Entries in sales tax (2)

Wednesday
Mar222017

NC Department of Revenue advises on Sales Tax law

Thanks to the NC Constuction News for the heads-up on this...

On March 17, 2017, the North Carolina Department of Revenue published an advisory notice that provides the most extensive and detailed guidance to date for the construction industry on what is, and is not, covered by the "capital improvement" and "repair, maintenance, and installation services" categories of the recently amended sales and use tax laws.  While explicitly disclaimed that it is "not specific tax advice," the chart in the bulletin breaks down various construction categories, and indicates whether activities applicable to that trade or activity are capital improvements or RMI services.  

This blog would strongly recommend bookmarking to the notice if any construction business has questions about application of the sales and use taxes in North Carolina.

Monday
Feb222016

New NC Sales Tax on Services Goes Into Effect March 1

On March 1, 2016, changes to North Carolina’s sales tax laws go into effect, including an expanded application of sales taxes to include “service contracts” and “repair, installation and maintenance services” (“RMI services”).  The following is a summary of the changes, and how they may affect companies in the construction industry:

What is a “service contract?”  A “service contract” is defined as a “contract where the obligor under the contract agrees to maintain or repair tangible personal property, regardless of whether the property becomes a part of or is affixed to real property, or a motor vehicle.”  (N.C. Gen. Stat. § 105-164.3(38b).)  Examples of service contracts include warranty agreements other than a manufacturer’s warranty or dealer’s warranty provided at no charge to the purchaser, an extended warranty agreement, a maintenance agreement, a repair contract, or a similar agreement or contract.”  (Id.)  Prior to the March 1 change, service contracts for tangible personal property that is or will become a part of real property was not subject to sales tax, unless the service contract was sold by the obligor or by a third party or facilitator at the same time as the item of tangible personal property covered by the service contract.  (former N.C. Gen. Stat. § 105-164.4l(c).)

What are “repair, maintenance, and installation services?”  RMI services are activities defined in the 2015 Appropriations Act (HB 97) as those services to: (1) keep or attempt to keep tangible personal property or a vehicle in proper working order so as to avoid the property from breaking down or needing repair; (2) calibrate, restore, or attempt to calibrate or restore tangible personal property or a vehicle to proper working order or to a good condition including replacing or putting back together broken parts; (3) troubleshoot, identify, or attempt to identify the source of a problem in order to determine what must be done to restore the tangible personal property or the vehicle to its proper working condition or a good condition; and (4) install or apply tangible personal property, except for tangible personal property installed or applied by a real property contractor pursuant to a real property contract.  (N.C. Gen. Stat. § 105-164.3(33d).)

In addition to defining RMI services, the bill expands the definition of a “retailer” to include a person who “is engaged in business of delivering, erecting, installing, or applying tangible personal property fur use in this State, regardless of whether the property is permanently affixed to real property or other tangible personal property,” unless this person solely operates as a real property manager or if the person is one whose only business activity is providing repair, maintenance, and installation services where the person’s activities do not otherwise meet the definition of a “retail trade.”  (N.C. Gen. Stat. § 105-164.3(35)(b).)  A “retail trade” is defined in the amendments as a trade where a majority of revenue comes from retailing tangible personal property, digital property, or services to consumers.  The term also includes maintaining an inventory and may include the provision of repair, maintenance, and installation services.  (N.C. Gen. Stat. § 105-164.3(35b).)

Where have the changes occurred?  The privilege tax imposed upon retailers engaged in business in the state has been expanded to apply the 4.75% rate to the sales price of or the gross receipts derived from repair, maintenance, and installation services.  (N.C. Gen. Stat. 105-164.4(a)(15).)  The retail sales tax statute was also amended to exclude from taxation “[r]epair, maintenance, and installation services provided for an item for which a service contract of the item is exempt from tax under G.S. 105-164.4I,” and “[r]epair, maintenance, and installation services purchased for resale.”  (N.C. Gen. Stat. § 105-164.13(61a), (61b).)   In addition, “repair, maintenance, and installation services used to maintain or repair tangible personal property or motor vehicle pursuant to a service contract taxable under this Article if the purchaser of the contract is not charged or the item” are also exempt from the retail sales tax.  (N.C. Gen. Stat. § 105-164.13(62).)

How do the changes affect construction firms?  To figure out whether a construction firm is required to collect sales tax for RMI services requires parsing the various new definitions and how they apply to the company’s business.  There are four different categories of business operations which could conceivably apply to a particular construction business.  Those are:

(1) “Real property contractor” – This is defined as “a person that contracts to perform construction, reconstruction, installation, repair, or any other service with respect to real property and to furnish tangible personal property to be installed or applied to real property in connection with the contract and the labor to install or apply the tangible personal property that becomes part of real property. The term includes a general contractor, a subcontractor, or a builder for purposes of G.S. 105‑164.4H. The term does not include a person engaged in retail trade.”  (N.C. Gen. Stat. § 105-164.3(33a).

