§ 1501.1. Research and Development Contracts.
18 CA ADC § 1501.1Barclays Official California Code of Regulations
Barclays California Code of Regulations
Title 18. Public Revenues
Division 2. California Department of Tax and Fee Administration-- Business Taxes (State Board of Equalization-- Business Taxes, See Ch. 6 and 9.9)
Chapter 4. Sales and Use Tax (Refs & Annos)
Article 1. Service Enterprises (Refs & Annos)
18 CCR § 1501.1
§ 1501.1. Research and Development Contracts.
A qualified research and development contract shall not include a contract for research for the purpose of improving a commercial product if the improvements relate to style, taste, cosmetic or seasonal design factors. A qualified research and development contract shall also not include a contract for the design and production of a custom-made item as defined in subdivision (a)(5).
(2) Research. A planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service (product) or a new process or technique (process) or in bringing about a significant improvement to an existing product or process.
“Development” includes the conceptual formulation, design, and testing of product alternatives, and construction of prototypes but does not include:
(6) Functional Use -- Use for which the property was designed which occurs after completion of the research and development. Custom-made items normally are intended for functional use and not for informational and testing use. Informational and testing use of a prototype by the contractor or its customer does not qualify as a functional use.
Examples of functional use include:
(8) Phased Contracts. A phased contract is a contract which provides for separate phases wherein the purchaser has the specific right to terminate the contract prior to commencement of the next phase without the delivery of tangible personal property required to be delivered in any subsequent phase specified in the contract and without further obligation except for compensation for work completed or cancellation fees.
A contract for the design and manufacture of a custom-made item shall be considered a “phased contract” when:
(1) General. Persons engaged in the business of rendering services pursuant to a qualified research and development contract are consumers of tangible personal property which they use incidentally in rendering the service. Tax applies to the sale of the property to them. Tax does not apply to receipts derived from qualified research and development contracts except as provided below.
(2) Prototypes. Prototypes transferred in a qualified research and development contract for informational and testing purposes, as defined in subdivision (a)(7), are not subject to tax regardless of the fact the research contract may place a value on the prototype. Prototypes transferred are for verification that a design meets the required technical specifications of the contract. No functional use, as defined in subdivision (a)(6), of the prototypes is made. Either the sales tax or the use tax applies with respect to sales of such tangible personal property to the contractor.
Sales of additional prototypes transferred in a qualified research and development contract for purposes other than informational and testing use, where a functional use occurs, are subject to tax. This includes prototypes transferred for the purpose of testing the aesthetic features of the product by independent third parties for marketing purposes, or used for the purpose for which the property was designed. The measure of tax is the stated value for such property in the contract, or if none is stated, at the computed fair market value as determined by applying a factor of three to the cost of direct materials used in the production of the prototype.
Tax applies to the transfer of title or possession of prototype tooling, in a qualified research and development contract, for functional use as defined in subdivision (a)(6), regardless of the form of the media, even if a separate charge is not made for these properties. The measure of tax is the amount provided for in the contract for duplicate or replacement sets of the property, or if no such amount is provided, the measure of tax will be equal to fair market value as determined by applying a factor of three to the cost of direct materials used in the production of the prototype tooling.
(3) Custom-Made Items. A contract to design, develop, and manufacture a custom-made item is a contract to sell tangible personal property. Generally, custom-made items are intended for functional use and not for informational and testing use. Unless the sale of the property is a sale for resale, tax applies to the gross receipts from the sale of the property. Gross receipts includes the entire amount of the contract price, including charges related to research, design, and development activities. Tax applies to the entire contract price without regard to the fact that the research, design, and development charges may be separately stated. See subdivision (b)(4) if the contract qualifies as a phased contract.
(4) Phased Contracts. The research and development phase and the production phase of a phased contract shall remain as two separate contracts and shall be taxed as such. Items produced for functional use in the production phase of the contract shall be subject to tax unless the purchaser provides the contractor with a resale certificate or the transfer is otherwise exempt.
Pattern generation tapes, wafer probe test tapes, final test tapes, schematic diagrams for the probe board, and schematic diagrams for the final test load board are informational items, if transferred for archival or other informational purposes not involving a functional use. The contractor is the consumer of the direct materials.
Credits
Note: Authority cited: Section 7051, Revenue and Taxation Code. Reference: Sections 6006, 6009, 6010, 6011, and 6012, Revenue and Taxation Code.
History
1. New section filed 2-21-96; operative 3-22-96 (Register 96, No. 8).
2. Editorial correction (Register 97, No. 15).
This database is current through 5/10/24 Register 2024, No. 19.
Cal. Admin. Code tit. 18, § 1501.1, 18 CA ADC § 1501.1
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