New York Denies Manufacturing Exemption for Software

A New York Advisory Opinion has reminded sellers that just because a customer provides an exemption certificate, a seller cannot automatically accept it in good faith.

By Tina Chunn, SALT senior manager

Many states’ sales and use tax rules include broad manufacturing equipment exemptions to include items that are part of the manufacturing process but not traditionally classified as manufacturing machinery. However, each state may draw a different line in determining which purchases qualify as part of the manufacturing process and which do not.

On Nov. 13, 2015, New York issued an Advisory Opinion addressing the use of a manufacturing exemption certificate for the purchase of the taxpayer’s software by a manufacturer. [1] This Advisory Opinion concluded that the software does not qualify for the manufacturing exemption and reminds us that just because a customer provides an exemption certificate, a seller cannot automatically accept it in good faith. The “good faith” standard of care typically obligates the seller to carefully consider the property being purchased and its qualification for specific sales tax exemptions. [2]

The facts set forth in the ruling are as follows: a software company, headquartered in Ohio, develops software for manufacturers to assist with the production process. This software allows manufacturing companies to track and control production and costs through each stage of the production process. The software is customizable through the use of different modules to assist with various manufacturing and accounting requirements such as quote pricing, order processing and job scheduling. Specifically, the software coordinates different stages of manufacturing in a way that streamlines the process and allows more control over monitoring the jobs.

New York provides a manufacturing exemption for machinery and equipment used directly and predominately in the manufacture of tangible personal property. [3] Direct use is further defined to require the machinery or equipment to have a direct interaction with the property being produced. [4] Predominate use requires that more than 50 percent of its use be directly in the production phase. [5]

To determine if this exemption was applicable, New York considered whether the functions performed by the software directly interacted with the items being produced. In this case, these functions were primarily associated with the administrative process of manufacturing, rather than the production of these items. [6]

New York also considered if this software would qualify for the research and development exemption. [7] However, the research and development exemption requires that the property is used in activities related to advancing science and technology, developing new products, or improving or developing new uses for existing products. [8] The administrative functions performed by this software do not meet this requirement.

In transactions such as the one outlined in this Advisory Opinion, sellers should take a closer look at what exemptions are being claimed and if there is validity to the assertion that the property qualifies for the exemption before accepting the exemption certificate (if the state is one, like New York, that imposes a “good faith” requirement).

The SALT team at Aprio is experienced with sales tax exemptions and is available to assist you in reviewing your transactions to identify proper sales tax treatment. We constantly strive to keep our clients advised of important issues and developments in state and local taxes in order to help them address their specific tax situations. We will continue to monitor these and other significant state tax developments and include any updates in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn, SALT senior manager, at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the January 2016 SALT Newsletter. To view the newsletter, click here.

[1] TSB-A-15(44)S

[2] It is worth noting that the “good faith” requirement for accepting exemption certificates is not universal. Many states will relieve a seller of liability as long as it accepts a fully completed certificate. Therefore, it is important for sellers to know the rules for the states where they have sales/use tax obligations regarding the requirements for accepting exemption certificates.

[3] Tax Law § 1115(a)(12)

[4] 20 NYCRR § 528.13(c)

[5] 20 NYCRR § 528.13(c)(4)

[6] 20 NYCRR § 528.13(b)(1)

[7] Tax Law § 1115(a)(10)

[8] 20 NYCRR § 528.11(b)

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.

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