I design store signage and trim on a computer using 3D drafting software, then fabricate and install it in new stores -- am I taxed as a contractor or as a manufacturer, and does my design equipment qualify for the manufacturing exemption?

Subject

Sign/Signage/Trim — Designed By Contractor On Computer Using Three Dimensional Drafting — After Approval Contractor Fabricates And Installs — Contractor Vs. Manufacturer

Plain-English summary

A company designs retail store interiors on a computer using advanced three-dimensional drafting and rendering software. Once a customer approves the virtual design, each sign, trim piece, or display is pulled from the design and sent over a computer network to specialized manufacturing equipment, which uses the design as a "die" or "pattern" to automatically cut and create the actual signage and trim. The company then installs the finished signage and trim in the customer's new stores as they're built.

The company billed customers in three stages: (1) creating approval posters of the virtual design, which are handed over to the customer and often kept as wall décor; (2) fabricating the signage and trim using the computer-driven cutting equipment; and (3) installing the signage and trim during store construction.

Contractor, not manufacturer. The Comptroller held that because the company affixes the signage and trim it fabricates to real property under a contract for new construction, it is treated as a contractor under Rule 3.291, not as a manufacturer under Rule 3.300. Rule 3.291 defines a contractor as anyone who builds new improvements to real property (or repairs/remodels residential real property) and incorporates tangible personal property into the property being improved.

Tax on materials depends on contract structure. Because the company is a contractor, tax is due either on its cost of materials (if the contract is lump-sum) or on its charge to the customer for materials incorporated into the realty (if the contract is separated into materials and labor). The posters, however, are not incorporated into realty -- they're handed to the customer as tangible personal property -- so sales of the posters are taxable in total regardless of contract structure.

Design and networking equipment don't qualify for the manufacturing exemption. The 3D rendering computer equipment and software used to design the store interior do not qualify as "manufacturing equipment" under Texas Tax Code Sec. 151.318, unless the designs created on it are themselves sold. The same is true of the networking equipment and software used to transmit the computer codes (dies/patterns) to the cutting equipment -- it does not qualify for the same reason.

Installation labor is non-taxable finish-out. So long as the store being outfitted is a new store, the labor to install the signage and trim is the non-taxable "finishing out" of commercial new construction.

What this means for you

Sign/display fabricators who also install their work

If you fabricate signage or trim and then affix it to real property under a new-construction contract, expect to be taxed as a contractor under Rule 3.291, not as a manufacturer under Rule 3.300 -- even if you use sophisticated computer-driven design and manufacturing equipment. Whether tax applies to your cost of materials or to your billed charge for materials depends on whether your contract is lump-sum or separated between materials and labor.

Businesses selling design proofs, mockups, or posters separately

If part of your fee is for a tangible item that is transferred to the customer and not incorporated into real property (like an approval poster), that charge is taxable in full, separate from how the incorporated materials are taxed.

Businesses claiming the manufacturing equipment exemption for design/CAD equipment

3D drafting, rendering, or networking equipment used only to create designs or route data to cutting/fabrication equipment does not qualify for the Sec. 151.318 manufacturing equipment exemption unless the designs themselves are sold as a product.

Contractors doing finish-out work on new commercial construction

Labor to install signage and trim as part of finishing out a genuinely new store is not taxable. This letter's answer is limited to its specific facts -- similar facts could still yield a different result.

Common questions

Q: My company fabricates signage using computer-driven cutting equipment and then installs it -- am I a contractor or a manufacturer for Texas sales tax purposes?
A: If you affix the fabricated signage and trim to real property under a contract for new construction, you're treated as a contractor under Rule 3.291, not a manufacturer under Rule 3.300.

Q: How is tax calculated on the materials I incorporate into a new store as a contractor?
A: It depends on how the contract is structured -- tax is due on your cost of materials under a lump-sum contract, or on your charge to the customer for materials incorporated into the realty under a separated contract.

Q: I create and hand over design approval posters to my customer before fabrication -- are those taxable?
A: Yes. Because the posters are transferred to the customer and are not incorporated into realty, sales of the posters are taxable in total.

Q: Does my 3D design/rendering software and computer equipment qualify for the manufacturing equipment sales tax exemption under Sec. 151.318?
A: No, not unless the designs created on the equipment are themselves sold.

