Is a manufacturer's computer system exempt from New York sales tax under the production-machinery exemption when it is used mostly to track and route product through the plant?

Plain-English summary

Spence Engineering Co. manufactures automatic temperature and pressure regulating valves for sale. It bought a computer system and estimated that about 60% of its use would go to "routing" product through manufacturing — factory workers using computer stations to record the start and finish of each operation, with the system producing shortage reports and recording rejections so the company could adjust the production flow. The other 40% would handle inventory control, order entry, and accounting.

The Department held the computer is taxable because it isn't used "directly" in production.

• The production exemption has two requirements. Section § 1115(a)(12) exempts machinery or equipment used directly and predominantly in producing tangible personal property for sale. Both prongs must be met.
• "Predominantly" is a 50%-plus test. Under 20 NYCRR 528.13(c)(4), equipment is used predominantly in production if over 50% of its use is directly in the production phase. Spence's 60% estimate went to that prong.
• But "directly" is a separate, stricter test. Under § 528.13(c)(1), machinery is used "directly" only if, during the production phase, it acts on or changes the material, has an active causal relationship in making the product, handles/stores/conveys the materials or product, or packages the product for commerce. And § 528.13(c)(2) says usage "collateral to the actual production process" is not direct use.
• Recording operations is collateral. The Department found that recording the start and finish of each operation is collateral to production and has no active causal relationship in making the valves. It monitors production; it doesn't perform it.
• Result: because the computer is not used "directly" in production, it fails § 1115(a)(12) and its purchase is subject to State and local sales tax — even though a majority of its use was production-related.

What this means for you

"Directly" and "predominantly" are two different hurdles — you must clear both. A common mistake is to count up how much of a machine's use touches production (the "predominantly" prong) and assume that wins the exemption. It doesn't. The machine must also act on the product itself or have an active causal role in making it (the "directly" prong).

Monitoring, tracking, and reporting are collateral. Equipment that records, schedules, or reports on production — rather than acting on the material — is treated as used in an activity collateral to production, and doesn't qualify for the exemption. That's true even if the same computer is essential to running the plant efficiently.

Percentages don't rescue a collateral use. Spence's 60% production figure didn't matter once the use was classified as collateral, because collateral use isn't "direct" use at all. Before assuming a computer, sensor, or control system qualifies, ask whether it physically acts on the goods or merely tracks them.

Common questions

Q: 60% of the computer's use was production-related — isn't that "predominantly in production"?
A: The 60% goes to the "predominantly" prong, but the exemption also requires the equipment be used "directly" in production. Recording operations is a collateral activity, so it isn't "direct" use, and the exemption fails regardless of the percentage.

Q: What kind of computer use would qualify?
A: Use that has an active causal relationship in making the product — for example, a computer that actually controls machinery acting on the material, or that handles, conveys, or packages the product. Simply logging when steps start and finish does not.

Q: The accounting use is obviously taxable — but does mixing it in matter?
A: The result here didn't turn on the 40% accounting use. Even the 60% "routing" use was collateral, so the whole system was taxable.

Citations and references

Statutes and regulations:

• Tax Law § 1105(a) — tax on receipts from every retail sale of tangible personal property
• Tax Law § 1115(a)(12) — exemption for machinery/equipment used directly and predominantly in production for sale
• 20 NYCRR 528.13(c)(1) — definition of "directly"
• 20 NYCRR 528.13(c)(2) — activities collateral to production are not "direct" use
• 20 NYCRR 528.13(c)(4) — "predominantly" means over 50% of use directly in the production phase

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1981.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a81_51s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-81(51)S
Sales Tax
November 17, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S810210A

On February 10, 1981 a Petition for Advisory Opinion was received from Spence
Engineering Co., Inc., 150 Coldenham Road, Walden, New York 12586.
The issue raised is whether Petitioner's purchase of computer system for use in billing,
accounts payable, control of inventory and production is subject to State or local sales taxes.
Petitioner is engaged in manufacturing automatic temperature and pressure regulating valves
for sale. Petitioner estimates that 60% of the computer use will be for the routing of Petitioner's
product through the various stages of manufacturing. To accomplish this, Petitioner's manufacturing
employees will use various computer stations to record the start and finish of each operation
performed on the product. This will expedite the routing of the product through the various
production activities in each manufacturing department. The computer will produce shortage reports
and will record rejections, thus enabling Petitioner to make the necessary adjustments to the
production flow. The remaining 40% of computer use will be for inventory control, order entry,
accounts receivable, accounts payable and similar accounting functions.
Section 1105(a) of the Tax Law imposes a tax on: "The receipts from every retail sale of
tangible personal property, except as otherwise provided in this article." An exemption from such
tax is provided with respect to "Machinery or equipment for use or consumption directly and
predominantly in the production of tangible personal property, . . . for sale, by manufacturing,
processing . . ." Tax Law, § 1115(a)(12).
The Sales and Use Tax Regulations provide that "Machinery or equipment is used
predominantly in production, if over 50% of its use is directly in the production phase of a process."
20 NYCRR 528.13(c)(4). The Regulations also define "directly" to mean "the machinery or
equipment must, during the production phase of a process,
(i)

act upon or effect a change in material to form the product to be sold, or

(ii)

have an active causal relationship in the production of the product to be sold, or

(iii)

be used in the handling, storage, or conveyance of materials or the product to be sold,
or

(iv)

be used to place the product to be sold in the package in which it will enter the stream
of commerce." 20 NYCRR 528.13(c)(1).

JAMES H. TULLY., COMMISSIONER
TP-8 (4/80)

LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-81(51)S
Sales Tax
November 17, 1981

The Regulations further state that: "Usage in activities collateral to the actual production
process is not deemed to be used directly in production." 20 NYCRR 528.13(c) (2).
The recording of the start and finish of each operation performed on a product is an activity
which is collateral to the actual production process and does not have an active causal relationship
in the production of the product.
Accordingly, as the computer will not be used "directly" in Petitioner's manufacturing
process, as defined in Section 528.13(c) of the Regulations, Petitioner's purchase of the computer
system at issue will be subject to State and local sales tax.

DATED: October 29, 1981

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau