Does Texas sales tax apply to materials, equipment, and electricity used to build a product prototype?

Subject

Prototype — Research And Development — Materials/Equipment/Electricity Not Exempt — Not Sale For Resale

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9402L1285C11

Plain-English Summary

The taxpayer was building a prototype of an oil and gas instrument control process to manufacture and market to domestic and international customers. Because the taxpayer did not yet have a sales tax permit and could not issue a resale certificate, tax had already been paid on the prototype materials. The taxpayer asked the Comptroller to clarify the tax treatment of those materials and the required effective date of a sales tax permit.

The Comptroller ruled that materials used to fabricate the prototype do not qualify for the sale-for-resale exemption, even though the prototype was later demonstrated to prospective customers. The letter explains that "there is no exemption for items used in research and development" — such items are fully taxable. The resale exemption applies only to property that is purchased exclusively for resale and not for use. A prototype, by contrast, is "an original that is used as a representative, example, model, or sample (sometimes for testing) for later manufacture." Because a prototype is used as the pattern or model from which other items are copied, it is not purchased or manufactured exclusively for sale — it is used, which disqualifies it from the resale exemption. This applies whether the prototype was for research/proof-of-concept purposes or for demonstration to customers.

The letter also addresses two related administrative questions:

• Sales tax permit timing: A business can obtain a sales tax permit before making its first sale, which lets it purchase resale inventory tax-free. However, the Comptroller generally does not issue a permit more than 90 days before the "first sale date," because permit holders must file returns for every period the permit is in effect — even periods with no sales — and unfiled returns create unnecessary burden for both the state and the permit holder. The taxpayer may choose any date, including a future planned manufacturing or sales date, for item 27 of the application, but must then file returns from that date forward even without sales.
• No permit needed to buy manufacturing components: Because the taxpayer is a manufacturer, it does not need a sales tax permit just to buy the materials that become components of the actual instrument control systems it will sell (as opposed to the prototype). Those component materials can be purchased tax-free using either a resale certificate or a manufacturing exemption certificate. The letter also notes a possible exemption for tangible personal property used exclusively in exploration for or production of oil, gas, sulphur, or other minerals offshore outside Texas waters, which might apply to the taxpayer's wellhead control instrument.
• Gross sales vs. taxable sales reporting: On sales tax returns, "gross sales" includes all sales — international, interstate, and domestic, taxable or not — while "taxable sales" includes only sales without an applicable exemption. A filing period can show gross sales with no taxable sales, or both, but never negative amounts in either category.

A currency ALERT attached to the top of this letter by the publishing system notes that Senate Bill 2206 (89th Legislative Session) repeals Tax Code Section 151.3182 — a later-enacted research and development property exemption — effective January 1, 2026, and that a related exemption for certain depreciable property used in "qualified research" was added to Section 151.3182 by the 83rd Legislature (2013) via H.B. 800. These ALERTs describe legislative developments decades after this 1994 letter was issued; the original letter itself does not cite Section 151.3182 or any other statute, and its "no exemption for R&D items" holding rests on the definition of the resale exemption, not on the 151.3182 provision referenced in the ALERT.

What This Means For You

If you are building a product prototype in Texas: Expect to pay sales tax on the materials, equipment, and electricity used to build and test the prototype. Because the prototype is used — for research, proof-of-concept, or demonstration — rather than purchased exclusively for resale, it does not qualify for a resale certificate or exemption certificate, regardless of whether it is later shown to potential customers.

If you are a manufacturer without a sales tax permit yet: You do not need a sales tax permit to buy the components of the actual product you will manufacture and sell — those can be purchased tax-free with a resale certificate or manufacturing exemption certificate. You only need the permit to make sales, collect and report tax, and purchase resale inventory going forward. Expect the Comptroller to decline to issue a permit more than about 90 days before your planned first sale date, since the permit obligates you to file returns from that point forward even with no sales.

If you are researching whether an R&D exemption might apply today: This 1994 letter predates the later-enacted (and now-scheduled-for-repeal) Tax Code Section 151.3182 research-property exemption referenced in the ALERT banner. That statute did not exist when this ruling issued and played no role in its reasoning; consult current law (including 34 Tex. Admin. Code Rule 3.340) to determine whether any R&D exemption is available for your situation now.

Q&A

Q: Do I owe Texas sales tax on the materials I use to build a prototype of a product I plan to manufacture and sell?
A: Yes. There is no exemption for items used in research and development, and a prototype does not qualify for the resale exemption because it is used — as a research or proof-of-concept model, or as a demonstration piece — rather than purchased exclusively for resale.

Q: Does it matter that I plan to demonstrate the prototype to prospective customers before selling copies of it?
A: No. The letter explains that a prototype is generally not itself offered for sale while being demonstrated; instead, it demonstrates the copies that are or will be offered for sale. Because the prototype itself is used as the pattern or model for later manufacture, it remains taxable regardless of its demonstration use.

