Is a per-unit 'production fee' charged under a packaging machine lease a taxable lease charge, or an exempt royalty for use of the machine's patent?

Plain-English summary

A company that manufactures and leases a patented packaging machine asked the Commission to confirm that a "production fee" it charges lessees — calculated by the number of packages the machine produces each month, on top of a base rental fee — is an exempt royalty or other intangible property right (compensation for use of the machine's patent), rather than a taxable part of the equipment lease.

The taxpayer made an unusually detailed legal case: citing Black's Law Dictionary's definition of "royalty," several federal appellate and state court decisions distinguishing "rent" (a fixed periodic charge regardless of use) from "royalty" (a charge based entirely on actual use), and Utah's own Mark O. Haroldsen, Inc. v. State Tax Comm'n, 805 P.2d 176 (Utah 1990), for the "essence of the sale" test used to distinguish taxable tangible property from exempt intangible property. The taxpayer argued its lease cleanly separated a taxable base rental fee (for the tangible machine) from a nontaxable production fee (for use of the intangible patent).

The Commission rejected this and held the production fee taxable. Adopting the Auditing Division's staff recommendation, the Commission characterized the production fee simply as "an additional charge for use of the equipment to compensate the lessor for wear and tear as a result of varying production levels" — i.e., part of the lease of the tangible machine itself, fully subject to Utah sales and use tax under § 59-12-103(1)(k). The Commission's written response did not directly engage with the taxpayer's royalty/intangible-property case law analysis; it simply recharacterized the fee's economic substance (wear-and-tear compensation tied to equipment use) rather than accepting the taxpayer's patent-royalty framing.

What this means for you

Equipment lessors with per-unit or usage-based lease charges

Structuring a usage-based charge as a separate "production fee," "royalty," or similar label doesn't automatically make it an exempt intangible charge in Utah — the Commission will look at what the fee is actually compensating (equipment wear-and-tear from use) rather than the label the parties give it. A charge tied to how much a leased machine is used is likely to be treated as part of the taxable equipment lease.

Businesses licensing patents alongside leased equipment

If you genuinely want a portion of your charges treated as an intangible patent royalty rather than taxable equipment lease payments, be aware the mere existence of separately stated fees and sophisticated legal argument didn't succeed here — the Commission focused on the fee's underlying economic function, not its label or legal categorization under general royalty case law.

Accountants and tax professionals

This ruling is a useful illustration that the "essence of the sale"/true-object test discussed in Haroldsen can cut against a taxpayer even when supported by substantial legal authority on the general rent-vs-royalty distinction — the Commission's actual reasoning here was brief and fact-focused rather than engaging the cited case law point by point.

Common questions

Q: If I charge a per-unit fee tied to how much a leased machine produces, is that automatically an exempt royalty?
A: Not under this ruling. The Commission treated a similar per-unit "production fee" as taxable equipment-lease compensation, not an exempt royalty, based on what it actually compensated for (wear and tear from use).

Q: Does it matter that the fee was tied to a patent on the machine?
A: The taxpayer argued yes, citing extensive royalty case law — but the Commission's response didn't adopt that framing, instead characterizing the fee as compensation for the equipment's use.

Q: Can I rely on this ruling for my own equipment lease structure?
A: A private letter ruling binds the Commission only for the taxpayer and facts it addresses. Confirm your own fee structure and its economic substance with a tax professional.

Citations and references

Statutes and rules:

• Utah Code Ann. § 59-12-102(13)(a), (b) (tangible personal property definition)
• Utah Code Ann. § 59-12-103(1)(k) (tax on leases of tangible personal property)
• Utah Const. art. XIII, § 2(1)
• Utah Admin. Rule R865-19-26S (tangible property)

Case law cited by the taxpayer (not directly adopted in the Commission's brief response):

• Mark O. Haroldsen, Inc. v. State Tax Comm'n, 805 P.2d 176 (Utah 1990)
• Bullock v. Statistical Tabulating Corp., 549 S.W.2d 166 (Tex. 1977)
• Campbell v. Great Nat'l Life Ins. Co., 219 F.2d 693 (5th Cir. 1955)
• Commissioner of Internal Revenue v. Clarion Oil Co., 148 F.2d 671 (D.C. Cir. 1945)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original PDF: https://files.tax.utah.gov/tax/commission/ruling/93-014.htm

Original ruling text

Response August 20,
1993

Request

Joe B. Pacheco,
Commissioner

Utah State Tax
Commission

160 East Third South

Salt Lake City, UT
84134

Re: Request For Advisory Opinion

Dear Mr. Pacheco,

XXXXX is a company
which manufactures and leases, among other things, a packaging machine. This machine is patented. XXXXX's lease agreement requires the lessee
to pay all sales and use taxes, a base rental fee, and a �production� fee for
use of the patent. This production fee
is based on the number of packages the machine produces each calendar month. In
an earlier letter, the Tax Commission stated that �[w]hen the rental or lease
of tangible person property is subject to tax, the 'amount paid or charged is
taxable whether based on hours, units' produced, a combination of the two or
some other basis.� Att. 5A. However, XXXXX seeks an advisory opinion
that the production fee qualifies as a �royalty� or other intangible property
and therefore is exempt from Utah sales and use tax.

