturing use. Merely incidental manufacturing use was insufficient under the ruling.

Citations and references

• S.C. Code Ann. § 12-36-2120(17) (machines used in manufacturing tangible personal property for sale)
• S.C. Regulation 117-174.120 (parts and attachments necessary and customary to machine operation)
• Hercules Contractors and Engineers, Inc. v. South Carolina Tax Commission, 280 S.C. 426, 313 S.E.2d 300 (1984) (substantial-use rule discussed)
• Bird & Son, Inc. v. Limbach, 45 Ohio St. 3d 76, 543 N.E.2d 1161 (1989) (preliminary, preparatory, and post-production operations discussed)
• Owen Industrial Products, Inc. v. Sharpe, 274 S.C. 193, 262 S.E.2d 33 (1980); Hollingsworth on Wheels, Inc. v. Greenville County Treasurer, 276 S.C. 314, 278 S.E.2d 340 (1981); York County Fair Association v. South Carolina Tax Commission, 249 S.C. 337, 154 S.E.2d 361 (1967) (strict construction of exemptions discussed)

Subject

Computer Aided Designs Systems and Computer Aided Manufacturing Systems

Source

• Landing page: https://dor.sc.gov/advisory-opinion-search
• Original PDF: https://dor.sc.gov/sites/dor/files/policies/RR98-19.pdf

Original ruling text

State of South Carolina

Department of Revenue
301 Gervais Street, P.O. Box 125, Columbia, South Carolina 29214

SC REVENUE RULING #98-19

SUBJECT:

Computer Aided Designs Systems and Computer Aided Manufacturing
Systems
(Sales and Use Tax)

EFFECTIVE DATE:

Applies to all periods open under the statute.

SUPERSEDES:

All previous documents and any oral directives in conflict herewith.

REFERENCES:

S. C. Code Ann. Section 12-36-2120(17) (Supp. 1997)

AUTHORITY:

S. C. Code Ann. Section 12-4-320 (Supp. 1997)
SC Revenue Procedure #97-8

SCOPE:

A Revenue Ruling is the Department of Revenue’s official advisory
opinion of how laws administered by the Department are to be applied to
a specific issue or a specific set of facts, and is provided as guidance for
all persons or a particular group. It is valid and remains in effect until
superseded or modified by a change in the statute or regulations or a
subsequent court decision, Revenue Ruling or Revenue Procedure.

Questions:

1. Are the sales or purchases of computers and machines to be used by a manufacturer in a
   computer aided design system subject to the sales and use tax?
2. Are the sales or purchases of computers and machines to be used by a manufacturer in a
   computer aided manufacturing system subject to the sales and use tax?
3. Are the sales or purchases of computers and machines to be used by a manufacturer in an
   integrated computer system, one that employs computers and machines in computer aided
   design and computer aided manufacturing, subject to the sales and use tax?
4. Is the sale or purchase of a computer or machine to be used by a manufacturer in both
   computer aided design and computer aided manufacturing subject to the sales and use tax?
   Conclusion:
5. Sales or purchases of computers and machines to be used by a manufacturer in a computer
   aided design system are subject to the sales and use tax since such computers and machines
   will be “employed in operations preliminary or preparatory to the production of the

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marketable product.” See Discussion - Bird & Son, Inc. v. Limbach, 45 Ohio St. 3d 76, 543
N.E.2d 1161 (1989).

2. Sales or purchases of computers and machines to be used by a manufacturer in a computer
   aided manufacturing system are exempt from the sales and use tax under Code Section 1236-2120(17) since such computers and machines are “used in manufacturing ... tangible
   personal property for sale.”
3. Sales or purchases of computers and machines to be used by a manufacturer in an integrated
   computer system, one that employs computers and machines in computer aided design and
   computer aided manufacturing, are:
   (a) subject to the sales and use tax for computers and machines in the integrated system used
   in designing a product since such computers and machines are “employed in operations
   preliminary or preparatory to the production of the marketable product”; and
   (b) exempt from the sales and use tax under Code Section 12-36-2120(17) for computers and
   machines in the integrated system since such computers and machines are “used in
   manufacturing ... tangible personal property for sale.”
   With respect to an integrated computer system, it must be determined where the computer aided
   design part of the system ends and where the computer aided manufacturing part of the system
   begins. This determination “depend[s] largely upon the peculiarities of the taxpayer's
   operations, so as to be essentially a question of fact in each case.” 30 A. L. R. 2d 1449 (1953).
   It must be determined whether particular computers and machines are “employed in operations
   preliminary or preparatory to the production of the marketable product” or are employed in the
   production of the marketable product.
4. The sale or purchase of a computer or machine to be used by a manufacturer in both computer
   aided design and computer aided manufacturing is exempt from the sales and use tax under
   Code Section 12-36-2120(17) if it is used substantially (not merely incidentally) in the
   “manufacturing tangible personal property for sale.” (See Hercules Contractors and
   Engineers, Inc. v. South Carolina Tax Commission, 280 S.C. 426, 313 S.E. 2d 300 (1984).)
   Facts:
   Recently, questions have arisen as to the taxability for sales and use tax purposes of computers
   and other machines used within a computer aided design system (CAD) or computer aided
   manufacturing system (CAM). For purposes of this advisory opinion, the following definitions
   will be used:
   Computer Aided Design Systems - a system of computers and other machines used by a
   manufacturer to design products, often to meet the specific needs of a customer. For example, a
   manufacturer of towels may manufacture towels of specific sizes; however, the design on the
   towel will be designed for the specific customer who may want the design to reflect a college
   mascot, a local landmark, a specific emblem, etc.

