Is the charge for 'notching' sample pipe to calibrate quality-control equipment taxable under Texas sales and use tax?

Subject

Pipe — Notching Sample Pipe Is Remodeling

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9409L1315A01

Plain-English Summary

An out-of-state pipe fabricator asked the Texas Comptroller whether a Texas vendor's "notching" service was subject to sales or use tax. "Notching" means deliberately disfiguring sample pipe so a testing lab can calibrate its quality-control equipment to recognize defects. The fabricator sent sample pipe to a Texas company for notching, then sent the notched pipe on to a Texas lab to set up the lab's inspection equipment; the fabricator's actual pipe held for sale would later be sent to the same lab for product testing. The notched sample pipe itself was eventually scrapped.

The Comptroller ruled that the charge for notching is taxable as remodeling. Two possible tax breaks were considered and rejected. First, the manufacturing exemption does not apply, because notching is not quality control or testing of the pipe that is actually being processed for sale — it is service work performed on separate sample pipe used only to calibrate someone else's equipment. Second, the interstate commerce exclusion does not apply, because the notched pipe is not shipped out of Texas by the company that performs the notching; both the sale and the use of the notching service occur entirely within Texas. Because the pipe is used in Texas, Texas use tax is due (with credit available for legally paid, comparable tax already paid to another state), and if the pipe were purchased in Texas, Texas sales tax would be due unless the seller shipped it directly out of state.

What This Means For You

Manufacturers and fabricators using Texas quality-control vendors

If you send sample or scrap material to a Texas vendor purely to calibrate a lab's test equipment — rather than to inspect or test the actual product you intend to sell — do not assume the manufacturing exemption covers that service charge. The Comptroller draws a sharp line between processing performed on goods actually held for sale and processing performed on stand-in samples used only to set up equipment; only the former can qualify for manufacturing-related exemptions.

Out-of-state companies with Texas vendor relationships

Even if your business is based outside Texas, a service performed by a Texas vendor on property that stays in Texas is subject to Texas sales/use tax. The interstate commerce exclusion depends on the vendor actually shipping the property out of state — it does not apply just because your company's headquarters or ultimate customers are elsewhere.

Accountants and tax professionals

This ruling illustrates that "remodeling" or altering tangible personal property is a taxable service in Texas, and that the manufacturing exemption for quality control/testing is read narrowly: it protects testing of the product itself, not ancillary work on separate items used to calibrate testing equipment. Also note the ruling's use tax credit mechanism — tax legally paid in another state can offset Texas use tax on the same property.

Q&A

Q: Is a charge for "notching" sample pipe used to calibrate quality-control equipment taxable in Texas?
A: Yes. The Comptroller held this charge is taxable as remodeling.

Q: Does the manufacturing exemption cover this notching charge?
A: No. The exemption doesn't apply because the notching is not quality control or testing of the pipe being processed for sale — it's separate sample pipe used only to calibrate testing equipment.

Q: Since the fabricator is based in Louisiana, does the interstate commerce exclusion apply?
A: No. The exclusion doesn't apply because the notched pipe is not shipped out of Texas by the Texas company performing the notching; the sale and use of the notching occur in Texas.

Citations

No specific statutes or rules were cited in the text of this letter ruling.

Original ruling text

September 14, 1994

Dear ****:

I am responding to your request for an opinion on the sales tax status of
"notching." "Notching" is the disfiguring of sample pipe for the purpose
of calibrating or setting quality control equipment that will be used in
quality control inspections of pipe for sale.

You explained that your company is in the business of fabricating alloy
pipe and are using Texas vendors to test and implement your quality program.
You send sample pipe to a *****, Texas company. This company "notches"
the pipe. The "notched" pipe is sent to a Texas lab to be used to calibrate
or set their equipment to recognize pipe defects. (Your company will later
send the fabricated alloy pipe held for sale to this lab for product testing
before it is sent to your customers.) The "notched" pipe is returned to your
company and is eventually scrapped.

You asked that we consider the following facts when rendering an opinion:

1. Your business location is ***, Louisiana.

2. Your company representative accompanies the test pipe to the
   *****, Texas company to verify the "notching."

3. The "notching" of the sample pipe is a necessary extension of the lab
   testing.

The charge for "notching" the sample pipe is taxable as remodeling. The
manufacturing exemptions do not apply because the "notching" is not
quality control or testing of the pipe being processed for sale. The
interstate commerce exclusion does not apply because the "notched" pipe
is not shipped out of Texas by the processor or company that provides the
"notching." The sale and use of the "notching" takes place in Texas.

Also, the pipe is being used in Texas. Texas use tax is due; however,
credit may be taken for comparable sales or use tax paid to another state
when the other state's tax was legally due and paid. If the pipe is
purchased in Texas, Texas sales tax is due if not delivered directly out
of Texas by the seller.

This opinion is based upon the facts presented. If there are additional
or different facts, this opinion may change. If you have other questions
or require additional information, you may write. The address is Tax
Administration Division, Comptroller of Public Accounts.

Sincerely,

Tax Administration Division

NOTE: Previous Accession Number 9409573L