The production fee seems
to fit the classic definition of a royalty, which is �compensation for use of
property . . . expressed as a percentage or receipts from the property or as an
account per unit sold.� Black's Law
Dictionary 1330 (6th ed. 1990) (att. 4H).
Most cases define royalty either as the share of the product or profit
reserved by the owner for permitting another to use the property, see
Commissioner of Internal Revenue v. Clarion Oil Co., 148 F.2d 671, 673 (D.C.
Cir. 1945) (att. 2E); In re Tidy House Products Co., 79 F. Supp. 674, 677 (S.D.
Iowa 1948) (att. 2A), or as a tax or duty paid to the owner of a patent for the
privilege of manufacturing or using the patented article. Velsicol Chemical Co. v. Hooker Chemical
Corp., 230 F. Supp. 998, 1007 (N.D. Ill. 1964) (att. 2D); Hubenthal v. Kennedy,
39 N.W. 694, 695 (Iowa 1888) (att 2B).

The difference between
�rent� and a royalty is explained in Campbell v. Great Nat'l Life Ins. Co., 219
F.2d 693 (5th Cir. 1955) (att. 2C), which states that �rent� is compensation for
the right to use property which is certain in amount and payable periodically
over a fixed period regardless of the extent of use of the property, while a
�royalty� is compensation for the use of property which is based entirely on
the amount of actual use made of the property.
See also Bettis Rubber Co. v. Kleaver, 233 P.2d. 82 (Cal. Dist. Ct. App.
1951) (att. 2J).

Given these
authorities, it seems clear that the production fee charged by XXXXX is a
royalty.

Even if in your
opinion the production fee is not specifically a �royalty,� the fee still seems
to fit the definition of �intangible property.� Although �royalties� or �production fees� are not specifically
mentioned in the Utah Tax Code, these charges do not fit into the definition of
�tangible property� contained in Tax Commission Rule R865-19-26S and Utah Tax
Code � 59-12-102(13)(a) & (b).
These sections of the Code describe �tangible property� as �corporeal
things and substances� intangibles, on the other hand, are securities, bonds,
bank accounts, currency, etc. Id.; see
also 68 Am. Jur. 2d Sales and Use Taxes � 71 (att. 3A). Black's Law Dictionary defines �intangibles�
as �property that is a right such as a patent, copyright, trademark, etc. . . .
� (att 4F). While the machine itself is
tangible property, use of the patent is not.

The test for
determining whether something is intangible or tangible seems to focus on what
is the object or essence of the sale.
In Bullock v. Statistical Tabulating Corp., 549 S.W. 2d 166 (Tex. 1977)
(att. 2L), the Supreme Court of Texas stated that [t]he basic question here is
what is being sold?� Id. at 168. �If
the object or the essence of the sale is not tangible personal property but
intangible property than the transaction is not taxable under any definition of
'sale.' Id. see, e.g., Mark O.
Haroldsen, Inc. v. State Tax Comm'n.
805 P.2d 176 (Utah 1990) (att. 2K); 91 A.L.R. 3d 282 (att. 3E).

In Haroldsen, the
court held that the actual thing bargained for was printed mailing lists, not
the service which provided them.
Haroldsen, 805 P.2d at 181-82 (att. 2K). However, in Bullock, the court held that the object of the
bargain was not the printed information, but �intangible property�; i.e., the
�purchase of coded or processed data� (italics omitted). Bullock, 549 S.W. 2d
at 168 (att. 2L,).

Under this test, the
fee for use of the patent is a sale or lease of an �intangible,� and therefore
not taxable as a sale of tangible property.

The fine line that the
courts had to walk in the above cases is not a source of controversy in this
case. XXXXX's lease contains both a fee
for tangible property (the base rental fee for the machine) and a fee for
intangible property (the production fee for use of the patent). These two fees easily separate the charge
for tangible property, which is taxable, and the fee for intangible property,
which is not.

Because the production
fee is in fact a royalty or other intangible, we feel that it is not subject to
Utah sales and use tax, for the Tax Code is only applicable to sales and leases
of tangible property. Utah Const. att.
XIII 2(1) (att. 1C); Utah Tax Code �
59-12-103(1)(k) (att. 1A).

We would appreciate an
advisory opinion on behalf of XXXXX confirming our view on this matter.

Sincerely,

XXXXX

TO: XXXXX, Director

FROM: XXXXX, Secretary

DATE: XXXXX

SUBJECT: Request for Advisory Opinion - No. 93-014DJ

Attached is a request
for an advisory opinion from XXXXX for XXXXX.
Will you please review the request of XXXXX regarding the application of
a production fee on a packaging machine.

Please prepare the
response for signature by the Commission as per the guidelines established by
them.

Thank you.

XXXXX

Re: Advisory Opinion - Sales Tax Applicability
to �Production Fees� Associated with the Lease of a Packaging Machine

Dear XXXXX:

Your request (copy attached) for an advisory opinion as to
whether sales or use tax applies to a �production fee� associated with a
packaging machine lease was referred to the Auditing Division for their
analysis.

The division's staff
recommendation is as follows:

1. The production fee is an additional charge
   for use of the equipment to compensate the lessor for wear and tear as a result
   of varying production levels. The fee
   is part of the lease and subject to the tax.

For The Commission,

Alice Shearer

Commissioner