Were per-foot patent and trademark royalties taxable when tied to a contractor's purchases and use of gutter coil?

Subject

Royalties charged in connection with sale of tangible personal property to the Taxpayer

Plain-English summary

Virginia treated the gutter royalties as part of the taxable material price because they were directly and inseparably linked to gutter coil and accessories. Calling them patent and trademark license fees did not make them standalone intangible charges.

The agreement licensed the taxpayer to manufacture, market, and sell the proprietary gutter system, required it to buy coil and accessories from the manufacturer, charged royalties per linear foot of coil used, and tied weekly royalty invoices to material purchases. A discount also depended on buying all requirements from the manufacturer.

The sale was not complete until the royalty was paid, making the fee additional consideration for the coil. The contractor also could not claim resale because furnishing and installing gutters improved real property, so it was the taxable consumer of the materials.

What this means for you

• Review whether a royalty is triggered by units of tangible property bought, used, or sold.
• Separate invoicing does not separate charges that the contract makes integral to the material sale.
• Real-property contractors generally consume installed materials rather than resell them under the rule applied here.

Citations and references

• Va. Code §§ 58.1-602 and 58.1-610.
• P.D. 00-76 (May 15, 2000), P.D. 91-29 (March 11, 1991), P.D. 93-230 (December 15, 1993), and P.D. 99-7 (January 8, 1999).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-213

Original ruling text

December 20, 2007

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the "Taxpayer") in which you seek correction of the consumer use tax assessment issued for the period May 2000 through April 2006. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a real property installation contractor that furnishes and installs gutters. An audit resulted in the assessment of consumer use tax on royalty fees charged in connection with the Taxpayer's purchases of gutter coil material. The Taxpayer contests the entire assessment on the basis that the royalty fees constitute charges for intangible rights, i.e. , licenses to use registered trademarks and patents of the gutter material manufacturer as set out in a distributor agreement between the Taxpayer and the manufacturer.

DETERMINATION

To determine whether the retail sales and use tax applies to a royalty, we examined the language of the agreement for terms and conditions that would create a link to the sale of tangible personal property and determine whether there is any statutory authority for applying the tax in case such a link is established.

Distributor Agreement

The language of the distributor agreement definitely establishes a direct and integral link between the patent and trademark licenses and the sales of the gutter systems. For example, according to Section II of the distributor agreement, the Taxpayer is granted a patent license "to manufacture, use , offer to sell and sell the [a proprietary gutter] System under the patents . . .." In Section III of the agreement, the Taxpayer is granted a trademark license "to use the registered trademarks . . . and such other trademarks and/or service marks . . . on and in connection with the marketing , manufacture and sale of the System in the Territory." [Emphasis added.]

Section VI of the agreement sets out the Taxpayer's obligations. According to subsection D, the Taxpayer is required to purchase its requirements of gutter coil stock and accessories, such as end caps, straps, inside miters, outside miters and brackets (hangers), downspouts and elbows, from the manufacturer of such products.

Section VIII of the agreement explains the royalties and other payments required of the Taxpayer. In subsection A 1, the Taxpayer is required to pay the manufacturer a royalty of eighty cents per lineal foot for all coil roll-formed by the Taxpayer through the machine during the term of the agreement. In subsection A 2, the Taxpayer is given a royalty discount of forty cents per lineal foot provided the Taxpayer purchases all of its requirements of coil and accessories from the manufacturer. Subsection C further provides that the manufacturer shall invoice the Taxpayer for royalties on a weekly basis based on the Taxpayer's weekly purchases of coil and accessories.

Based on the terms and conditions of the distributor agreement, the royalty is charged only when tangible personal property ( i.e. , the coil or accessories) is sold or used by the Taxpayer. Although the royalty fee and coil and accessories may not be invoiced together, the two are integrally linked and inseparable. That is, the actual cost of the coil and accessories is not merely the price charged initially but also includes the royalty fee. As such, the royalty constitutes an incremental addition to the purchase price of the coil and accessories because the royalty must be charged whenever the coil is used or sold by the Taxpayer.

Statutory Authority

Virginia Code § 58.1-602 defines "sale" to mean, " any transfer of title or possession or both , ... lease or rental, conditional or otherwise, in any manner or by any means whatsoever , of tangible personal property and any rendition of a taxable service for a consideration . . .." [Emphasis added.] Thus, a sale occurs upon any transfer of title or possession in any manner of tangible personal property for a consideration.

The Department has traditionally held royalties paid only for an intangible right without any transfer of tangible personal property are not subject to sales and use taxation. However, pursuant to the above authority, the Department has traditionally held that royalties paid by a licensee not only for intellectual property rights but also for tangible personal property are analogous to leases of tangible personal property. See Public Document (P.D.) 00-76 (5/15/00).

In the instant case, the sale of gutter coil material is not entirely completed until the Taxpayer has been invoiced and paid a royalty. The royalty is the final consideration given for the right to use or sell the coil. Thus, the payment of the royalty is part of the taxable price paid for the coil because it completes the transaction that fits into the statutory definition of "sale."

This treatment is consistent with similar royalties addressed in public documents issued by the Department, such as P.D. 91-29 (3/11/91), 93-230 (12/15/93), and 99-7 (1/8/99). In these cases, the Department determined that a royalty fee is taxable because the royalty had been charged in connection with the sale of tangible personal property. Because the royalty fees at issue in the Taxpayer's case are directly linked to the amount of gutter materials sold, I find that the royalties are charged in connection with the sale of tangible personal property to the Taxpayer. The Taxpayer is not entitled to the resale exemption because the sale and installation of a gutter system by the Taxpayer is a real property improvement ( i.e. , a service transaction with respect to real estate). As such, the Taxpayer is ultimately liable for the tax on all of its purchases of tangible personal property pursuant to Va. Code § 58.1-610. Based on all of the foregoing, the royalty fees at issue are taxable.

CONCLUSION

Based on this determination, the assessment is correct. An updated bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

Please note that failure to remit full payment within the 30-day period may result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's recent Amnesty. See the enclosure entitled "Important Payment Information."

The Code of Virginia section and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Ruling, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1111909683R