(2) “Retailer” – This is defined as a person engaged in business of making, offer, or soliciting sales at retail “of tangible personal property, digital property, or services for storage, use, or consumption in this State.”  (N.C. Gen. Stat. § 105-164.3(35)(a).)  It also covers a person “engaged in business of delivering, erecting, installing, or applying tangible personal property for use in this State, regardless of whether the property is permanently affixed to real property or other tangible personal property unless” the person is a person that solely operates as a real property contractor, or a person whose only business activity is providing repair, maintenance, and installation services where the person's activities do not otherwise meet the definition of a retail trade.  (N.C. Gen. Stat. § 105-164.3(35)(b).)

(3) “Retailer-contractor” – This is defined as a person that acts as a retailer when it sells tangible personal property at retail and as a real property contractor when it performs real property contracts.  (N.C. Gen. Stat. § 105-164.3(35a).)

(4) “Retail trade” – This is defined as “a trade in which the majority of revenue is from retailing tangible personal property, digital property, or services to consumers. The term includes activities of a person properly classified in NAICS sector 44‑45, buying goods for resale, and rendering services incidental to the sale of merchandise. The term typically includes maintaining an inventory and may include the provision of repair, maintenance, and installation services. Not all activities provided in this subdivision are required for a trade to be considered retail trade.”

The easiest category to figure out for application of the new sales tax is the real property contractor.  A company that only performs “construction, reconstruction, installation, repair, or any other service with respect to real property” is effectively exempted from having to charge and collect the new sales tax for its construction-related services, because those businesses do not fit the definition of a “retailer.”  However, the converse is also true – a business engaged in a retail trade cannot be treated as a real property contractor under the sales tax statutes.  The statute specifically cites to the NAICS (North American Industry Classification System) retail trade sector codes 44 and 45, which apply to companies “engaged in retailing merchandise, generally without transformation, and rendering services incidental to the sale of merchandise.”  Construction companies typically are classified under NAICS sector 23.

The greatest points of confusion affect the two categories of services:  service contracts, and RMI services.  According to the NC Department of Revenue, the sale of service contracts is taxable, even if sold by a real property contractor.  (See N.C. DOR Notice regarding sale or renewal of service contracts dated Feb. 2, 2016.)  The Department detailed examples including an HVAC company selling a service contract, and a garage door retailer selling a service contract.  For the garage door example, the Department wrote:

On March 1, 2016, a retailer engaged in business in North Carolina makes a retail sale of a service contract on a garage door installed in a customer’s home in North Carolina.  The retailer collects sales tax on the sales price of the service contract.  On March 31, 2016, the customer’s garage door requires service covered by the service contract.  The obligor arranges for repair services and is charged $250.00 for parts and installation by a garage door retailer.  The obligor provides Form E-595E to the garage door retailer to purchase the parts and installation exempt from sales and use tax and does not charge the purchaser of the service contract for the parts and installation.

(Id., p. 2.)  In relation to that or similar situations, the Department notes that purchases of items or RMI services to maintain or repair tangible personal property pursuant to service contract subject to the new sales tax should be exempted from those taxes (so as to avoid double taxation) by giving a properly completed Form E-595E exemption certificate to the seller.  (See id.)

Finally, there is the determination of whether a construction company qualifies as a “retailer-contractor,” in which case the retailing operations are subject to the sales tax provisions, and the real property contracting operations are not.  The test used there is the “majority of revenues” standard from the definition of “retail trade” under Section 105-164.3(35b).  According to the Department of Revenue, a business who is not in the retail trade sector can meet the definition of “retail trade” if a majority of its revenue is from retailing tangible personal property, digital property, or services to consumers in the State.  (See N.C. DOR Directive SD-16-1, pg. 4.)  According to Directive SD-16-1, a kitchen remodeling company with $2 million in cumulative revenue, with $1.5 million from kitchen remodeling contracts and $500,000 from retail sales of kitchen cabinets, is deemed to have received 75% of its revenue from the “real property contracting” activities, and 25% of its revenue from the retail sales, and could therefore be a “retailer-contractor.”  (See id., p. 5.)

What do construction companies do now?  This article is not intended to give legal advice or tax advice to any reader regarding how much a construction company is required to charge or withhold in sales tax beyond what it presently does.  Any company doing business in North Carolina should retain experienced counsel who can review the new laws and advise the company on how its particular business will be affected by the changes.

That said, there are some general conclusions that can be drawn for all contractors:

1.     Any business that sells or furnishes service contracts other than a manufacturer’s or dealer’s warranty, will need to account for those contracts and charge sales tax to customers.

2.     A company engaging solely as a real property contractor is largely unaffected by the changes, because the “repair, maintenance, and installation services” definition excludes the installation or application of tangible personal property by a real property contractor pursuant to a real property contract.  (See N.C. Gen. Stat. § 105-164.3(33d)(d).)  This applies to both installation and repair services, so long as the property being serviced is affixed to the real property.  (See N.C. Gen. Stat. § 105-164.3(33a).)

3.     Any business that both sells materials to be installed by its own workers, and sells materials that may be utilized or installed by the customers or others, needs to keep extra care with its records, especially if the split between the sales and the installation work gets close to the 50% threshold.  Once the majority of revenue comes from retail sales, the company may automatically tip into being defined into the “retail trade.”

For further questions regarding how House Bill 97 may affect your business, please call us at (919) 828-1396 to set up an appointment.