Laws, Regulations & Annotations

Business Taxes Law Guide – Revision 2018

Sales and Use Tax Annotations

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Annotation 515.0660


515.0660 Research Contracts. A research and development contract must be distinguished from a contract for the manufacture of a "custom made" item. In the latter, the research, design, etc., although necessary to the manufacture of the item, is incidental to the primary purpose of the contract. Generally, "custom made" items are for consumption or resale. The buyer wants the item for its intrinsic value as an item, and is not interested in the data developed in the course of its manufacture. In such contracts, the entire contract price is subject to tax if the tax applies. A person contracting for research and development is primarily contracting for information which is intangible. Generally, the person contracting for information is going to use it to manufacture and sell some item of tangible personal property.

The development of the information in a research and development contract is not a sale of tangible personal property. It is a service. Since the information such as plans, design, parts lists, etc., cannot ordinarily be conveyed orally, the information is conveyed on paper. The transfer of the information on paper is not a sale of tangible personal property, and the transfer is incidental to the service of developing the information. In a few rare instances, the information cannot be conveyed without the transfer of a prototype. In these cases the transfer of the prototype is incidental to the transfer of the information and is not a sale of the prototype. In most instances the information cannot be developed without the production of a prototype, but the information can be conveyed without it. In these instances, if the prototype is also transferred, it is a sale of the prototype along with a sale of intangible information.

In a true research and development contract, where a prototype is manufactured, the researcher (taxpayer) owes use tax on the materials used to construct the prototype since it was used to compile the data, design, drawings, etc. The measure of the tax is the cost of the materials going into the manufacture of the prototype as well as all other materials consumed. Thus, if the true research and development contract calls for the researcher to furnish a prototype along with the engineering data, parts lists, design blueprints, operating instructions, etc., the transfer of the prototype (previously used to develop the data called for in the nontaxable service portion of the contract) is a sale of it without any credit for the use tax paid on the materials. The measure is not the full contract price since the primary purpose of the contract was one for the service of developing information. 3/11/66.