REQUEST LETTER

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Response March 5, 2001

Dear NAME:

COMPANY (ACCOUNT NUMBER) is a computer drafting service. We use AutoCad by Autodesk, Inc. and other similar software to produce electronic files that contain our client's ideas. These files are delivered to our clients so that they may be used to produce a product or passes on to their clients. Since 1989, when we incorporated, we have been collecting sales tax from all of our clients unless they have provided us with a sales tax number. Recently we have started working with a new client who is an architect. The architect is not required to have a sales tax number and because he has not provided us with one, we have been adding sales tax to his invoices. He has informed us that his accountant has stated that we should not be charging him sales tax on his electronic files.

I have asked a gentleman in your office about his question and was told that the Tax Commission office is discussing the question of taxing electronic files provided by a service. I would like to have an advisory opinion covering the following questions:

1) Should sales tax be added to an invoice for service that is the result of placing an architect's an engineer's or a designer's ideas, notes or oral description into proper format to be understood by a machinist, builder or fabricator? This is accomplished on a computer and the client receives his electronic files on magnetic media or by e-mail.

2) Should sales tax be added to an invoice for printing the client's electronic file, which we have created, onto paper so that it can be given to their client or used to produce a product? The files are printed on a laser printer or a large format platter. The output can then be taken to another company and blueprints can be produced.

3) Should sales tax be added to an invoice for printing the client's electronic file, which we have not created, onto paper so that it can be given to their client or used to produce a product? These files are not created in our office and we are only providing a hard copy of the files. The files are printed on a laser printer or a large format plotter. The output can then be taken to another company and blueprints can be produced.

It is our wish to comply with all of the tax requirements of the State of Utah. We also would like to stay competitive in our service industry and not be at a disadvantage compared to our competition if we are unnecessarily adding sales tax inappropriately.

Thank you for any guidance you may provide us concerning these tax questions.

Sincerely,

NAME

RESPONSE LETTER

March 5, 2001

RE: Taxation of Computer Drafting Services

Dear NAME,

We have received your request for an advisory opinion on whether the services provided by your computer drafting firm are taxable. From your letter and by telephone, we understand that you use computer software to convert a client=s ideas into an electronic file that you deliver either on magnetic media or by e-mail. Your clients are mainly architects, engineers, or other designers. Sometimes, a client will bring in the idea already printed on paper in its final form for you to convert into the electronic file. Often, the client=s idea is presented in an unfinished state, either as a verbal description, as notes, or as a rough sketch on paper. In this case, you will either fill in the missing details or provide design input or other suggestions prior to the conversion.

Question 1. Service to Convert Ideas to Electronic File. Utah Admin. Rule R865-19S-92(E) provides that the Asale of computer generated output is subject to the sales or use tax if the primary object of the sale is the output and not the services rendered in producing the output.@ In Eaton Kenway, Inc. v. Auditing Div. of the Utah State Tax Comm=n, 277 Utah Adv. Rep. 22, 906 P.2d 883 (Utah 1995), the Utah Supreme Court applied this administrative rule in a situation where a customer hired a vendor to transfer its drawings from paper to computer disks. The vendor did not manipulate the drawings in any way, merely transforming them into a computer-readable form.

The Court stated that taxability depended on the Aprimary object@ of the transaction. If the Aprimary object@ of the transaction was to receive the disks, the transaction was taxable. On the other hand, if the Aprimary object@ was the vendor=s services in producing the disks, the transaction would be nontaxable. Here, the Court determined that the customer was primarily purchasing the vendor=s services, because the disks were merely a method of returning the data, documents, and information which the customer had supplied and already owned in an electronic format.

We find that your services to transform your client=s ideas into electronic form is primarily a transaction for your services to produce an electronic file (i.e., to convert the customer=s ideas into a computer-readable form) and is not a transaction for tangible personal property. Accordingly, your transactions to create and sell electronic files under the circumstances described in your first question are not taxable.

Of course, any items of tangible personal property you consume in providing this service are taxable to your firm. For example, if you deliver the electronic file to the client on a disk, you would be considered to have Aconsumed@ the disk in providing your nontaxable service. Accordingly, you should pay sales tax at the time you purchase the disk. If, instead, you bought the disk tax-free, you should accrue and pay use tax upon consuming the disk under these circumstances.

Question 2. Creating and Printing an Electronic File. Your next question concerns not only converting a design into an electronic file, as previously described, but also printing a hard copy of the electronic file onto paper. Again, whether the charges are taxable or not depends upon the primary object of the transaction, as discussed in the following examples.

Hard Copy is Primary Object, Not Electronic Copy

Assume a client has a hard copy design that she wants duplicated into a separate hard copy. To print the new hard copy, you first convert the original drawing into an electronic file, then print the new copy from this file. The client is primarily interested in receiving the printed copy of the design and has little or no interest in the electronic file that you created to produce it. Under these circumstances, the primary object of the transaction is printing a hard copy of the design. Utah Admin. Rule R865-19S-80(C)(1)(a) provides that charges for printed material are taxable. The conversion services you provided would be considered incidental to the tangible personal property you sold, and accordingly, your entire charge would be taxable as a charge for printing.

Electronic Copy is Primary Object, Not Hard Copy

Assume a client is primarily interested in having his design converted into an electronic file as discussed in Question 1 above. However, for no additional charge, your services to convert a design into an electronic file include printing a copy of electronic file for the client. Although the hard copy of the file is useful for the client’s future reference, the hard copy is incidental to the services the client purchased. Accordingly, your entire charge would remain nontaxable.

Electronic Copy and Hard Copy are Both Primary Objects

Assume a client has purposes for both an electronic file of her design and a hard copy of the electronic file and asks you to produce each. You charge one price for the conversion services and an additional price for printing the hard copy. Under these circumstances, neither the conversion services nor the printing would be considered incidental to the other. Each is a primary object of the transaction. Accordingly, each transaction would be considered separately for taxation purposes, with the charge for the conversion service remaining nontaxable and the charge for printing the hard copy being taxable. The two charges would need to be invoiced as separate items, or the entire charge would be taxable.

Question 3. Printing an Electronic File You Did Not Create. The only object of this transaction is printing a hard copy onto paper. As previously discussed, charges for printing are taxable. Accordingly, charges for printing onto paper an electronic file you did not create are taxable.

Please contact us if you have any other questions.

For the Commission,

Marc B. Johnson

Commissioner

MBJ/KC

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