Are industrial-design and mechanical-engineering design fees subject to Kansas sales tax when an agency also delivers proofs, prototypes, or finished products?

Plain-English summary

An advertising and design agency planned to add industrial-design and mechanical-engineering design services. The Department treated those services like graphic design and advertising creative work.

The creative design charge was not taxable because Kansas did not list those design services as taxable services. Delivering a proof of concept — such as a design drawing, prototype, or computer medium containing the concept — did not turn the service into a taxable sale.

The result changed when the agency sold finished tangible property for the customer's use, whether it fabricated the property itself or hired someone else. Examples included imprinted T-shirts, displays, exhibits, billboard advertisements, and outdoor signs. In those transactions:

• the finished product was taxable; and
• the design fee stayed nontaxable only if it was separately billed or separately stated as a distinct line item.

If design and finished property were combined into one lump-sum charge, the whole amount was taxable. The Department recommended separate invoices for creative services and the taxable product.

An agency making taxable product sales had to register as a retailer and could buy incorporated materials under resale or ingredient-and-component-part treatment. For its nontaxable service business, it remained the consumer and paid sales or use tax on what it purchased. Installation or repair of a designed product could create separate taxable-service consequences.

What this means for you

Industrial and engineering design firms

Separately state the design service whenever you also sell a finished product. Keep proof-of-concept deliverables distinct from products intended for the customer's operational or display use.

Advertising and creative agencies

A logo-design fee can be nontaxable while imprinted merchandise using the logo is taxable. A single bundled price risks tax on the whole invoice.

Fabricators and multidisciplinary firms

Register as a retailer if you sell displays, signs, prototypes intended as usable finished goods, or other tangible products. Pay tax on service inputs, but use resale or component documentation for materials incorporated into taxable retail products.

Common questions

Q: Are industrial-design and mechanical-engineering design services taxable?
A: No under this opinion, because they were not enumerated taxable services.

Q: Is a proof drawing or prototype taxable?
A: Not when it is the proof of concept delivered as part of the design service rather than a finished product sold for customer use.

Q: What if the agency also sells the finished item?
A: The item is taxable, and the design charge must be separately stated to remain outside the product's tax base.

Q: What happens with one lump-sum charge?
A: The entire amount is taxable when it combines design services with tangible property sold to the customer.

Q: Are installation and repair services covered by the design exemption?
A: Not automatically. The Department warned they may have their own sales-tax consequences.

Citations and references

• Kansas retailers' sales tax act — design services were not enumerated as taxable services in the letter
• Resale and ingredient-or-component-part treatment — available for materials incorporated into tangible products the agency sells at retail, as described in the letter

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: O-2009-004

Original ruling text

Opinion Letter

Body:

Office of Policy & Research

March 10, 2009

XXXX
XXXX
XXXX

RE: Your letter dated March 3, 2009

Dear XXXX:

Thank you for your recent letter. You work for an advertising and design agency that intends to begin offering industrial design and mechanical engineering design services. Your company's website lists the services your company currently provides:

What we do.

Marketing

Brand development
Strategic planning
Applied research
Creative consultation

Graphic Design

Brand identity
Logo design and development
Print promotion
Sales collateral
Internal communications

Advertising

Market research
Direct marketing
Creative concepts
Media planning and buying
Print, broadcast, and internet campaigns
Database integration
Displays and exhibits
Promotional packaging
Billboard and outdoor signage
Photography and video coordination
Public relations management

Rich Media

Website design and development
Multi-media presentations
HTML email
Corporate videos

You ask how Kansas sales tax will apply to your company's charges for industrial design and mechanical engineering design services. Charges for these services are taxed in much the same way as charges for graphic design and advertising services.

As a general rule, an advertising agency's or graphic designer's charges to a customer for creative services and the resulting proof of concept, which typically is delivered to the customer as tangible personal property, are not subject to Kansas sales tax. These charges are for creative concept development services, which are not enumerated, taxable services under the sales tax act. However, to be exempt, these charges must be separately stated when a customer is billed for employee-fabricated property, or for property that is fabricated by a third-party and billed to the customer by the advertising agency or graphic designer.

For example, an advertising agency's or graphic designer's charge to a customer for designing a logo is not subject to Kansas sales tax. However, when an advertising agency or graphic designer imprints the logo on T-shirts for a customer, the charge to the customer for the T-shirts is taxable. If the charge for the creative concept development services to create the logo is not separately billed or separately stated on the customer's invoice for the T-shirts, the lump-sum charge for the T-shirts and design services is taxable. When this type of transaction is undertaken, the department recommends that the advertising agency or graphic designer issue one invoice for the nontaxable creative concept development services, and a second invoice for the customer's taxable purchase of the imprinted T-shirts or other tangible personal property.

Similarly, if the same underlying transaction occurs except that a third party imprints the logo on T-shirts and the advertising agency or graphic designer then charges the customer for the T-shirts, sales tax should be charged on the total amount that is billed to the customer unless the creative concept development services are separately billed or separately stated on the customer's invoice for the T-shirts. If an advertising agency or graphic designer provides creative concept development services and sells tangible personal property that it fabricates or another company fabricates for it, it should register with the department as a retailer for purposes of collecting sales tax on its sales of the tangible personal property.

From your web-site's "What we do" section, your business appears be making taxable retail sales whenever it custom designs and fabricates (or pays to have fabricated) displays, exhibits, billboard advertisement, or outdoor signage for a customer's use. The sale of a single finished display, exhibit, billboard advertisement, or outdoor sign is taxable if it is fabricated with the understanding that the customer will use the finished product. As discussed above, the total amount billed to the customer is subject to sales tax unless the charge for the creative concept development services are separately billed to the customer or are separately stated on the customer's invoice for the taxable display, exhibit, billboard advertisement, or outdoor sign

This same sales-tax treatment applies to your company when it provides industrial design and mechanical engineering design services. Your company's charges for the design services are not subject to sales tax. This is because the Kansas retailers' sales tax act does not list design services as services that are subject to sales tax. Similarly, an industrial design and mechanical engineering design service is not required to collect sales tax when it provides property to a customer as a proof of concept for the design services.

A charge for industrial design and mechanical engineering design services is taxed when the charge is lumped together with a charge for tangible personal property that is based on the design services and sold to the customer for its use. As with advertising agencies or graphic designers, taxable sales do not include transferring a proof-of-concept design drawing, prototype, computer medium containing the concept, or similar item to a customer that is paying for design services.

When your business charges a customer for industrial design and mechanical engineering design services, the company should avoid installing the finished product for either the customer or for another end user. Assisting with installation or repair of something that you designed could have sales tax consequences if the installation or repair services are taxable. As with advertising and graphic design services, your charges for industrial design and mechanical engineering design services should be billed separately from or as a separate non-taxable, line-item charge whenever any property is sold to a customer for its use.

Since your company is providing non-taxable services, everything it buys is subject to sales or use tax. The only exception to this would be if you produce or fabricate something for a customer that you sell to them at retail. These things could include advertising goods, a single finished display, an exhibit, a billboard advertisement, or an outdoor sign. If you are engaged in making taxable retail sales, you should register as a retailer with the department. The materials that go into the items being sold can then be purchases tax exempt as a sale for resale or as an ingredient or component part of the item being sold.

If you have any questions about the taxability of your services, please call me at 785-296-3081.

Sincerely,

Thomas E. Hatten
Attorney/Policy & Research

Date Composed: 03/12/2009 Date Modified: 03/12/2009

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