Washington – Medical Prototype did Not Qualify for Exemption or the High Technology Tax Deferral Program

3/4/2013

SALT Report 2212 – A Washington Appeals judge upheld a ruling by the Department of Revenue that disallowed the machinery and equipment exemption and the high technology tax deferral for purchases of materials used to build a medical device prototype.

Initially, the Taxpayer was approved for the High Technology Sales and Use Tax Deferral Program by the Department of Revenue. The Taxpayer was issued the appropriate certificate which was valid during the audit period. However, during the course of the audit, it was determined that certain materials the Taxpayer purchased to build its prototypes did not qualify for the M&E exemption.

To build its prototypes, the Taxpayer purchased “consumable” items which were incorporated into the R&D control testing tools.  The Taxpayer kept detailed files that listed all of the items that were incorporated into each testing tool as well as records of every use of that particular tool. The Taxpayer stated that each prototype was developed for the purpose of testing software, testing the product’s design, testing or calibrating tools, making and building other tools, or in various stages of the medical device’s manufacturing process. Further, the Taxpayer claimed that the entire testing process was done in an effort to comply with the FDA’s guidelines.

However, in the audit report, the auditor determined that the consumable items used to build the prototypes did not qualify for the exemption and were subject to tax. The Taxpayer appealed the decision and did not pay the assessment.

Upon review of the case, the Appeals Judge stated that, although the building of a prototype may be an integral and necessary part of the development of a new product, the ingredients and components used in the creation of the prototypes are not eligible for the high technology sales and use tax deferral program.

Further, nothing in the tax deferral statute or rule indicates that prototypes or their component parts and ingredients qualify as “machinery and equipment.”  Therefore, the items used to create the Taxpayer’s prototype do not qualify for the manufacturing and equipment exemption provided in RCW 82.08.02565.

Additionally, the Judge stated that the only situation in which a prototype would qualify for the M&E exemption is if it was used to build or test a different product, or if it was used in “a supportive capacity in stages of the manufacturing operation.” However, the Taxpayer did not use its prototype to test other items of tangible personal property; rather it used the prototype to test new versions of the same product.

Based on the above, the Judge denied the Taxpayer’s appeal and upheld the Department of Revenue’s audit assessment.

For Further Information

Washington Department of Revenue – Tax Determination No. 11-0052