When a tenant installs a private telephone system, which components are nontaxable capital improvements and which parts (and the custom software) remain taxable?

Plain-English summary

Benton & Bowles, Inc., a tenant, had a contractor furnish and install a private telephone system in its leased premises and asked whether the installation is a capital improvement exempt from sales tax. The lease provides that installations built into the premises become the landlord's property and stay with the premises, except furniture, furnishings, trade fixtures, and business equipment not built in, which the tenant may remove.

The Department split the system into three parts.

• The in-wall lines are a capital improvement (not taxable). Items 7-10 — the SL-1 lines, 500/2500 lines, CO/WATS/FX trunk lines, and E&M tie & trunk lines — are installed throughout the walls and ceiling and can be removed only by demolishing the walls. Removal would cause material damage, the lease shows the parties intended them to be permanent, and they substantially add to the building's value. So they satisfy the three-part § 1101(b)(9) test, and the portion of the contractor's charge allocable to installing these lines is not subject to sales tax (§ 1105(c)(3) excludes installing a capital improvement).
• The removable units are taxable. Items 1-6, 11, and 12 — the processing unit, random-access memory, switch units, power cabinet, peripheral equipment shelf, emergency power panels, telephone sets, and attendant consoles — are not installed so that removal causes material damage, and do not otherwise become part of the realty (citing the Beaman Corp. Advisory Opinion of Aug. 19, 1982). They are not capital improvements, so their purchase and installation are taxable.
• The custom software is exempt. The custom software (item 13), created to Benton & Bowles's instructions and delivered on tape, is of the type described in Technical Services Bureau Bulletin 1978-1(S) as exempt, so its purchase is not subject to sales tax.

What this means for you

A single system can be part capital improvement, part taxable. Don't assume a whole installation is either all exempt or all taxable. The test is applied component-by-component: what's built into the structure so that removal means demolition can be a nontaxable capital improvement; what unbolts or unplugs and walks out the door is taxable equipment.

"Removal requires demolition" is the pivotal fact. Lines buried in the walls qualified because you can't get them out without tearing the walls apart. Cabinets bolted to the floor and sets plugged into jacks didn't — they come out cleanly, so they stayed taxable even under the same lease.

Allocate the contractor's charge. Because only the in-wall portion is exempt, the installation charge has to be split between the capital-improvement work and the taxable equipment. Keep the contract detailed enough to support that allocation.

Custom software rode a separate rule. The tailored software was exempt under the Department's software bulletin, independent of the capital-improvement analysis.

Common questions

Q: Is installing a whole phone system a nontaxable capital improvement?
A: Only the parts that become part of the building. Here, only the lines embedded in the walls/ceiling (removable only by demolition) qualified; the removable processing unit, sets, and consoles stayed taxable.

Q: Why were the telephone sets and consoles taxable?
A: They plug in or bolt down and can be removed without material damage to the realty, so they aren't capital improvements under § 1101(b)(9). Their purchase and installation are taxable.

Q: Was the custom software taxable?
A: No. The tailored software, delivered on tape, was of the type the Department's Bulletin 1978-1(S) treats as exempt.

Citations and references

Statutes and guidance:

• Tax Law § 1105(c)(3) — tax on installing tangible personal property, except installing property that becomes a capital improvement to real property
• Tax Law § 1101(b)(9) — three-part definition of "capital improvement" (adds value; permanently affixed so removal causes material damage; intended to be permanent)
• Technical Services Bureau Bulletin 1978-1(S) — custom software of the type described is exempt

Authority cited:

• Beaman Corp., State Tax Commission Advisory Opinion (Aug. 19, 1982) — components removable without material damage are not capital improvements

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1983.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a83_3s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-83(3)S
Sales Tax
February 15, 1983

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S811020A

On October 20, 1981, a Petition for Advisory Opinion was received from Benton & Bowles,
Inc., 909 Third Avenue, New York, New York 10019.
The issue raised is whether a private telephone system which Petitioner had installed in
leased premises constitutes a capital improvement for purposes of the Sales Tax imposed under
Article 28 of the Tax Law.
Petitioner, a lessee of real property, entered into a contract for the furnishing and installation
of a private telephone system. The major components of the system and their manner of annexation
to the real property leased by Petitioner are, as stated by Petitioner, as follows:
1)

Processing Unit

1-3)

Bolted to concrete floor via bolts
imbedded in concrete; also attached to
walls via bolts. Removal would cause
structural damage to floor and walls in
the form of holes in walls and floor.

