If my engineering firm designs products for clients and delivers drawings, prototypes, and CAD data, which parts of my charges and which of my own material purchases are subject to New York sales tax?

Plain-English summary

An engineering design firm takes a client's product concept through phases — research, concept sketches, preliminary engineering, prototypes, and finally manufacturing-ready CAD data — and asked how New York sales tax applies to its charges for this work and to its own purchases of prototype materials. The Department split the answer into two questions.

On the firm's charges to clients: design and engineering services aren't on New York's list of taxable services, so the firm's product-development charges are generally not taxable — as long as they aren't bundled, without a separate charge, into something that IS taxable. The final CAD data the firm hands over electronically is just a blueprint for manufacturing, not taxable "information" or software, so transferring it doesn't trigger tax by itself (even custom CAD data that happened to be software would be custom software, not taxable prewritten software, unless the firm modifies existing prewritten programs). Physical prototypes delivered along with the service stay untaxed too — unless the firm separately sells and charges for the prototype itself, in which case that specific charge becomes a taxable sale of tangible personal property.

On the firm's own material purchases: if the firm isn't separately selling prototypes, it can't buy prototype materials tax-free "for resale," and those purchases are generally taxable — unless they qualify for the research and development exemption. That exemption only reaches materials used in genuine experimental/laboratory-sense R&D: here, the functional ("breadboard") and final prototypes, which are built and tested to verify the product actually works and meets design/function requirements, qualify. But the earlier concept/form-study prototypes (which just show what the product will look like, without testing function) and sketches, drawings, renderings, and presentation boards don't qualify — those are analogous to an architect's non-functional models, and their purchase remains taxable.

What this means for you

Engineering, industrial design, and product development firms

Your service fees generally escape sales tax as long as you don't bundle in a taxable item without separately charging for it. Watch two triggers specifically: (1) separately selling a physical prototype to the client (that specific charge becomes taxable), and (2) delivering CAD data that turns out to be built from prewritten (not custom) software components — that portion could be taxable regardless of how it's transmitted.

R&D-heavy manufacturers claiming the research and development exemption

Not every prototype qualifies. The line is functional testing versus appearance: a prototype used to validate that a design actually works (mechanically, electrically, structurally) is exempt R&D material; a prototype, model, sketch, or rendering used only to show what something will look like is not, even if it's an essential step in the same overall product-development process.

Accountants and tax professionals

This opinion is a granular application of the Tax Law §1115(a)(10) R&D exemption and the custom-vs-prewritten software distinction under §1101(b)(14) to a multi-phase engineering workflow — useful as a checklist for classifying each deliverable (drawings, CAD data, concept prototype, functional prototype, final prototype) separately rather than treating the whole engagement as one undifferentiated service.

Common questions

Q: We deliver CAD files electronically as the final output of our design work — is that taxable?
A: Generally no. CAD data functioning as a manufacturing blueprint isn't taxable software or information, even delivered over the Internet. It could become taxable only if it actually constitutes prewritten (not custom-developed) computer software.

Q: We build physical prototypes as part of our process but don't sell them separately — do we owe tax on our own prototype material purchases?
A: Only if those specific prototypes qualify for an exemption. Materials for functional/testing prototypes can qualify for the research and development exemption; materials for purely cosmetic concept models, sketches, or renderings generally don't and remain taxable purchases for you.

Q: What if we do sell a prototype to the client as a separate line item?
A: Then that charge is a taxable sale of tangible personal property, and — unlike when prototypes are just part of an untaxed service — you can then buy the prototype materials tax-free for resale.

Q: Does the research and development exemption cover concept sketches and 3D renderings used early in the design process?
A: No, per this opinion — those are used to convey a conceptual look, not to test functional performance, so they don't meet the experimental/laboratory-sense R&D standard.

Q: Does this ruling apply to any product-development firm's engagement?
A: Not automatically. An advisory opinion binds the Department only as to the taxpayer who requested it and only on the facts described; a firm's specific deliverables and billing structure need to be checked against the same phase-by-phase framework.

Citations and references

Statutes and regulations:

• Tax Law §1105(a) (sales tax on tangible personal property)
• Tax Law §1101(b)(4)(i) (resale exclusion)
• Tax Law §1101(b)(6), (14) (prewritten software; custom software)
• Tax Law §1115(a)(10) (research and development exemption)
• Tax Law §1115(a)(12) (production exemption)
• 20 NYCRR §526.6(c)(7); §528.11(c)(2)

Cited opinions and cases:

• ECVS, Inc., TSB-A-93(66)S
• Spiritual Compass, LLC, TSB-A-07(16)S; Debra Horn Stachura, TSB-A-04(26)S
• Dresser-Rand Company, TSB-A-97(5)S
• Matter of Protocom Devices, TSB-A-88(4)S
• Matter of Sybron Corp, TSB-A-85(17)S
• Matter of Lenon Sokolowski Models, TSB-D-92(70)S
• Awad Architectural Models, Inc., TSB-A-86(9)S

Source

• Landing page: NY Sales Tax Advisory Opinions, 2009
• Original opinion: TSB-A-09(21)S

Original ruling text

New York State Department of Taxation and Finance

TSB-A-09(21)S
Sales Tax
May 22, 2009

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S090114A

Petitioner name and address redacted asks whether the receipts from its sale of product development
services and related items and its purchases of property and materials used in the performance of such
services are subject to sales and use taxes.
We conclude that (1) Petitioner’s sales of product development services are not enumerated taxable
services, or taxable sales of tangible personal property, under Tax Law §1105, unless Petitioner makes taxable
sales of product prototypes or software; and (2) some of Petitioner’s purchases of tangible personal property
may qualify for the exemption from sales and use taxes for property used or consumed in research and
development pursuant to Tax Law section 1115(a)(10) if used directly and predominantly in such activities.
Facts
Petitioner is an engineering design firm that provides product development services to unrelated
businesses that are attempting to develop new products or improve upon existing products. Businesses
approach Petitioner with a concept for a new or enhanced product. Petitioner performs the product
development tasks necessary to bring the concept to reality. These tasks may involve numerous revisions and
refinements.
This process may include the following phases:
Research and Product Definition - Petitioner works with its customer to define the new product’s
purpose and function, providing a critical analysis of the customer’s goals and requirements. This
may result in the creation of a product specification detailing a general description of the new
product.
Concept Development – Petitioner will generate possible solutions to the design challenges and
requirements. Sketches, simple engineering drawings, and presentation boards of the new product
may be created.
Preliminary Design and Engineering – Petitioner and its customer identify the most promising ideas
from concept development. Product rendering may be produced and provided to the customer. The
critical mechanical function elements are identified and preliminary mechanical engineering will be
performed. Additional drawings, renderings, and first-draft computer aided design (CAD) data may
be created and transferred to the customer.
Concept Prototype – A form study prototype designed to show the physical dimensions of the product
and approximating the size, shape and look of the finished product is created. Once there is agreement
upon the look of the final product, Petitioner begins the task of making the product functional.
Detailed Engineering - The agreed upon style and functional requirements are engineered and
integrated, typically resulting in updated CAD data.

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Functional Prototype – A functional (“breadboard”) prototype is made using the CAD data. This
permits validation of functional aspects of the computer aided design and allows the customer to
evaluate whether the product will function in accordance with the original concepts. This prototype
merely demonstrates the functional capabilities of the new design, and is fabricated using components
and materials appropriate for the prototype but not necessarily suitable for the final product. This
prototype is not intended to reflect the look of the final product.
Final Engineering – Engineering revisions based on the fabrication and evaluation of the functional
prototype are applied to the mechanical design and the CAD data are updated. Inspection drawings
and 3-dimensional CAD models may be provided to the customer.
Visual and Functional Prototype – Using the CAD data, a final prototype is built. This prototype is a
cosmetically finished, functional prototype suitable for testing and evaluation by the customer to
ensure the final product meets design, function, and concept requirements.
Manufacturing Release – Final engineering revisions based on the evaluation of the final prototype
are incorporated into the CAD data. Customers are provided with tooling-ready two-dimensional and
three-dimensional CAD data necessary for manufacturing the new product.
Petitioner typically creates a prototype’s simple components in-house. More complex prototype
components are purchased from third party fabricators, who use Petitioner’s CAD data to create the
components. Petitioner passes its costs for the creation of the prototypes on to the customer.
In connection with the performance of its services, Petitioner may transfer to the customer some or all
of the following property: (1) conceptual and engineering drawings; (2) an intermediate prototype that looks
like the new product; (3) a functional intermediate or “breadboard” prototype that works like the new
product; (4) a final prototype that closely resembles the new product in appearance and function; and (5)
computer aided design data (CAD data) for the completed project. The CAD data allows the customer to
begin manufacturing the new product and is essentially the mechanical blueprint for creating the finished
product. The CAD data are transferred to the customer electronically via the Internet. Not all customers
receive tangible personal property such as the prototypes. Some customers receive only the CAD data for the
completed project. Petitioner does not separate charges for product development service from charges for the
property created and transferred to the customer. Petitioner may, however, list separate charges for the
various phases of the work it performs for a customer.
Analysis
Petitioner asks (1) whether its charges to customers for product development and related items are
subject to sales tax; and (2) whether its purchases of tangible personal property for its use in product
development are subject to tax.
Issue 1 – Petitioner’s charges for product development and related items
Sales tax is imposed on the sale of all tangible personal property, unless otherwise exempted (See Tax
Law §1105(a) and §1115), and on the sale of certain specifically enumerated services in Tax Law Section
1105. Design and engineering services are not among the enumerated services subject to sales tax. However,
if such services were provided to a customer in conjunction with taxable services or tangible personal
property, and were not offered for sale separately from the taxable services or property, the entire charge to
the customer would be taxable. See ECVS, Inc., Adv Op Comm T & F, December 27, 1993, TSB-A-93(66)S.

