Connecticut State Department of Revenue Services

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Ruling 94-3

Sales and Use Taxes
Manufacturing Machinery
Manufacturing Recovery Act of 1992

FACTS:

A Connecticut company (the "Company") manufactures architectural models and industrial prototypes which it sells to its customers. The Company receives plans for the finished products from its customers either as drawings or as data on computer discs. The Company then edits the plans, using a software program on a computer, to break them down into computer images of the individual parts that will eventually be cut out on its computerized milling machines. The Company then uses another software program to write programs to "instruct" the computerized milling machinery how to cut out the parts, based on the analysis of the individual parts performed by the first program.

ISSUE:

Whether the Company may claim exemption under Conn. Gen. Stat. § 12-412(34) for the purchase of software programs it uses in the production of architectural models and industrial prototypes.

Whether the Company may claim exemption under the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i, for the purchase of software programs it uses in the production of architectural models and industrial prototypes.

DISCUSSION:

Conn. Gen. Stat. §12-412(34) exempts sales of "machinery used directly in a manufacturing production process." The statute defines "machinery" as:

... the basic machine itself, including all of its component parts and contrivances, such as belts, pulleys, shafts, moving parts, operating structures and all equipment or devices used or required to control, regulate or operate the machinery, but excluding office equipment or data processing equipment other than numerically controlled machinery used directly in the manufacturing process.

Conn. Agencies Regs. §12-412(34)-1(f)(3) elaborates on the type of property included within the scope of the exemption by stating that

[machinery ... (A) that is used exclusively to control or monitor an activity occurring during the manufacturing production process, or exclusively to design a product as well as to control or monitor an activity occurring during the manufacturing production process (e.g., a computer aided design/computer aided manufacturing machine), and (B) that is directly linked with machinery [other machinery used directly in a manufacturing production process], is used directly in a manufacturing production process.

Therefore, computers and computerized machinery used as described in Conn. Agencies Regs. §12-412(34)-1(f)(3) are considered "machinery" that may qualify for exemption under Conn. Gen. Stat. §12-412(34) if the remaining requirements for exemption are met. In addition, since such computers and computerized machinery will not function without software, software may be "equipment or [a] device used or required to control, regulate or operate the machinery..." that also qualifies for exemption under Conn. Gen. Stat. § 12-412(34) when purchased in the same transaction with the machinery.

In Ruling No. 93-1, a distinction was made between the sale of prewritten (or "canned") software, which is taxable as the sale of tangible personal property, and the sale of custom software, which represents a combination of the sale of a nontaxable license of intangible personal property and the sale of taxable computer and data processing services. Customized software represents a combination of the characteristics of prewritten software and custom software, in that customized software is made up from a "base" of prewritten software to which significant modifications are made. The sale of customized software combines a taxable sale of computer and data processing services and the nontaxable sale of a license. Sales and use taxes are due on the purchase of prewritten software to be customized, whether such purchase is made by a customizer or its customer (resale treatment is not appropriate when prewritten software is purchased by a customizer because the software is used by the customizer in rendering a service).

The exemption under Conn. Gen. Stat. §12-412(34) applies only to sales of tangible personal property (in fact, the same is true for all of the exemptions from the sales and use taxes for items purchased in connection with manufacturing, such as in subsections (18), (34) and (73) of Conn. Gen. Stat. §12-412 and in Conn. Gen. Stat. § 12-412i). Under the distinction made in Ruling No. 93-1 between sales of prewritten software and sales of custom or customized software, only sales of prewritten software, as sales of tangible personal property, are able to qualify for any of the exemptions provided in the Sales and Use Taxes Act for items purchased for use in connection with manufacturing (except when software is purchased in the same transaction with the machinery on which it is to be used; see below). Both of the software programs used by the Company are prewritten, in that they are produced for a general class of users and need little if any modification to be able to function in the manner required by the Company, and so they may qualify for a manufacturing exemption.

Conn. Agencies Regs. §12-412(34)-1(b) provides that component parts and contrivances of machinery exempt under Conn. Gen. Stat. §12-412(34) (including equipment and devices used or required to control, regulate or operate machinery) are exempt only if they are purchased in the same transaction with the basic machine. Thus, prewritten software purchased in a separate transaction from the machinery on which it is to be used is not exempt under Conn. Gen. Stat. §12-412(34). However, the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i (the "MRA"), also includes in its definition of "machinery" "all equipment or devices used or required to control, regulate or operate the machinery," and it does not limit its exemption to such equipment or devices purchased in the same transaction as the machinery on which they are to be used. Therefore, prewritten software that does not qualify for exemption under Conn. Gen. Stat. § 12-412(34) may qualify for the partial exemption under the MRA. (See Special Notice SN 93(1).)

Taxable charges for custom or customized software that is purchased in the same transaction (i.e., at the same time and from the same vendor) with the machinery on which such software is to be used may be included in the exemption under Conn. Gen. Stat. §12-412(34). Such sales of custom or customized software may be exempted under Conn. Gen. Stat. §12-412(34), despite the fact that the software is not being sold as tangible personal property, by reason of Conn. Gen. Stat. §§12-407(8)(a) and 12-407(9)(a), which provide that "sales price" and "gross receipts" include "[any services which are part of the sale." Thus, since any charges for taxable computer and data processing services rendered in the creation or customization of software accompanying manufacturing machinery are included in the gross receipts and sales price, such charges must also be included in the exemption under Conn. Gen. Stat. §12-412(34).

RULING:

If the Company purchases software, whether it is prewritten, custom or customized, in the same transaction with the machinery on which it is to be used, all otherwise taxable charges for such software may qualify for exemption under Conn. Gen. Stat. §12-412(34). If the Company purchases prewritten software in a transaction separate from its purchase of the machinery on which the software is to be used, such software may be purchased under the partial exemption provided by the Manufacturing Recovery Act of 1992, Conn. Gen. Stat. §12-412i.

LEGAL DIVISION

Issued: February 8, 1994