When does equipment a data-communications hardware maker buys for research and development qualify for New York's sales-tax exemption for R&D property?

Plain-English summary

Protocom Devices Inc. makes data-communication hardware and software — "packet assemblers/disassemblers" (PADs) that connect vendor-specific data-processing equipment to X.25 packet-switched networks. It develops and continually improves the software inside these products by building test environments (emulation, simulation, debugging, transmission monitoring and analysis). It bought equipment for that work — PC-based development stations, data analyzers/simulators/scopes, a development system, test/debug devices, terminals, printers, modems, and a mainframe — and asked whether the sales tax it paid is refundable under the R&D exemption.

The Department explained the test: the equipment is exempt only to the extent it is used directly and predominantly in true experimental research.

• The exemption. Tax Law § 1115(a)(10) exempts tangible personal property used directly and predominantly in research and development in the experimental or laboratory sense.
• What counts as R&D. Under 20 NYCRR 528.11, experimental/laboratory R&D means research aimed at basic research, advancing the technology, developing new products, improving existing products, or new uses for existing products. It does not include testing or inspecting materials or products for quality control.
• "Direct" and "predominant." Direct use means actual use in the R&D operation (materials worked on, and the machinery, equipment, and supplies used to perform the actual R&D). Predominant means the property is used directly in R&D more than 50% of the time. Property qualifies only if it meets both tests.
• Where the line falls. Equipment used to adapt or modify a customer's hardware or software, to test products intended for sale, or merely to design or redesign a hardware configuration is not R&D use. But a computer used to test models of a new product for quality and performance before manufacturing the new models is a directly experimental use — and if over 50% of its use is for that, it qualifies for exemption from state and local (including New York City) sales tax.
• Utilities. Section 1115(b)(ii) separately exempts gas, electricity, refrigeration, and steam used directly and exclusively (100%) in such R&D. Because utilities arrive in bulk, the user claims a refund/credit for the exempt portion, supported by an engineering survey or documented formula (see TSB-M-82(25)S). Utilities for general heating, cooling, and lighting of research buildings do not qualify.
• How to claim it. Protocom may request a refund or credit of tax paid on qualifying property and utilities by filing Form AU-11.

What this means for you

New York's R&D exemption is powerful but narrow — it turns on actual use, not on being a "research company." Property qualifies under § 1115(a)(10) only if it is used directly in experimental or laboratory research and more than 50% of the time.

Distinguish real experimentation from production-support work. Testing a new-product model for quality and performance before manufacturing it is experimental R&D. But adapting or modifying a customer's system, testing products meant for sale, or designing/redesigning a configuration is not — even if it happens in an R&D department.

Quality-control testing is expressly excluded. Inspecting or testing materials or finished products for quality control is not experimental R&D, so equipment devoted to it does not qualify.

Utilities have their own, stricter test. Gas, electricity, refrigeration, and steam must be used exclusively (100%) in qualifying R&D, and you recover the exempt share by refund with an engineering survey. General heating, cooling, and lighting of buildings never qualifies. Claim refunds on Form AU-11.

Common questions

Q: Does buying equipment for our R&D department automatically make it tax-exempt?
A: No. It qualifies only if it is used directly in experimental or laboratory research and more than 50% of the time. Both tests must be met.

Q: We use a computer to test a new product's quality and performance before we start manufacturing it. Is that exempt?
A: Yes, that is a directly experimental use, and if over 50% of the computer's use is for that, it qualifies for exemption.

Q: What about equipment used to adapt a customer's system, test products we sell, or design a hardware configuration?
A: Those are not research and development in the experimental sense, so that equipment does not qualify.

Q: Can we get the R&D exemption for our electricity and gas?
A: Only for the portion used exclusively in qualifying R&D — not general heating, cooling, and lighting. You claim it as a refund/credit supported by an engineering survey, using Form AU-11.

Citations and references

Statute and regulation:

• Tax Law § 1115(a)(10) — exempts property used directly and predominantly in R&D in the experimental or laboratory sense
• Tax Law § 1115(b)(ii) — exempts gas, electricity, refrigeration, and steam used directly and exclusively in such R&D
• 20 NYCRR 528.11 — defines experimental/laboratory R&D (basic research, advancing technology, new/improved products, new uses), excludes quality-control testing, and sets the direct-use and over-50% predominant-use tests
• 20 NYCRR 518.11(a)(2) — the R&D exemption does not extend to repair and installation services for the property
• TSB-M-82(25)S — Department guidance on allocating electricity between taxable and exempt uses
• Form AU-11 — Application for Credit or Refund of State and Local Sales and Use Tax

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a88_4s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-88(4)S
Sales Tax
December 3, 1987

