I run a home-based S-corp doing computer animation and multimedia work for clients, using purchased computers, printers, scanners, and modems. Does my business qualify as tax-exempt, and can I buy my equipment tax-free?

Plain-English summary

A home-based S-corp doing computer animation and multimedia work for in-state and out-of-state clients asked whether its business fits into a nontaxable category, having already purchased hardware and software to do the job.

The Comptroller's answer has several distinct moving parts:

Selling the finished product. The sale of a video master (the original computer animation that will itself be sold, offered for sale, licensed, distributed, broadcast, or exhibited) is not taxable when the purchaser gives the seller a motion picture master exemption certificate. But selling duplicate copies of that video master directly to an individual in Texas is taxable.

Buying equipment to make the product. Producing computer animation for sale is treated as manufacturing. Under Tax Code Section 151.318, tangible personal property directly used in a manufacturing process that causes a chemical or physical change in the product (or an intermediate/preliminary product that becomes part of it) can be bought tax-free. So computers, printing devices (including ink cartridges), and scanners used only to produce animated computer images that will be sold qualify for the manufacturing exemption.

The equipment exemption has real limits. A modem does not qualify — it doesn't make or cause any chemical or physical change in the product being manufactured, so it's taxable when purchased regardless of what else the business does. More importantly, if the same qualifying equipment (computers, printers, scanners) is also used for things that AREN'T part of manufacturing a sold product — producing designs/concepts that don't get sold, nontaxable "preliminary art," Internet access, or e-mail — that's a divergent use, and tax becomes due based on the fair market rental value of that non-qualifying portion of use. The same manufacturing exemption extends to using computer equipment to create software for sale, but using that same computer for data processing services like HTML web page design is likewise a divergent, taxable use.

What this means for you

Animators, video producers, and multimedia freelancers selling finished work

Your production hardware (computers, printers, scanners) used exclusively to create animation/video that you sell can be bought tax-free as manufacturing equipment — but track your equipment's actual use carefully. Any personal, administrative, or non-sold-output use of that same equipment creates a divergent-use tax liability based on fair rental value of that use, and modems never qualify for this exemption regardless of use.

Businesses selling both original masters and duplicate copies

Structure your invoicing to distinguish a sale of the master (which can be exempt with the right certificate from the purchaser) from sales of duplicate copies to individual Texas consumers (which are taxable).

Web designers and other computer-based service providers

This letter is a clear warning that using "manufacturing-exempt" equipment for web page design or similar data processing services converts part of that equipment's use into a taxable divergent use — the exemption follows the equipment's actual use, not just its original purchase justification.

Accountants and tax professionals advising creative/tech businesses

The Sec. 151.318 manufacturing exemption for animation/software production hinges entirely on whether equipment use "makes or causes a chemical or physical change" in a product being manufactured for sale — divergent, non-manufacturing uses of the same equipment must be tracked and taxed separately based on fair market rental value.

Common questions

Q: Can I buy my animation computers and scanners tax-free?
A: Yes, if they're used only to produce computer animation images that will be sold, under the Sec. 151.318 manufacturing exemption.

Q: Does the exemption cover my modem?
A: No — a modem doesn't cause a chemical or physical change in the manufactured product, so it's taxable regardless.

Q: What if I also use my exempt equipment for e-mail or unsold preliminary designs?
A: That's a divergent use, and you owe tax based on the fair market rental value of that portion of the equipment's use.

Q: Is selling a finished video master taxable?
A: Not if the purchaser gives you a motion picture master exemption certificate. Selling duplicate copies directly to an individual in Texas is taxable, though.

Q: Can I rely on this letter for my own animation or media business?
A: No. This opinion is rendered based on the facts presented, and if there are additional or different facts, the opinion may change; it can be relied on only by the taxpayer it was issued to.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318 (manufacturing exemption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9902258L

Original ruling text

February 17, 1999

Dear Mr. **:

Thank you for your recent email, which is restated in part with response below.

I have a home base s-corporation and do computer animation/multimedia work for
clients in state and out. I have purchased hardware and software to get my jobs
done. I need to know what sales tax number/category I fall in to file and
receive a certificate? I believe that this is a non-taxable category my
company fits into? Am I correct?

Response: The sale of a video master computer animation, a copy that will be
sold, offered for sale, licensed, distributed, broadcast, or exhibited is not
taxable when the purchaser issues an exemption certificate claiming the motion
picture master exemption. The sale of duplicates of the video master are
taxable when sold to an individual in Texas.

The process of producing a computer animation for sale is considered to be
manufacturing. Tangible personal property directly used in the manufacturing
process that makes or causes a chemical or physical change in the product being
manufactured for sale or in an intermediate or preliminary product that becomes
a part of the product manufactured for sale may be purchased tax free under Tax
Code 151.318. Accordingly, computers, printing devices, including ink
cartridges, and scanners used only for production of animated computer images
that will be sold qualify for exemption as manufacturing equipment. To the
extent the equipment is used to produce designs or concepts that are not sold
or sold as nontaxable "preliminary art" or used for Internet access or e-mail,
these uses would be considered a divergent use of the equipment and tax would
be due based on fair market rental value of that use.

Modems to not make or cause a chemical or physical change in the product being
manufactured and are subject to sales tax when purchased.

You may download an exemption certificate through our Window on State
Government website at
. A sales tax
permit application is at
. The resale
certificate form is also available at this URL.

There are also several rules that you should review such as Seller's and
Purchaser's Responsibilities at
, Sales for Resale at
, and Records Required at
.

The use of computer equipment to create software for sale also qualifies for
the manufacturing exemption. However, the use of the same computer to perform
data processing services such as web page design using HTML would constitute a
divergent use of the computer and related equipment.

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

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 Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division