Does the Texas pollution control or manufacturing exemption apply to air quality monitoring systems (instruments, analyzers, computers, software) sold to manufacturers?

Plain-English summary

A company that sold air quality monitoring systems to manufacturers — and then used those same systems to perform monitoring services for the manufacturers — asked the Comptroller whether the systems qualified for a sales tax exemption. The systems included hardware (instruments, analyzers, computers), replacement parts, repair and maintenance labor, and software programming and modifications.

The taxpayer believed the manufacturing exemption in Tax Code Section 151.318 covered equipment used in manufacturing operations generally. The Comptroller corrected this: Section 151.318(g) provides a phased-in exemption only for machinery and equipment that a manufacturer or processor uses in a pollution control process — specifically, equipment that removes pollutants from waste or by-products before that waste is discharged into the environment. Equipment that merely monitors air quality (rather than actually removing pollutants) does not fit that description, so the air quality monitoring systems, and the repair and replacement parts for them, do not qualify for the exemption.

The letter also addressed the software separately. Programming and modifications to the system's software are taxable. Under Section 151.0101(a)(5)(D), modifying software is excluded from tax only when the person doing the modification did not sell the software. Because the seller of the software was also the one modifying it, the modification was taxable as repair, remodeling, restoration, or maintenance of tangible personal property, citing Rule 3.308 (computer software sales and services).

Finally, the letter addressed an argument the taxpayer's customer had raised: trying to claim exemption on the software modifications and other system components under both Rule 3.357(b)(2) (real property repair and remodeling) and Rule 3.300(d)(3)(C) (manufacturing exemptions) at the same time. The Comptroller held the services cannot qualify under both exemptions — Rule 3.300's exemptions apply only to tangible personal property, not real property. The services could potentially qualify as exempt real property maintenance under Rule 3.357(a)(3), but only if the system becomes an improvement to realty after installation. The phased-in manufacturing exemption in Rule 3.300(f)(4) also does not apply to this monitoring equipment, for the same reason the Section 151.318(g) pollution control exemption doesn't apply — it's monitoring equipment, not pollution-removal equipment.

What this means for you

Sellers of monitoring or testing equipment to manufacturers

If you sell instruments, analyzers, computers, or similar systems that manufacturers use to monitor air quality (or presumably other environmental conditions), this letter indicates those sales are taxable — the pollution control exemption does not extend to monitoring equipment, only to equipment that actually removes pollutants from waste before discharge. The same goes for related repair and replacement parts.

Businesses that also sell software and later modify it

If you sell software and later go back and modify or reprogram it for the customer, this letter indicates that modification is taxable as repair/remodeling of tangible personal property — the exclusion for software modification only applies when the modifier is a different party from the original seller.

Accountants and tax professionals

This letter is useful for the specific line it draws: monitoring equipment (which observes air quality) is different from pollution control equipment (which physically removes pollutants from waste before discharge), and only the latter qualifies for the Section 151.318(g) phased-in exemption. It also confirms a customer cannot stack the real property repair exemption and the tangible personal property manufacturing exemption for the same services — the services must be characterized as one or the other, and the manufacturing-related exemptions in Rule 3.300 apply only to tangible personal property, not real property improvements.

Common questions

Q: Does the pollution control exemption under Section 151.318(g) cover equipment used to monitor air quality?
A: No. The Comptroller held that exemption applies only to equipment that removes pollutants from waste or by-products before the waste is discharged into the environment — not to equipment that monitors or tests air quality.

Q: Are repair and replacement parts for the monitoring systems taxable too?
A: Yes. Since the underlying systems don't qualify for the pollution control exemption, their repair and replacement parts don't qualify either.

Q: Is modifying software always taxable?
A: Not necessarily in every case, but here it was. Section 151.0101(a)(5)(D) excludes modification of software from tax only if the person doing the modification is not the one who sold the software. Because the same company sold and modified the software, the modification was taxable as repair/remodeling of tangible personal property.

Q: Can a customer claim both the real property repair exemption and the manufacturing exemption on the same installation?
A: No. The Comptroller held the services cannot qualify under both exemptions at once. The real property repair exemption (Rule 3.357) can potentially apply if the system becomes an improvement to realty after installation, while the manufacturing-related exemptions in Rule 3.300 apply only to tangible personal property, not real property.

Citations and references

• Tex. Tax Code § 151.318(g) — phased-in exemption for machinery and equipment used by a processor or manufacturer in a pollution control process; limited to equipment that removes pollutants from waste before discharge, and does not extend to air quality monitoring equipment.
• Tex. Tax Code § 151.0101(a)(5)(D) — excludes software modification from tax only when performed by someone other than the seller of the software; modification by the original seller is taxable as repair/remodeling of tangible personal property.
• The letter also references Comptroller Rule 3.308 (computer software sales and services), Rule 3.357(a)(3)/(b)(2) (real property repair and remodeling), and Rule 3.300(d)(3)(C)/(f)(4) (manufacturing exemptions), without providing full text of those rules.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9404L1299E11

Original ruling text

April 6, 1994

Dear ****:

Thank you for your letter of March 7, 1994, concerning the
taxability of sales of air quality monitoring systems
(systems) to manufacturers for use in monitoring air
quality.

You sell the systems to manufacturers then use the systems
to perform the monitoring services. The systems consist of
hardware (instruments, analyzers, computers, etc.),
replacement parts, labor to maintain and repair the
equipment, software programming, and software modifications.

You understand the exemption in Texas Tax Code Section 151.318
applies to equipment used only in manufacturing operations.
That is not so. Texas Tax Code section Section 151.318 (g) allows
the phased-in exemption for machinery and equipment used by
a processor or manufacturer in a pollution control process.
This exemption applies to equipment that removes pollutants
from the by-products or waste resulting from the
manufacturing process before discharging the waste into the
environment. The exemption does not extend to equipment
used to monitor air quality. Thus, the air quality
monitoring systems and their repair and replacement parts do
not qualify for exemption.

The programming and modifications of the system's software
are taxable. Texas Tax Code Section 151.0101(a)(5)(D) excludes
from taxation the modification of software that is not sold
by persons performing the modification. The modification of
software by the person who sold the software is taxable as
the repair, remodeling, restoration or maintenance of
tangible personal property. See Rule 3.308 concerning
computer software sales and services.

Your customer attempts to claim exemption from taxation on
the modifications to the software and other system
components by citing Rule 3.357(b)(2) concerning real
property repair and remodeling and Rule 3.300(d)(3)(C)
concerning manufacturing exemptions. The services cannot
qualify under both exemptions. The services may qualify for
exemption if the system, after installation, becomes an
improvement to realty and the services qualify as real
property maintenance as defined in Rule 3.357(a)(3). The
exemptions under Rule 3.300 apply to tangible personal
property, not to real property.

Rule 3.300(f)(4) concerning the phased-in exemption for
manufacturing equipment does not apply to this monitoring
equipment because of the reason cited in paragraph 3 above.

The services to repair, maintain, restore, remodel, or
maintain tangible personal property that is taxable are also taxable.

This opinion is based on the facts presented. If there are
additional or different facts, the opinion may change.

You may call toll free 1-800-531-5441, extension 3-4683 if
you have any questions or need more information. You may
write to Tax Administration Division, Comptroller of Public Accounts.

Sincerely,

Eddie C. Washington
Tax Administration Division

NOTE: Previous Accession Number 9404320L