2)

Random Access Memory

3)

Switch Units

4)

Power Cabinet

4-6)

Imbedded in walls via holes cut to
accommodate equipment. Removal would
leave holes in walls.

5)

Peripheral Equipment
Shelf

6)

Emergency Power Panels

7)

SL-1 Lines

8)

500/2500 Lines

9)

Co/Watts/Fx Trunk Line

10)

E & M Tie & Trunk Lines

11)

Telephone Sets

11)

Attached to lines via modular jacks.

12)

Attendant Consoles

12)

Bolted jacks to floor and wired into
system.

13)

Custom Software

13)

Programmed into processing unit.

7-10) Installed in building throughout the
walls and ceiling. Removal would
require demolition of the walls.

ROBERT W. BOUCHARD, ACTING COMMISSIONER
GABRIEL B. DiCERBO , DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (8/82)

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TSB-A-83(3)S
Sales Tax
February 15, 1983
Petitioner's lease with the owner of the real property provides, in pertinent part, as follows:
"All alterations, decorations, installations, additions or improvements upon
demised premises, made by either party, including all paneling, decorations,
partitions, railings, and the like, shall, become the property of Landlord, and shall
remain upon, and be surrendered with, the demised premises, as a part thereof, at the
end of the term or renewal term, as the case may be, except that such furniture,
furnishings, trade fixtures and business equipment as are not built into the demised
premises and are installed by Tenant solely at its own expense may be removed."
Section 1105(c)(3) of the Tax Law imposes a tax on the receipts from the following service:
"Installing tangible personal property, . . . or maintaining, servicing or
repairing tangible personal property . . . except . . . for installing property which,
when installed, will constitute an addition or capital improvement to real property,
property or land, as the terms real property, property or land are defined in the real
property tax law as such term capital improvement is defined in paragraph nine of
subdivision (b) of section eleven hundred one of this chapter . . . "
Section 1101(b)(9) of the Tax Law defines the term "capital improvement" as follows:
"Capital improvement. An addition or alteration to real property which: (i)
Substantially adds to the value of the real property, or appreciably prolongs the useful life of the real
property; and (ii) Becomes part of the real property or is permanently affixed to the real property so
that removal would cause material damage to the property or article itself; and (iii) Is intended to
become a permanent installation."
The items numbered 7 through 10 in the above listing are installed in the real property in such
a manner that they may be removed only by demolition of the walls of the building. Removal of
these lines would thus cause material damage to the underlying real property. The lease between
Petitioner and its lessor provides that installations built into the premises shall become the property
of the lessor upon the expiration of the lease. The lease demonstrates an intention on the part of
Petitioner and its lessor that installations in the nature of these telephone lines be permanent. The
presence of these lines in the walls of the building leased by Petitioner substantially add to the value
of the building. These lines, therefore, qualify as capital improvements under section 1101(b)(9) of
the Tax Law. Accordingly, the amount paid by Petitioner to its contractor which is allocable to the
installation of these lines is not subject to sales tax.
The custom software referred to above as item 13 is created, pursuant to Petitioner's
instructions, in order to enable the telephone system to perform various functions desired by
Petitioner. These functions include such matters as the generation of itemized billings for each
extension and the restriction of each extension to certain types of calls. The software is purchased
by Petitioner in the form of tape. The tape, once installed, can subsequently be removed and replaced

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TSB-A-83(3)S
Sales Tax
February 15, 1983
by another tape. In addition, the software purchased by Petitioner is occasionally re-designed by the
contractor, at Petitioner's request. Such software is of the type described in Technical Services
Bureau Bulletin 1978-1(S) as being exempt from tax. Accordingly, Petitioner's purchase of such
software is not subject to sales tax.
The remaining components of the telephone system (i.e., those numbered 1 through 6, 11 and
12) are not installed in such a manner that their removal would cause material damage to the
underlying real property or to themselves, nor do they otherwise become part of the real property.
Beamon Corporation, State Tax Commission Advisory Opinion, August 19, 1982. These
components of the telephone system, therefore, do not constitute capital improvements within the
meaning of section 1101(b)(9) of the Tax Law. Petitioner must therefore pay sales tax with respect
to the purchase and installation of these components.

DATED:

January 26, 1983

s/FRANK J. PUCCIA
Director
Technical Services Bureau