Q: Do I need a sales tax permit before I can buy the components that will go into the actual product (not the prototype) tax-free?
A: No. As a manufacturer, you can purchase the components of the manufactured item you will sell using a resale certificate or manufacturing exemption certificate without first having a sales tax permit. You need the permit itself to make sales, collect and report tax, and it generally won't be issued more than about 90 days before your planned first sale date.

Citations

• Referenced only in the publisher's currency ALERT (not cited by the 1994 letter itself): Tex. Tax Code § 151.3182, as amended by 83rd Legislature (2013) H.B. 800 and scheduled for repeal by 89th Legislature S.B. 2206, effective January 1, 2026; see also 34 Tex. Admin. Code Rule 3.340.
• Rule 3.300 (referenced in the letter as covering items a manufacturer may buy tax free or partially tax free for use in the manufacturing process).
• Rule 3.287 (referenced in the letter as containing a blank exemption certificate).
• Rule 3.332 (referenced in the letter as covering exemptions that may apply to the sale of the taxpayer's product).

Original ruling text

ALERT: Senate Bill 2206, 89th Legislative Session, repeals Tax Code Section 151.3182 relating to the exemption for certain property used in research and development activities. Effective 01/01/2026.

ALERT: An exemption for certain depreciable property used in "qualified research", as added to Section 151.3182 by the 83rd (2013) Legislative Session (H.B.800), may be available. See Rule 3.340 for additional details.

February 15, 1994

Dear *****:

Thank you for asking for clarification regarding the tax due on the

materials to fabricate a prototype of your product and the required

effective date of a sales tax permit for reporting sales of your

product. I have tried to reach you by phone to discuss these issues.

You indicate that you are building a prototype of an oil, gas instrument

control process that you will manufacture and market to domestic and

international customers. You also indicate that you have paid tax on the

materials for the prototype because you did not have a sales tax permit

and were unable to issue a resale certificate. The prototype will be for

two purposes; research or proof of concept, and demonstration to

prospective customers.

Unfortunately, the materials for the prototype, although demonstrated, do

not qualify for the sale for resale exemption. There is no exemption for

items used in research and development. These items are fully taxable.

Generally, a prototype is not offered for sale while it is being

demonstrated. Instead, it demonstrates copies that are or will be offered

for sale. The sale for resale exemption applies to property that is

purchased exclusively for resale and not for use. A prototype is an

original that is used as a representative, example, model, or sample

(sometimes for testing) for later manufacture. Because a prototype is used

as the original pattern or model of which other like items are

representations or copies, it is not purchased or manufactured exclusively

for sale and not for use.

You are right about the sales tax permit. You can get one before you make

your first sale. The sales tax permit allows you to make sales, collect

sales tax and report use tax, and also, to purchase your resale inventory.

Obviously, you can have a sales tax permit so that you can purchase your

inventory for resale before you make your first sale.

However, we generally do not issue a sales tax permit earlier than 90

days before the "first sale date." The reason for this is that sales tax

reports are due for periods when the sales tax permit is in effect and

most people don't think to file the reports if no sales have been made.

Both the state and the permitee are inconvenienced and incur unnecessary

expense when required reports are not filed.

I am sending you the application for the sales tax permit under separate

cover. You may fill in item 27 with any date including the date you plan

to begin manufacturing the instruments or making sales. Whatever date you

choose, you will be required to file returns that include that date even

if you have no sales to report.

Because you are a manufacturer, you do not need the sales tax permit in

order to buy your materials for the actual instrument control systems

that you will sell. The components of a manufactured item may be purchased

with either a resale certificate or an exemption certificate. You may begin

purchasing materials that are components of the wellhead controls that you

will sell, (not of the prototype) without a sales tax permit by issuing a

manufacturing exemption certificate for those materials. Rule 3.300 in your

packet covers items that you may buy tax free or partially tax free that

you use in your manufacturing process. A blank certificate is included in

rule 3.287 in your application packet. Also included in your packet is Rule

3.332 that covers exemptions that may apply to the sale of your product.

Generally, tangible personal property that is used exclusively in

exploration for or production of oil, gas, sulphur, or other minerals

offshore outside Texas waters is exempt. Your wellhead control instrument

may fit into this category.

You also asked whether you are required to report sales for export or

only domestic sales. The return asks for gross sales and for taxable sales.

Gross sales is all sales including international and interstate sales whether

taxable or not. Taxable sales are only those sales where there is not an

exemption. In any reporting period you may have no gross sales, gross sales

but no taxable sales or gross sales and taxable sales. You may not have sales

of less than zero in either category.

This option is based on the facts presented. Additional or different facts

may produce a different result.

You may have more questions or need more information because of the

complexity of the issues you raised. Please call or write. The toll free

number is 1-800-531-5441, ext. 3-4675. My direct line number is

(512)463-4675.

Sincerely,

Tom Soto

Tax Administration Division

NOTE: Previous Accession Number 9402040L