United States

Colorado: Department Addresses Various Issues Related to a Company's Use of Property in R&D Activities

Apr 13, 2015
From KPMG TaxWatch

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Recently, the Colorado Department of Revenue was asked to rule on various sales and use tax issues associated with a taxpayer’s use of tangible personal property in research and design activities occurring in Colorado. The taxpayer at issue was engaged in research and development of comprehensive systems that would eventually be sold to a third-party, an affiliate, or used by the taxpayer itself to provide services to companies in the oil, gas, and mining industries. The taxpayer purchased items of tangible personal property that were necessary to design, build, surface test, and field test its systems.  These so-called pre-deployment activities occurred in Colorado. The taxpayer requested guidance as to whether tangible personal property purchased for use in building and testing its systems would give rise to a Colorado sales or use tax obligation.

In an earlier ruling (PLR 10-006), the Department ruled that property incorporated into manufactured articles was not subject to Colorado sales or use tax when the only "use" of the goods in Colorado was to test the products prior to sale. The primary purpose of the specific "use" of the property (i.e., testing) was not the primary purpose of the good itself, and, therefore, the Department concluded that no taxable use occurred.  The Department also noted that the testing was an integral part of the process of manufacturing or reselling the completed goods. Seeing no reason to depart from its earlier analysis, the Department concluded that as long as the taxpayer’s systems were eventually resold, the tangible personal property would not be subject to Colorado sales and use tax.  The fact that the taxpayer was depreciating or expensing the property purchased did not change this conclusion, although generally depreciating or expensing property indicates a taxable use by the taxpayer. The taxpayer next asked whether selling the system to a related party outside of Colorado for use in providing the service would potentially be disregarded as not being a “true sale.” The concern appeared to be that the taxpayer would be treated as using the property itself to provide the service directly. The Department concluded that, based on the facts presented in the ruling request, the sale to the related party would be respected as long as consideration was paid for the system. Finally, the taxpayer requested guidance on the taxability of the property if it decided to deliver the service itself. In other words, would that retroactively change the tax consequences of the transaction?  The Department noted that sales tax is a tax driven by form, not generally by substance. Although there is very little substantive difference between the taxpayer selling the system to a related party to provide the service and providing the service itself, the Department noted that the difference in form may have tax consequences for the taxpayer.  Under previous Colorado case law, items withdrawn from inventory for a taxpayer’s own use created a taxable event at the time the items were withdrawn, rather than a retroactive use tax obligation on which penalties and interest could be imposed.  The Department noted that the company raised a “difficult” question: if the company uses the property withdrawn from inventory to deliver the services itself outside of Colorado, is there a Colorado use tax obligation as a result of the company having used and developed the property in the state without further resale. Although raised in the PLR request, the parties apparently agreed to put aside the issue as to whether subsequent out-of-state use of property withdrawn from inventory in Colorado would give rise to a Colorado sales and use tax obligation and to focus only on the timing of any obligation that might arise.  For more information on PLR 15-002 (Feb. 17, 2015), please contact Steve Metz at (303) 382-7177.


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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.