Is an integrated CAD/CAM/CAE computer system used both to develop generic product designs and to configure specific customer orders exempt from New York sales tax as research and development or production equipment?

Plain-English summary

Dresser-Rand Company manufactures capital equipment for the energy and process industries, engineered to each customer's specific order. It planned to install a fully integrated Computer Aided Design/Manufacturing/Engineering system (CAD/CAM/CAE) -- hardware, software, and maintenance -- used across two linked processes. In the Product Development Process, engineers use the system to build a generic "parametric solid model" of a marketable product, complete with engineering rules, supporting drawings, and numeric-control (NC) toolpath data -- essentially a reusable design template. In the Order Execution Process, when a customer order comes in, engineers search for and reuse existing generic models, copy and rename them into order-specific parts, adjust parameters to match the customer's exact requirements, and finally assemble everything into an order-specific package that generates the NC programs driving the CNC machines that actually manufacture the parts.

The Department split its analysis cleanly along these two processes. The Product Development Process -- creating the documented, generic marketable product definition -- qualifies for New York's research and development exemption, as long as the system is used predominantly (over 50% of the time) for that purpose. But the Order Execution Process, where the system configures a generic design into a specific customer's part, does not qualify for the production exemption on its own -- because merely designing or configuring a product doesn't "act upon material" or have "an active causal relationship" in actually producing it. However, where the system's output is the numeric-control (NC) program that directly drives the CNC manufacturing equipment, that specific function does qualify for the production machinery exemption if used more than 50% of the time for that purpose. Since the same integrated system handles both R&D-qualifying design work and production-qualifying NC-program generation, the combined exemptions apply if the system's qualifying uses (research/development plus production) together exceed 50% of its total use -- but exactly how any given business's actual usage breaks down between qualifying and non-qualifying functions is a factual question the Department can't resolve in an advisory opinion.

What this means for you

Manufacturers using integrated CAD/CAM/CAE or similar design-and-production systems

Don't assume an entire integrated design-and-manufacturing system is either fully exempt or fully taxable -- break its actual functions into: (1) genuine R&D work creating new or improved generic product designs (exempt if predominant), (2) pure order-configuration/customization work applying an existing design to one customer's order (not itself exempt), and (3) generating the machine-control programs that directly drive production equipment (exempt if predominant). Track usage across these categories, since the combined qualifying-use percentage is what determines the exemption.

Engineering and industrial equipment manufacturers with custom, made-to-order products

If your design process moves from a generic template to a customer-specific configuration, the "generic template creation" stage is your strongest R&D-exemption claim -- the customer-specific configuration stage in between generally isn't exempt on its own, only the final step that actually generates production-driving code.

Accountants and tax professionals

This ruling is a useful three-way functional split for any capital-intensive engineering software purchase: R&D exemption (§ 1115(a)(10)) for genuinely new/generic design work, no exemption for pure order-configuration, and production exemption (§ 1115(a)(12)) for the piece that directly drives manufacturing equipment -- with the "more than 50% combined qualifying use" rule allowing the two exemptions to stack for one integrated system.

Common questions

Q: Does configuring a generic design to meet one customer's specific order count as production or R&D?
A: Neither, on its own -- the ruling specifically found that configuring parametric models for a specific customer order doesn't "act upon material" to form the product, so it falls outside both exemptions unless the system's other qualifying uses (generic design work, NC-program generation) push total qualifying use over 50%.

Q: Does the whole CAD/CAM/CAE system need to be used 50%+ of the time for just one exempt purpose?
A: No -- the ruling allows research/development use and production use to be combined together against the 50% threshold, since both are separately exempt purposes.

Q: Can another manufacturer rely on this ruling for its own CAD/CAM system?
A: No. This advisory opinion binds the Department only as to Dresser-Rand Company and the specific system architecture and workflow described; the actual usage-percentage breakdown for any other business is a separate factual question.