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Sales Tax
May 22, 2009

Petitioner’s product development services, which may include the Manufacturing Release phase and
each of the preliminary phases of its product development services described in this Opinion, whether
performed with respect to the creation of a new product or the improvement of an existing product, are not
among the enumerated services subject to sales tax pursuant to section 1105 of the Tax Law. Thus, unless
these services were provided to a customer in conjunction with taxable services or tangible personal property,
and were not offered for sale separately from taxable services or property sold by Petitioner, Petitioner's
charges to its customers for product development services are not subject to sales tax.
Petitioner’s product development service as ultimately sold to a customer generally includes CAD
data that are furnished to the customer for use in manufacturing the customer’s product. If the CAD data
constitute a taxable service or tangible personal property, Petitioner's charges for its product development
service would be subject to sales tax.
The provision of the CAD data to customers does not constitute an information service subject to
sales tax under Tax Law §1105(c)(1). Petitioner is paid for performing the service of product development
rather than for furnishing information to its customer. However, even if these data were considered an
information service, the service would be excluded from tax unless the information is not personal or
individual in nature or is or may be substantially incorporated into reports furnished to others.
Likewise, the CAD data in and of itself do not appear to be software. Rather, they appear to be a
blueprint for the manufacture of the product, which is not subject to sales tax if furnished to a customer
electronically via the Internet. See Spiritual Compass, LLC, Adv Op Comm T & F, June 22, 2007, TSB-A07(16)S; Debra Horn Stachura, Adv Op Comm T&F, November 22, 2004, TSB-A-04(26)S.
Even if the CAD data did constitute software, they would not be subject to tax if they were designed
and developed by Petitioner to the specifications of a specific purchaser. In that case, the CAD data would be
custom software, not prewritten software. See Tax Law §1101(b)(14). However, any portion of the CAD data
that constituted prewritten computer software would be tangible personal property subject to tax under Tax
Law §1105(a). See Tax Law §1101(b)(6). Sales by Petitioner of prewritten software to a customer would
qualify for exemption under Tax Law §1115(a)(12) if the software was for use directly and predominantly in
the production of tangible personal property for sale (e.g. if the software (CAD data) was used to operate the
customer's machinery that produces the customer’s product for sale). See Dresser-Rand Company, Adv Op
Comm T & F, February 6, 1997, TSB-A-97(5)S.
Thus, Petitioner’s receipts from sales of its product development services are not subject to the sales
taxes imposed by Tax Law §1105, unless the CAD data resulting from these services constitute prewritten
software that is not otherwise exempt. If the CAD data are prewritten software, then reasonable, separately
stated charges for custom modifications or enhancements to the software would not be taxable. See Tax Law,
§1101(b)(14).
Petitioner’s transfers of a prototype to its customer in conjunction with Petitioner's design services
would not be subject to sales tax, provided that Petitioner does not separately contract for or charge for the
sale of the prototypes to the customer. If prototypes are not separately sold by Petitioner to its customers,
Petitioner’s costs in creating the prototypes are part of its expense in performing the product development
services and preparing the final CAD data. However, if Petitioner separately sold prototypes that are
delivered to customers in New York, the charges for the prototypes, unless otherwise exempt as described
below, would be subject to sales tax. In that case, Petitioner’s product development services might constitute
an expense item that is part of the cost of production of the prototype being sold and included in the receipt
subject to tax.

