Is copying seismic data onto tape taxable, even when it's outsourced to a related company or billed directly to the end client?

Plain-English summary

A company (Company A) maintains a library of seismic data from geophysical surveys and licenses it to customers, downloading requested data onto tapes it sends them. Company A used to do the tape-copying itself in-house, invoicing clients for both a license fee and a tape charge, with only the license fee treated as nontaxable per an earlier 1997 Comptroller letter and Rule 3.342(d)(2). Company A then spun off a 90%-owned affiliate (Company B) to handle the tape-copying, and asked about three billing structures: Company B copies tapes for Company A, who still invoices the client (Company A keeps a 10% commission); Company B invoices the client directly for the copying while still working exclusively for Company A; and Company B also copies tapes directly for other seismic-data owners and brokers.

The Comptroller's answer was the same in all three scenarios: the tape-copying charge is taxable, regardless of which related entity performs the copying or which one bills the client. Copying seismic data onto tape is "processing tangible personal property," and "the essence of the transaction is unchanged" no matter how the corporate structure or billing arrangement is set up. Company A's purchase of the copying service from Company B is itself taxable in the same way Company A's own tape purchases would have been. Only the separately identified license/information fee for the underlying seismic data stays nontaxable -- the copying charge does not.

What this means for you

Information-service or data-licensing companies

Splitting off a related company to perform a taxable processing function (like copying data onto physical media) doesn't change the tax result -- the Comptroller looks through corporate restructuring to the "essence of the transaction." Structuring a deal to shift where the copying charge is billed doesn't create an exemption that wasn't there before.

Companies using affiliated service providers

Whether your affiliate bills you, bills your client directly, or serves other outside customers too, a taxable processing service stays taxable. Related-party billing arrangements don't launder a taxable charge into a nontaxable one.

Accountants and tax professionals

This is a textbook "essence of the transaction" analysis: the substance of what's being done (copying tangible personal property) controls over the form (which entity in a related-party structure performs or bills for it).

Common questions

Q: If I license nontaxable information but charge separately for copying it onto tape, is the copying charge taxable?
A: Yes, per this letter -- physically copying data onto tape is processing tangible personal property and is taxable even though the underlying information license fee is not.

Q: Does using a related company to do the copying change the answer?
A: No. This letter tested three different arrangements involving a 90%-owned affiliate and found the copying charge taxable in every one -- the essence of the transaction doesn't change based on corporate structure.

Q: What if the copying company also serves outside customers, not just the related data owner?
A: Still taxable -- the letter reached the same conclusion whether the copying company worked exclusively for the related data owner or also served other seismic-data owners and brokers directly.

Citations and references

Rules and statutes:

• 34 Tex. Admin. Code Rule 3.342(d)(2) (nontaxable license fee vs. taxable copying charge)
• Tex. Tax Code § 151.005 (definition of "sale" or "purchase")
• Tex. Tax Code § 151.007(a)(2) (definition of "sales price")

Related STAR authority referenced in the letter (not independently verified here):

• Comptroller letter 9707583L (July 22, 1997)
• Hearing No. 19,287 (1986) / STAR document 8609H0770A01
• Letter 8811L1032G13

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9911892L

Original ruling text

November 23, 1999

Dear **:

Thank you for your letter concerning your client's, ** (COMPANY
A'S) Texas sales and use tax responsibilities.

Information Provided:

COMPANY A maintains a library of seismic data obtained from geophysical
surveys. When a customer, requests information, COMPANY A downloads the data
onto tapes which are sent the customer. In the past, COMPANY A performed this
tape-copying function in-house. In accordance with 34 TAC 3.342 (d)(2), COMPANY
A invoiced the client for both license fees and tape charges and did not charge
sales tax. ( Letter 9707583L, July 22,
1997).

Recently, COMPANY B, LLC has been created to provide this tape-copying service
for COMPANY A. COMPANY B is owned 90% by the stockholders of COMPANY A, but
will not file a consolidated tax return under COMPANY A for federal tax
purposes. COMPANY A will continue to invoice the client for both license and
tape charges. COMPANY A remits 90% of the tape charges to COMPANY B, leaving
COMPANY A with a 10% commission for providing COMPANY B with tape-copying
orders. COMPANY B is considering making two changes in the manner in which it
conducts business:

1. COMPANY B would continue to provide tape-copying services for COMPANY A.
   However, COMPANY B would invoice the client directly for tape-copying charges.
   COMPANY B would retain 90% of the tape copy revenue and remit the same 10%
   commission to COMPANY A. COMPANY B would provide tape-copying services for
   COMPANY A, other seismic data owners and seismic data brokers. COMPANY B would
   invoice the client directly for tape-copying charges.

QUESTIONS

1. If COMPANY B provides COMPANY A with seismic tape-copying services and
   COMPANY A invoices the client for the related tape-copying charges, are said
   tape-copying charges exempt from sales tax?

Answer: No. COMPANY B is copying information owned by COMPANY A onto tapes. The
tape copying is a separate transaction from COMPANY A'S sale to its clients.
COMPANY A'S purchase of the tape copying service from COMPANY B is taxable in
the same manner as were its purchases of tapes as explained in the
comptroller's July 22, 1997 letter (9707583L). See the enclosed Hearing No.
19,287 (1986) STAR document 8609H0770A01 and letter 8811L1032G13.

2. If COMPANY B provides COMPANY A with seismic tape-copying services and
   COMPANY B invoices the client directly for the related tape-copying charges,
   are said tape-copying charges exempt from sales tax?

Answer: No. COMPANY B is processing tangible personal property when it copies
COMPANY A'S seismic data. The essence of the transaction is unchanged. COMPANY
A owns the seismic data and COMPANY B copies the seismic data. COMPANY A needs
the seismic data copied and the copying is critical to the sale of the
nontaxable information. Texas Tax Code 151.005. The amount COMPANY B retains is
the consideration COMPANY A pays for the copying. Texas Tax Code 151.007(a)(2).

3. If COMPANY B provides other clients, data owners and brokers with seismic
   tape-copying services and invoices them directly for the related tape-copying
   charges, are said tape copying charges exempt from sales tax?

Answer: No. See the answer to Question 2.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

You may call me toll free 1-800-531-5441, extension 3-4683 if you have any
questions or need more information. The direct line is 512/463-4683. You may
also write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Eddie C. Washington
Tax Policy Division