Q: What about the networking equipment that sends my design files to the cutting equipment -- does that qualify for the manufacturing exemption?
A: No, for the same reason as the design equipment itself.

Q: Is the labor to install signage and trim in a brand-new store taxable?
A: No -- so long as the store is indeed new, that installation labor is non-taxable finish-out of new construction.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.291 (definition of a real-property contractor)
• 34 Tex. Admin. Code Rule 3.300 (manufacturer tax treatment, held inapplicable here)
• Texas Tax Code Sec. 151.318 (manufacturing equipment 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/9701280L

Original ruling text

January 16, 1997

Dear **:

This is in response to your request for a ruling on behalf of your client,
seeking guidance on the taxability of certain transactions under the Texas
Sales and Use Tax law. Your fact situations and questions are restated below
followed by my response.

Facts

Your client is in the business of designing and finish-out of retail store
interiors. The business is somewhat unique in that your client initially
designs the store interior on a computer using highly complex and advanced
three dimensional drafting and rendering computer equipment and software. The
actual design is then taken and directly used by specialized manufacturing
equipment to manufacture the signage and trim for the store's interior.

For example, the company designs how a store will look using specialized three
dimensional graphics rendering software. Each object in the store depiction,
such as a customer display or sign, is individually programmed as a separate
object in the computer. These objects are combined to create the virtual
display. Each sign or object can be extracted from the virtual depiction and
manipulated separately and individually from the rest of the depiction. The
depiction is then printed to a very realistic, poster-sized picture for
approval or modification by the customer.

Once the virtual store interior is approved by the customer, each sign, trim,
or display is
pulled from the virtual depiction and sent over a computer network to
specialized manufacturing equipment. This manufacturing equipment takes the
computer code objects and uses them as a "die" or "pattern" to automatically
cut and create the signage and trim to be used in the actual store.

Your client's fee is usually separated into three areas. The first stage is the
creation of the posters. Once created, these posters are actually transferred
to the customer, and often become a valued wall ornament in the new store. The
second stage involves the creation of the signage and trim by our client's
manufacturing equipment, using the computer codes as the die or pattern. The
third stage involves the installation of the signs in the stores as they are
built. The first two stages are continuous and uninterrupted. The third stage
is comprised mostly of labor charges during the finish-out of the new store.

Your client is a Texas corporation. Your client's customers are multistate, and
the various stores for the various clients are located nationwide.

Questions

1. Under the fact pattern noted above, which charges to your client's customers
   are taxable under the Texas Sales and Use Tax Act?

Response: A contractor is defined in Rule 3.291 as:

Any person who builds new improvements to real property or repairs, restores,
or remodels residential real property, and who, in making the improvement,
incorporates tangible personal property into the property being improved. The
term includes subcontractors but does not include material men and suppliers

Because your client affixes the signage and trim that he fabricates to realty
under a contract for new construction your client will be treated as a
contractor rather than a manufacturer. As such, the provisions of Rule 3.291
apply rather than Rule 3.300. Depending on how the contract is structured,
i.e., lump-sum or separated, tax will be due on your client's cost of materials
or charge to his customer for materials incorporated into the realty being
improved. Sales of tangible personal property (i.e., the posters) that are not
incorporated into realty are taxable in total.

2. Does the three dimensional rendering computer equipment and software
   utilized by your client qualify as "manufacturing equipment" entitled to an
   exemption under Texas Tax Code Sec. 151.318? Why or why not?

Response: The three dimensional rendering computer equipment and its software
for this purpose do not qualify as manufacturing equipment unless the designs
created on it are sold.

3. Does the networking computer equipment and software required by your client
   to convey the computer codes which form the dies and patterns for the signage
   cutting equipment qualify as manufacturing equipment under Sec. 151.318? Why or
   why not?

Response: No, see response to #1.

4. So long as the store being outfitted is indeed a new store, are your
   client's installation services for signage and trim considered the non-taxable
   "finishing out" of commercial new construction?

Response: Yes, the labor to install the signage and trim would not be taxable.
This opinion is based on the facts presented. Other facts though similar may
provide a different result.

You may call me toll-free at 1-800-531-5441, extension 3-4502. The direct line
is 512/463-4502. You may also write to Tax Policy Division, Comptroller of
Public Accounts. My Internet address is: [email protected].

Sincerely,
Gilbert Zamora
Tax Policy Division