Is the film used to create a template for burning circuit boards exempt from Texas sales tax, and are fees paid to programmers for custom software taxable?

Plain-English summary

ABC CO. manufactures PBX and telephone systems, including both hardware and software. To make the circuit boards that go into these systems, ABC CO. hires outside engineering firms to provide engineering consulting and labor to create "film" that is later used in the manufacturing process.

The letter explains the workflow in more detail: the outside engineering firm works with ABC CO.'s own engineers to produce an original design, and the outside firm then uses that design to produce the film. ABC CO. takes the finished film to a separate, third-party manufacturer, which uses the film as a template to "burn" (produce) the circuit boards. The outside engineering firm bills ABC CO. a single charge that covers both the engineering services and the production of the film. The finished circuit boards become part of ABC CO.'s inventory and are sold as part of its phone systems.

The Comptroller's office ruled that ABC CO.'s purchase of the film qualifies for exemption under Tax Code Section 151.318, because the film is used by the third-party custom manufacturer to produce circuit boards that ABC CO. sells as part of its phone systems.

The letter separately addresses ABC CO.'s software. ABC CO. uses software in its PBX and other telephone systems, and that software is custom written for ABC CO. by contract programmers who retain no right or title to the code once it is written. Under those conditions, the Comptroller ruled that the fees ABC CO. pays to the programmers are not taxable.

What this means for you

Manufacturers buying design film or artwork used in outsourced production

If you buy film, artwork, or a similar tooling item that a third-party custom manufacturer uses as a template to produce a component you will sell, this letter shows that the item can qualify for the Section 151.318 manufacturing exemption — even though the film itself is created by an outside engineering firm rather than by the manufacturer.

Businesses that hire contract programmers for custom software

If your custom software is written specifically for you by contract programmers who give up all right and title to the code once it's finished, the fees you pay those programmers were treated as not taxable in this letter. The key facts the Comptroller relied on were that the software was custom (not off-the-shelf) and that the programmers kept no ownership interest in the finished code.

Accountants and tax professionals

Note that this letter addresses two separate transactions under one set of facts: (1) the purchase of film used as a manufacturing template, analyzed under the Section 151.318 manufacturing exemption, and (2) fees for custom programming services, analyzed as nontaxable because of the custom nature of the work and the transfer of all rights to the code. Each conclusion depends on its own specific facts as stated by the taxpayer.

Common questions

Q: Why does the film used to make the circuit board template qualify for exemption?
A: Because ABC CO. uses the film through a third-party custom manufacturer that produces the circuit boards, and those boards become part of ABC CO.'s inventory and are sold in its phone systems. The letter states this purchase qualifies for exemption under Tax Code Section 151.318.

Q: Does it matter that the outside engineering firm bills engineering services and film production as a single charge?
A: The letter notes the single charge as a fact but does not separately break out taxability by component — it addresses the purchase of the film as a whole and finds it exempt under Section 151.318.

Q: Why aren't the fees paid to the contract programmers taxable?
A: Because the software is custom written for ABC CO., and the contract programmers retain no right or title to the code after it is written. Under those conditions, the letter states the fees are not taxable.

Q: Can ABC CO.'s facts be relied on by other taxpayers?
A: No. The letter explicitly states that the opinion is rendered based on the facts submitted, and that other facts, though similar, may yield different results.

Citations and references

• Tax Code Section 151.318 (cited as the basis for exempting the purchase of the film)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9503L1345B12

Original ruling text

March 8, 1995

Dear ****:

Thank you for your recent letters regarding the tax treatment of
programming and engineering services. Your facts are restated in part
with responses below.

ABC CO. is a manufacturer of PBX and telephone systems including hardware
and software for these systems. We use outside engineering firms to
provide engineering consulting and labor to create film which will be
used in the manufacturing of circuit boards. The finished circuit
boards will become part of inventory and sold by ABC CO.

Note - In our phone conversation of March 3, 1995, you said that the
outside engineering firm works with ABC CO. engineers to produce an original
design that the outside engineering firm then uses to produce the film.
ABC CO. then takes the film to a third-party firm that uses the film as a
template to burn boards for ABC CO. The outside engineering firm makes a
single charge for engineering services and production of the film.

Response: The purchase of the film qualifies for exemption under Tax
Code Section 151.318. ABC CO. uses the film through the third-party custom
manufacturer producing circuit boards for them to sell in ABC CO.
phone systems.

ABC CO. uses software in their PBX and other telephone systems. In our
phone conversation of March 3, 1995, you said that the software is
custom written for ABC CO., and that the contract programmers retain no
right or title to the code after it is written.

Response: Fees paid to programmers under these conditions are not taxable.

This opinion is rendered based on the facts you submitted. Other facts,
though similar, may yield different results.

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct
line is 512/463-4680. You may also write to Tax Administration,
Comptroller of Public Accounts.

Sincerely,

Al Van Allen
Tax Administration Division

NOTE: Previous Accession Number 9503055L