Response August 20,
1993
Request
Joe B. Pacheco,
Commissioner
Utah State Tax
Commission
160 East Third South
Salt Lake City, UT
84134
Re: Request For Advisory Opinion
Dear Mr. Pacheco,
XXXXX is a company
which manufactures and leases, among other things, a packaging machine. This machine is patented. XXXXX's lease agreement requires the lessee
to pay all sales and use taxes, a base rental fee, and a “production” fee for
use of the patent. This production fee
is based on the number of packages the machine produces each calendar month. In
an earlier letter, the Tax Commission stated that “[w]hen the rental or lease
of tangible person property is subject to tax, the 'amount paid or charged is
taxable whether based on hours, units' produced, a combination of the two or
some other basis.” Att. 5A. However, XXXXX seeks an advisory opinion
that the production fee qualifies as a “royalty” or other intangible property
and therefore is exempt from Utah sales and use tax.
The production fee seems
to fit the classic definition of a royalty, which is “compensation for use of
property . . . expressed as a percentage or receipts from the property or as an
account per unit sold.” Black's Law
Dictionary 1330 (6th ed. 1990) (att. 4H).
Most cases define royalty either as the share of the product or profit
reserved by the owner for permitting another to use the property, see
Commissioner of Internal Revenue v. Clarion Oil Co., 148 F.2d 671, 673 (D.C.
Cir. 1945) (att. 2E); In re Tidy House Products Co., 79 F. Supp. 674, 677 (S.D.
Iowa 1948) (att. 2A), or as a tax or duty paid to the owner of a patent for the
privilege of manufacturing or using the patented article. Velsicol Chemical Co. v. Hooker Chemical
Corp., 230 F. Supp. 998, 1007 (N.D. Ill. 1964) (att. 2D); Hubenthal v. Kennedy,
39 N.W. 694, 695 (Iowa 1888) (att 2B).
The difference between
“rent” and a royalty is explained in Campbell v. Great Nat'l Life Ins. Co., 219
F.2d 693 (5th Cir. 1955) (att. 2C), which states that “rent” is compensation for
the right to use property which is certain in amount and payable periodically
over a fixed period regardless of the extent of use of the property, while a
“royalty” is compensation for the use of property which is based entirely on
the amount of actual use made of the property.
See also Bettis Rubber Co. v. Kleaver, 233 P.2d. 82 (Cal. Dist. Ct. App.
1951) (att. 2J).
Given these
authorities, it seems clear that the production fee charged by XXXXX is a
royalty.
Even if in your
opinion the production fee is not specifically a “royalty,” the fee still seems
to fit the definition of “intangible property.” Although “royalties” or “production fees” are not specifically
mentioned in the Utah Tax Code, these charges do not fit into the definition of
“tangible property” contained in Tax Commission Rule R865-19-26S and Utah Tax
Code § 59-12-102(13)(a) & (b).
These sections of the Code describe “tangible property” as “corporeal
things and substances” intangibles, on the other hand, are securities, bonds,
bank accounts, currency, etc. Id.; see
also 68 Am. Jur. 2d Sales and Use Taxes § 71 (att. 3A). Black's Law Dictionary defines “intangibles”
as “property that is a right such as a patent, copyright, trademark, etc. . . .
“ (att 4F). While the machine itself is
tangible property, use of the patent is not.
The test for
determining whether something is intangible or tangible seems to focus on what
is the object or essence of the sale.
In Bullock v. Statistical Tabulating Corp., 549 S.W. 2d 166 (Tex. 1977)
(att. 2L), the Supreme Court of Texas stated that [t]he basic question here is
what is being sold?” Id. at 168. “If
the object or the essence of the sale is not tangible personal property but
intangible property than the transaction is not taxable under any definition of
'sale.' Id. see, e.g., Mark O.
Haroldsen, Inc. v. State Tax Comm'n.
805 P.2d 176 (Utah 1990) (att. 2K); 91 A.L.R. 3d 282 (att. 3E).
In Haroldsen, the
court held that the actual thing bargained for was printed mailing lists, not
the service which provided them.
Haroldsen, 805 P.2d at 181-82 (att. 2K). However, in Bullock, the court held that the object of the
bargain was not the printed information, but “intangible property”; i.e., the
“purchase of coded or processed data” (italics omitted). Bullock, 549 S.W. 2d
at 168 (att. 2L,).
Under this test, the
fee for use of the patent is a sale or lease of an “intangible,” and therefore
not taxable as a sale of tangible property.
The fine line that the
courts had to walk in the above cases is not a source of controversy in this
case. XXXXX's lease contains both a fee
for tangible property (the base rental fee for the machine) and a fee for
intangible property (the production fee for use of the patent). These two fees easily separate the charge
for tangible property, which is taxable, and the fee for intangible property,
which is not.
Because the production
fee is in fact a royalty or other intangible, we feel that it is not subject to
Utah sales and use tax, for the Tax Code is only applicable to sales and leases
of tangible property. Utah Const. att.
XIII 2(1) (att. 1C); Utah Tax Code §
59-12-103(1)(k) (att. 1A).
We would appreciate an
advisory opinion on behalf of XXXXX confirming our view on this matter.
Sincerely,
XXXXX
TO: XXXXX, Director
FROM: XXXXX, Secretary
DATE: XXXXX
SUBJECT: Request for Advisory Opinion - No. 93-014DJ
Attached is a request
for an advisory opinion from XXXXX for XXXXX.
Will you please review the request of XXXXX regarding the application of
a production fee on a packaging machine.
Please prepare the
response for signature by the Commission as per the guidelines established by
them.
Thank you.
XXXXX
Re: Advisory Opinion - Sales Tax Applicability
to “Production Fees” Associated with the Lease of a Packaging Machine
Dear XXXXX:
Your request (copy attached) for an advisory opinion as to
whether sales or use tax applies to a “production fee” associated with a
packaging machine lease was referred to the Auditing Division for their
analysis.
The division's staff
recommendation is as follows:
1. The production fee is an additional charge
for use of the equipment to compensate the lessor for wear and tear as a result
of varying production levels. The fee
is part of the lease and subject to the tax.
Based upon the facts
presented in your letter, we are in agreement with the Auditing Division's
recommendations. Obviously, if there
are deviations from these facts, this opinion may be negated.
If you do not agree with
this determination, you may appeal to the Tax Commission for a formal
hearing. The results of that hearing
would constitute a declaratory judgment and be appealable to the Utah State
Supreme Court. A Notice of Appeal
Rights and a copy of the Utah Taxpayer Bill of Rights are attached.
For The Commission,
Alice Shearer
Commissioner