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Issue (2) – Petitioner’s purchases of tangible personal property
If Petitioner is otherwise engaged in sales of tangible personal property, i.e., if Petitioner separately
charges or contracts for the sale of a prototype to a customer, then Petitioner would be eligible to purchase the
prototype, or component materials for making the prototype, for resale. The resale exemption will apply only
if the prototype or materials are purchased exclusively for resale and not otherwise used by Petitioner. See
Tax Law §1101(b)(4)(i). However, Petitioner’s purchases of prototypes, or of materials for making the
prototypes, or of other property that is not separately sold to the customer but is transferred to the customer in
the performance of a nontaxable service, do not qualify as purchases for resale as such or as a component part
of a taxable service. See Tax Law §1101(b)(4)(i); 20 NYCRR 526.6(c)(7). Accordingly, unless otherwise
exempt, these purchases by Petitioner of prototypes or other tangible personal property are retail purchases
subject to tax under Tax Law §1105(a).
The Tax Law provides an exemption for tangible personal property used directly and predominantly
in research and development in the experimental or laboratory sense. This research and development
exemption does not encompass the activities of ordinary testing or inspection of materials or products for
quality control or the performance of efficiency surveys, management studies, consumer surveys, advertising,
promotions or research in connection with literary, historical or similar projects. (See Tax Law §1115(a)(10)).
The testing of manufactured products intended for sale is not research and development in an
experimental or laboratory sense. But testing models of a new product for quality and performance standards
before manufacturing the new product is an experimental function qualifying as use in research and
development. (Matter of Protocom Devices, Adv Op Comm T & F, December 3, 1987 TSB-A-88(4)S.) The
use of a computer to design or redesign a new product’s appearance for cosmetic purposes does not qualify as
exempt research and development. But the use of a computer to test a new product's ability to meet function
and reliability standards before manufacture does qualify as exempt research and development. (Matter of
Sybron Corp, Adv Op STC, June 12, 1985, TSB-A-85(17)S) Thus, the intermediate functional “breadboard”
prototypes and the final prototypes that are used by Petitioner and its customers to test the new product’s
functional capabilities and to determine whether the product can meet design, function, and concept
requirements, are used and consumed in research and development for the purposes of Tax Law §1115(a)(10).
Accordingly, Petitioner's purchases or use of these prototypes, or of the component parts or other materials of
these prototypes, would be exempt from sales and use tax under Tax Law §1115(a)(10), provided that the
prototypes or the components or materials are used predominantly (more than 50% use) in research and
development. See 20 NYCRR 528.11(c)(2).
The intermediate “form study” prototype used by Petitioner and its customers appears analogous to
the architectural models used by architects. (See Matter of Lenon Sokolowski Models, TAT, decision dated
Oct 1, 1992, DTA no. 807478,807479 AND 807481 TSB-D-92(70)s; Awad Architectural Models, Inc., Adv
Op STC, February 14, 1986, TSB-A-86(9)S.) These prototypes provide the customer with a conceptual
image of the product but are not used to test the functionality of the product. Thus, Petitioner’s purchases or
use of such prototypes, or of the component parts or materials of these prototypes, does not qualify for the
exemption from sales tax for property used and consumed in research and development in the experimental or
scientific sense. Likewise, sketches, drawings, presentation boards, and renderings used by Petitioner and its
customers in the Research and Product Definition, Concept Development, and Preliminary Design and
Engineering phases are not used or consumed in research and development in determining the functionality of
the new product. Thus, purchases and use of these items do not qualify for the research and development
exemption under Tax Law §1115(a)(10). Additionally, these prototypes, sketches, drawings, presentation
boards, and renderings are not used directly in the production of tangible personal property for sale by
Petitioner or its customers. Accordingly, these items are not exempt from sales tax under Tax Law
§1115(a)(12). As previously noted, such property is not purchased by Petitioner for resale pursuant to Tax

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Sales Tax
May 22, 2009

Law §1101(b)(4)(i). Thus, Petitioner's purchases of these items are subject to sales or use tax under Tax Law
§1105(a) and §1110.

DATED: May 22, 2009

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to the
facts set forth therein and is binding on the Department only with respect to the
person or entity to whom it is issued and only if the person or entity fully and
accurately describes all relevant facts. An Advisory Opinion is based on the law,
regulations, and Department policies in effect as of the date the Opinion is issued or
for the specific time period at issue in the Opinion.