Citations and references

Statutes and regulations:

• Tax Law § 1115(a)(10) (research and development exemption)
• Tax Law § 1115(a)(12) (production machinery and equipment exemption)
• 20 NYCRR § 528.11 (research and development exemption; directly/predominantly)
• 20 NYCRR § 528.13(a)(1) (production machinery and equipment)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a97_05s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(5)S
Sales Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S960319C

On March 19, 1996 the Department of Taxation and Finance received a
Petition for Advisory Opinion from Dresser-Rand Company, 1 Baron Steuben Place,
Corning, New York 14830-2696.
Petitioner, Dresser-Rand Company, submitted
additional information pertaining to this petition on August 19, 1996.
The issue raised by Petitioner is whether a fully integrated computer aided
design (engineering) and manufacturing system (CAD/CAM/CAE) consisting of
hardware, software and maintenance, is subject to sales and compensating use tax.
Petitioner
presents
the
following
facts.
Petitioner
is
a
supplier/manufacturer of capital equipment and technological information used in
the energy and process industries, and engineers its products to the specific
requirements of customer orders. The CAD/CAM/CAE system will be used for the
design and manufacture of products. The CAD/CAM/CAE system is intended to be
used in two main processes, namely, Product Development and Order Execution.
The system provides a single CAD/CAM/CAE package solution for engineering
and manufacturing processes to meet customer needs and facilitates the
engineering and manufacturing process by eliminating the duplication of work,
reducing customer order cycle time, and improving customer order quality.
Product Development Process:
The end result of the Product Development Process will be a documented
definition of a marketable product. This documented definition will include a
parametric solid model of the product, and the engineering rules for its use and
applicability. Engineering will use the CAD/CAM/CAE system to develop product
designs necessary to meet customer order requirements utilizing parametric solid
modeling techniques.
The parametric solid model will be created in the CAD/CAM/CAE system and
will have associated with it the supporting drawings and numeric control (NC)
toolpath required for the manufacture of the product.
Once a product is developed, the parametric solid model will be made
available to the Order Execution Process for use on customer orders.
Order Execution Process:
In the Order Execution Process, which starts at the point of a customer
order, and ends at the delivery of the product ordered by the customer, much use
will be made of the CAD/CAM/CAE system. The envisioned workflow is outlined
below:

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1.
On receipt of a customer order a definition of the product sold will be
given to Engineering.
2.
Engineering will search the CAD/CAM/CAE system for previously created
components that meet the customer requirements.
3.
Any components located in step 2 above will be copied to an order specific
folder in the CAD/CAM/CAE system.
4.
Those components that are required to meet the customer order but have not
been previously created, will be created from parametric base models for the
components that are stored in the CAD/CAM/CAE system. These base models are
created in the product development process outlined above. These base models
represent the generic design for the component and contain the design rules and
constraints to produce a specific instance of the component in order to meet
customer requirements.
5.
In order to create a contract specific instance of a component from a
parametric base model, the parametric base model will be copied to the order
specific folder in the CAD/CAM/CAE system. The base model components will then
be renamed to order specific part numbers.
6.
The parameters of the base model will be adjusted as necessary to create
the order specific instance of the component.
7.
Attributes defining the order specific component will be added to the order
specific model, so that it can be searched for and re-used on later orders.
8.
Associated drawings and NC toolpath will be inspected and adjusted if
necessary for the order specific components.

9. An assembly will be created in the CAD/CAM/CAE system from the order specific
   components. This assembly will define the customer order, provide an engineering
   bill of material, provide the manufacturing and inspection drawings for the
   customer order, and provide the necessary NC programs to manufacture the
   components for the customer order. Manufacturing, due to the integration of the
   system, will utilize the numerical control (NC) programs generated by the
   CAD/CAM/CAE system to drive computer numerical controlled (CNC) machine tools to
   make the parts.
   Applicable Law and Regulations
   Section 1115(a)(10) of the Tax Law provides an exemption from sales and use
   tax for:
   Tangible personal property purchased for use or consumption directly
   and predominantly in research and development in the experimental or
   laboratory sense. Such research and development shall not be deemed
   to include the ordinary testing or inspection of materials or
   products for quality control, efficiency surveys, management
   studies, consumer surveys, advertising, promotions or research in
   connection with literary, historical or similar projects.