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S861215A

On December 15, 1986 a Petition for Advisory Opinion was received from Protocom Devices
Inc., 1666 Bathgate Avenue, Bronx, New York 10457.
The issue raised is whether equipment purchased for research and development by a producer
of data communication hardware and software qualifies for exemption from sales tax under Section
1115(a)(10) of the Tax Law.
Since the inception of Protocom Devices in February, 1983, Petitioner has, by its own
research and development efforts, created communication processors which function as the physical
connective points between vendor-specific (i.e., IBM, Sperry, Burroughs, Honeywell) electronic data
processing equipment and private and public X.25 packet switched networks (PSNs). X.25 is an
international standard defining the operation of a PSN.
The packet assemblers/dissassemblers (PADs) Petitioner has developed handle data going
into a PSN in a manner analogous to placing a letter in an envelope, addressing the letter and placing
the letter in a mailbox. The network functions as the "post office", delivering the letter (data) to its
destination. A receiving PAD checks the address, opens the envelope and delivers the letter (data)
to its destination.
These hardware products contain the software programs Petitioner has developed and is
continually improving by constructing test environments for performing procedures such as
emulation of host and terminal processors, simulation of network conditions, software debugging,
and data transmission, monitoring and analysis.
Equipment Petitioner has purchased for use in research and development includes PC based
development stations; data analyzers/simulators/scopes; one Ironics 1600 Development System;
various test/debug devices, terminals, printers and modems; one mainframe (with required software)
for developing software protocols and maintaining research and development data.
Petitioner inquires whether the sales tax it has paid on the purchase of this equipment is
refundable.
Section 1115(a)(10) of the Tax Law exempts tangible personal property used directly and
predominantly in research and development in the experimental or laboratory sense.
Pursuant to the Sales and Use Tax Regulations this exemption does not extend to repair and
installation services for such property. 20 NYCRR 518.11(a)(2).

RODERICK G. W. CHU, COMMISSIONER
GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (3/83)

-2­
TSB-A-88(4)S
Sales Tax
December 3, 1987

Regulation Section 528.11 explains further:
(b)...(1) Research and development, in the experimental or laboratory sense,
means research which has as its ultimate goal
(i) basic research in a scientific or technical field of endeavor;
(ii) advancing the technology in a scientific or technical field of endeavor;
(iii) the development of new products;
(iv) the improvement of existing products;
(v) the development of new uses for existing products.
(2) Research and development in the experimental or laboratory sense does not
include
(i) testing or inspection of materials or products for quality control.
(c)...(1) Direct use in research and development means actual use in the research and
development operation. Tangible personal property for direct use would broadly include
materials worked on and machinery equipment and supplies used to perform the actual
research and development work. Usage in activities collateral to the actual research and
development process is not deemed to be use directly in research and development.
(2) Tangible personal property is used predominantly in research and development
if over fifty percent of the time it is used directly in such function.
(3) Tangible personal property is exempt only if it meets the tests of direct and
predominant use.
Accordingly, when electronic data processing equipment is used to adapt or modify customer
hardware or software, to test products intended for sale or merely to design or redesign a hardware
configuration, it is not deemed to be used in research and development; but when a computer is
employed to test models of a new product for quality and performance standards prior to
manufacturing such new models, it is used directly in an experimental function, and if over 50% of
the computer's use is attributable to such function it is used predominantly in research and
development and will qualify for exemption from State and local (including New York City) sales
tax in accordance with Tax Law § ll15(a)(10).
Additionally, Section 1115(b)(ii) of the Tax Law exempts from sales tax gas, electricity,
refrigeration and steam used or consumed directly and exclusively in research and development in
the experimental or laboratory sense.

-3­
TSB-A-88(4)S
Sales Tax
December 3, 1987

The Sales and Use Tax Regulations state that gas, electricity, refrigeration and steam is used
exclusively in research and development if it serves 100 percent in such function. Because gas,
electricity, refrigeration and steam is normally received by the user in bulk or in a continuous flow,
a portion of which is usually consumed for nonexempt purposes, the user may claim a refund or
credit for the tax paid on the portion used directly and exclusively in research operations. The refund
request must be submitted with an engineering survey or documentation of the formula applied to
arrive at the exempt utility purchases. 20 NYCRR 528.11(c)(4). A Department of Taxation and
Finance Publication on Determining Electricity Used in the Production of Tangible Personal
Property for Sale (TSB-M-82(25)S) contains information generally helpful for allocating electric
power between taxable and exempt uses.
It should be noted that fuel, gas and electricity purchased for general heating, cooling and
lighting of research buildings or areas do not qualify for exemption, as they are neither consumed
directly nor exclusively in research and development operations.
Petitioner may request a refund or credit of taxes paid on purchases of tangible personal
property, fuel and utilities eligible for exemption pursuant to the above quoted sections of the Tax
Law and Regulations, by filing Form AU-11, Application for Credit or Refund of State and Local
Sales and Use Tax.

DATED: December 3, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.