If a company owns the patents and formulas for its products but has a separate contract manufacturer physically make the product under the company's supervision, is the company itself considered the 'manufacturer' for Texas sales and use tax purposes?

Plain-English summary

A company that owns three patents (with two more pending) and holds FDA and/or EPA approval on five products asked the Comptroller whether it would be considered a "manufacturer" for Texas sales and use tax purposes. The company had developed the formulation process for each product, then contracted with outside manufacturers to actually make the product using the company's manufacturing formulas and instructions. The company kept its own manufacturing manager and/or scientist on site during manufacturing and post-manufacturing testing, and it was responsible for releasing the product to market and for purchasing all component parts, molds, dies, and packaging.

The Comptroller answered yes: even though a third-party contractor physically performs the manufacturing, the company is still considered the manufacturer. The letter distinguishes this from a patent owner who merely licenses a patent and collects royalties from a third-party manufacturer — in that arm's-length royalty scenario the patent owner would not itself be the manufacturer, but here the company's level of involvement (supplying the formula and instructions, on-site oversight, market release responsibility, and purchase of components) means the company is treated as the manufacturer.

What this means for you

Companies that outsource physical production but control the process

If you develop the formula, supply manufacturing instructions, keep staff on site during production and testing, control release to market, and purchase the components/packaging, you may be treated as the "manufacturer" for Texas sales and use tax purposes even though a separate contractor physically makes the product. That status can matter for claiming manufacturing-related sales and use tax exemptions.

Patent owners who only license and collect royalties

This letter signals a contrast: an owner who simply licenses a patent and collects royalties from an independent manufacturer, without the hands-on control described above, would not be treated the same way. The degree of control and involvement in production appears to be the key factor.

Common questions

Q: If another company physically manufactures my product, can I still be the "manufacturer" for Texas sales and use tax purposes?
A: Yes, according to this letter, if you developed the formulation process, provide the manufacturing formulas and instructions, have your own personnel on site during manufacturing and testing, and are responsible for market release and purchasing components, molds, dies, and packaging.

Q: Does simply owning a patent and receiving royalties make you a "manufacturer"?
A: No. The letter contrasts the company's situation with a patent owner who merely receives royalties from third-party manufacturers — that arrangement, without the hands-on involvement described in the letter, is treated differently.

Q: Can I rely on this letter for my own business?
A: No. STAR letters may be relied upon only by the taxpayer to whom they were issued, and this letter is based on the specific facts described; different facts could yield a different result.

Citations and references

No specific statutes, rules, or regulations are cited in the text of this letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9601939L

Original ruling text

January 25, 1996

Dear *****:

Thank you for sending a description of the operations of *****.

I understand that the company owns three patents (with two more pending) and
has FDA and/or EPA approval on five products. The company developed a
formulation process for each product and contracted with manufacturers to use
its manufacturing formulas and instructions to make the product. The company
had its manufacturing manager and/or scientist on site during the manufacturing
and post-manufacturing testing of these products. The company is responsible
for the release to market and the purchase of all component parts, molds and
dies and packaging.

You asked if the company would be considered a "manufacturer" for sales and use
tax purposes. Yes, unlike a patent owner who receives royalties from
third-party manufacturers, in this situation, the company (and patent owner) is
considered the manufacturer.

I hope this satisfactorily answers your questions. My number is 463-4004, if
you have any questions.

Sincerely

Wade Anderson
Director, Tax Policy