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Section 1115(a)(12) of the Tax Law provides in part for an exemption from
sales and use tax for:
Machinery or equipment for use or consumption directly and
predominantly in the production of tangible personal property,...
for sale, by manufacturing, processing, generating, assembling,
refining, mining or extracting, ....
Section 528.11 of the Sales and Use Tax Regulations provides in part, that:
(a) Exemption. (1) The sale of tangible personal property
purchased for use or consumption directly and predominantly in
research and development in the experimental or laboratory sense
is exempt from the sales and use tax.
*

*

*

(4) An Exempt Use Certificate (form ST-121) is used to make
purchases eligible for this exemption, without payment of sales tax.
(See section 532.4(e) of this Title.)
(b) Research and development. (l) 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; and
(v) the development of new uses for existing products.
(2)
Research and development
laboratory sense does not include:

in

the

experimental

or

(i) testing or inspection of materials or products for quality
control (for machinery and equipment used for quality control in the
production of products for sale, see section 528.13 of this Part);
(ii) efficiency surveys;
(iii) management studies;
(iv) consumer surveys, advertising and promotions; and

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(v)research in connection with literary, historical or similar
projects. (c)Directly, predominantly, exclusively. (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 used directly in research
and development.
(2)
Tangible personal property is used predominantly in
research and development if over 50 percent of the time it is used
in such function.
(3) Tangible personal property is exempt only if it meets the
tests of direct and predominant use.
Section 528.13(a)(1) of the Sales and Use Tax Regulations provides that:
An exemption is allowed from the tax imposed under section
1105(a) of the Tax Law, and from the compensating use tax imposed
under section 1110 of the Tax Law, for receipts from sales of:
(i)
machinery or equipment used or consumed directly and
predominantly in the production for sale of tangible personal
property,
gas,
electricity,
refrigeration
or
steam,
by
manufacturing, processing, generating, assembling, refining, mining
or extracting; and ....

Opinion
Petitioner's Product Development Process results in the creation of a
documented definition of a generic marketable product. The documented definition
includes a parametric solid model of the product and the engineering rules for
its use and applicability. The parametric solid model will have associated with
it the supporting drawings and numeric control (NC) toolpath. Once a generic
product design is developed, the parametric solid model is made available to the
Order Execution Process as part of the fully integrated CAD/CAM/CAE system or the
design of specific products ordered by customers.
Petitioner's use of the
CAD/CAM/CAE system in this instance to create documented definitions of generic
marketable products is directly in research and development and qualifies for the
research and development exemption if used predominantly (more than 50% of the
time) in research and development.
In Petitioner's Order Execution Process, the use of the CAD/CAM/CAE system
to produce product designs for specific customers as outlined above, does not act
upon material to form a product for sale and does not have an active causal
relationship in the production of the product to be sold.
Petitioner's
CAD/CAM/CAE system, therefore, is not used directly in production within the

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meaning and intent of Section 1115(a)(12) of the Tax Law when it is used to
design products. Where the CAD/CAM/CAE system produces numerical control (NC)
programs to drive computer numerical controlled (CNC) machine tools to make the
parts, the machinery and equipment used to produce the numerical control (NC)
programs would qualify for the exemption provided under section 1115(a)(12) of
the Tax Law where used over 50% of the time directly in production for sale.
Where the Petitioner's totally integrated CAD/CAM/CAE system is used both
in research and development and production of tangible personal property for
sale, the exemptions provided in Sections 1115(a)(10) and (12) of the Tax Law
will apply if such machinery and equipment is used, in total, more than 50% of
the time for the qualifying purposes. However, whether Petitioner's use of the
CAD/CAM/CAE system described above is exempt from tax under Sections 1115(a)(10)
and (12) is a factual matter not susceptible of a determination in an advisory
opinion. Clearly, certain aspects of use by Petitioner of its CAD/CAM/CAE system
in its business activities fall within the purview of the above quoted sections
of the Tax Law and regulations.

DATED: February 6, 1997

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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