Does software that links a manufacturer's computer to its production machines qualify for the Texas manufacturing exemption, even when the same software also tracks orders and calculates scrap?

Plain-English summary

A manufacturer of engineered-to-order dampers and louvers bought a software system with controls and a link program connecting its company computer to its roll-forming, cut-to-length, and tube-mill machines. The software downloads orders and parts-pattern data directly into the machines, monitors them in real time, tracks how much material passes through, resets a footage counter, and calculates scrap.

The Comptroller split the software's functions into two categories. The part of the software that downloads pattern data into the machines that manufacture the product — i.e., has a direct effect on the product being manufactured — qualifies as exempt manufacturing equipment.

But the other functions — tracking orders, calculating scrap, and resetting the footage counter — don't have that direct manufacturing effect. The Comptroller treats those as "divergent use" of otherwise-exempt equipment, meaning the manufacturer owes Texas sales tax based on the fair market rental value attributable to that non-manufacturing use, even though the same software package also does exempt work.

What this means for you

Manufacturers buying integrated control/tracking software

A single software system can be part-exempt and part-taxable at the same time. If your control software both feeds production machines and handles administrative functions like order tracking or scrap accounting, expect to apportion — the manufacturing-control functions are exempt, but the administrative functions trigger accrued use tax on a fair-market-rental-value basis.

Accountants and tax professionals

This is a "divergent use" analysis, not an all-or-nothing exemption question — worth flagging to clients who buy bundled manufacturing execution/SCADA-style systems, since the exempt and taxable uses can occupy the very same software license.

Common questions

Q: Does all manufacturing-support software qualify as exempt equipment?
A: No — only the parts of the software that have a direct effect on the product being manufactured, such as downloading pattern data into production machines.

Q: What happens if exempt manufacturing software also performs administrative functions like order tracking?
A: That's "divergent use." The manufacturer must accrue Texas sales tax on the fair market rental value of the software attributable to the non-manufacturing (divergent) use.

Q: Can I rely on this exact split for my own manufacturing software?
A: Not directly. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own software's functions with a tax professional.

Citations and references

Statutes:

• Tex. Tax Code § 151.318 (manufacturing exemption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200012948L

Original ruling text

December 18, 2000

Dear **:

Thank you for your recent letter regarding your client and Texas sales tax.

You stated that your client, Company B, is a manufacturer of engineered to
order dampers and louvers. The company is purchasing software with controls
and link program. The software system links the manufacturer's company
computer with the roll forming, cut-to-length, or tube mills. The system
enables direct computer-to-computer transfer of data by downloading orders and
parts pattern data directly into the machines. The system monitors the
machines in real time and responds to problems as they arise. The system
accounts for every inch of material that passes through the machines. Also,
the system resets the footage counter and calculates any scrap.

You asked if the software qualifies as exempt manufacturing equipment.

Response: The software qualifies as manufacturing equipment if it has a direct
effect on the product being manufactured. For instance, software that
downloads pattern data into the machines that manufacture the product would
qualify.

However, any use of the software for purposes of tracking orders, calculating
scrap and resetting the footage counter are considered divergent use of the
exempt manufacturing equipment. The manufacturer must accrue Texas sales tax
based on the fair market rental value for any divergent use of the software.

This opinion is based on the facts presented. Additional or different facts
may yield different results.

You may call me toll free 1-800-531-5441, extension 5-9787, if you have any
questions or need more information. The direct line is 512/305-9787. You may
also write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Philip Knisely
Tax Policy Division