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Computer Aided Manufacturing Systems - a system of computers and other machines that
operate and monitor the production machines that directly manufacture the tangible personal
property for sale.
Discussion:
Code Section 12-36-2120(17) exempts from sales and use tax:
...the gross proceeds of sales of...machines used in ... manufacturing...tangible personal
property for sale. 'Machines' include the parts of machines, attachments, and
replacements used...in the operation of the machines and which are necessary to the
operation of the machines...
Furthermore, Regulation 117-174.120 provides an interpretation of the term "machines" and
reads, in part:
The terms "...parts of such machines" are restricted to the following: (a) they must be
used or manufactured for use, on or in the operation of such machines; (b) necessary to
the operation of such machines and (c) customarily so used. These restrictions are
interpreted to mean that the part or attachment must be purchased in the form in which it
will be used by the manufacturer without any fabrication or alteration by him, except the
usual and customary minor adjustment (except as stated at 117-174.123) and that it is a
standard part or attachment customarily used and, further, that the machine or machinery
on which it is used would not do the work for which it was designed if it were not used.
This, of course, exempts all parts and attachments without which the machine would do
no work, and, in addition, it exempts parts and attachments designed to increase the
efficiency of the machine.
The law, therefore, provides that machines, their parts and attachments, subject to certain restrictions, that
are used in manufacturing tangible personal property for sale qualify for the exemption found in Code
Section 12-36-2120(17). However, as a general rule, tax exemption statutes are strictly construed against the
taxpayer. Owen Industrial Products, Inc. v. Sharpe, 274 SC 193, 262 S.E. 2d 33 (1980), Hollingsworth on
Wheels, Inc. v. Greenville County Treasurer et al, 276 S.C. 314, 278 S.E. 2d 340 (1981). This rule of strict
construction simply means that constitutional and statutory language will not be strained or liberally
construed in the taxpayer's favor. York County Fair Association v. SC Tax Commission, 249 S.C. 337, 154
S.E. 2d 361 (1967).
In order to determine whether machines and attachments are exempt from the tax, it is essential to ascertain
the points at which manufacturing begins and ends. American Law Reports Annotated 2d suggests the
following in making this determination and reads:
While the determination of whether the use is a taxable one or not appears to depend
largely upon the peculiarities of the taxpayer's operations, so as to be essentially a
question of fact in each case, it seems that the tax will be imposed where the
transportation or storage is clearly of raw materials prior to the start of manufacturing or
processing, or of the completed product after such operations have clearly terminated,
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but that the handling and storage intermediate to the various manufacturing or processing
operations may be regarded as a part of those operations, and so free from the tax.
Annot., 30 A. L. R. 2d 1449 (1953).
Also, in Bird & Son, Inc. v. Limbach, 45 Ohio St. 3d 76, 543 N.E.2d 1161 (1989), the Ohio
Supreme Court concluded that "tangible personal property which is employed in operations
preliminary or preparatory to the production of the marketable product,..., or employed
subsequent to the completion of the manufacturing process,..., is not exempt" (emphasis added).
Based on the above, computers and other machines used as part of a computer aided design
system are used in designing a product and are not “used in manufacturing ... tangible personal
property for sale” since such computers and machines are “employed in operations preliminary or
preparatory to the production of the marketable product.”
Computers and other machines used as part of a computer aided manufacturing system are “used
in manufacturing ... tangible personal property for sale” provided such computers and machines
are not “employed in operations preliminary or preparatory to the production of the marketable
product,..., or employed subsequent to the completion of the manufacturing process.”
Sometimes a computer aided design system is integrated with a computer aided manufacturing
system. “[T]he determination of whether the use is a taxable one or not appears to depend
largely upon the peculiarities of the taxpayer's operations, so as to be essentially a question
of fact in each case.” 30 A. L. R. 2d 1449 (1953). Therefore, based on the facts in each case, it
must be determined where the computer aided design system ends and where the computer aided
manufacturing system begins. This is not always an easy determination and is essentially a
determination as to whether the computers and machines are “employed in operations preliminary
or preparatory to the production of the marketable product” or are employed in the production of
the marketable product.
Finally, it should be noted that, in accordance with the South Carolina Court of Appeals in
Hercules Contractors and Engineers, Inc. v. South Carolina Tax Commission, 280 S.C. 426, 313
S.E. 2d 300 (1984), a machine must be substantially used for a manufacturing purpose in order to
qualify for the exemption. As such, if a machine is used for both manufacturing (employed in the
production of the marketable product) and design (“employed in operations preliminary or
preparatory to the production of the marketable product”) purposes, then the sale or purchase of
the machine is exempt from the sales and use tax if it is used substantially (not merely
incidentally) in the “manufacturing tangible personal property for sale.”
SOUTH CAROLINA DEPARTMENT OF REVENUE

s/Burnet R. Maybank III
Burnet R. Maybank, III, Director
Columbia, South Carolina
September 9
, 1998

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