Edward S. Kisscorni, CPA-MBA Michigan State and Local Tax Newsletter

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1 Edward S. Kisscorni, CPA-MBA Michigan State and Local Tax Newsletter April 16, 2010 Michigan Department of Treasury Change in Policy on Sales and Use Tax Audits Troublesome for Retailers In recent months the Department of Treasury (Treasury) has stepped up its auditing for sales and use taxes. A specific area of concern involves the characterization of taxpayers as "contractors" for purposes of the sales tax or the use tax. In two cases, which my office is currently handling, Treasury in audit has determined that a retailer of commercial restaurant equipment is a contractor when installation is involved. In the other case, a retailer of theater seating was deemed on audit to be a contractor when installation is involved. In both cases, substantial tax deficiencies were computed as Treasury did not allow exemptions which were available to retailers but not contractors. Both field audits represented a change in policy from a previous audit. It appears now, the new policy is "when installation is involved, the taxpayer is deemed a contractor". Recent Blog PostsArticle 1 Headline Subscribe to Ed Kisscorni's Blog At: Friday, 16 April 2010 Single Business Tax Apportionment Sourcing of Sales Case Decided by the Michigan Court of Appeals Thursday, 15 April 2010 Michigan Tax Tribunal Exempts a Steel Company's Conveyor System Tuesday, 13 April 2010 Michigan Department of Treasury Rescinds Notice To Taxpayers Regarding Kmart Ed Kisscorni's Blog: Contractor or Retailer Determination of Type of Business Is Critically Important to the Tax Determination and Whether Exemptions are Applicable A very critical determination in the computation of tax base involves the categorization of a taxpayer as either a contractor or retailer. This determination can be critical when the application of one of the sales tax or use tax exemptions is applicable. Both the Michigan sales tax act and the Michigan use tax act provide exemptions for the purchase of tangible personal property when that

2 tangible personal property is used or consumed by an industrial processor or an agricultural producer. Both acts also provide exemptions from the purchase of tangible personal property for use or consumption by a church, school, governmental organization, or nonprofit organization. In all instances, the exemption only applies to the purchase of tangible personal property at retail. If the tangible personal property involved does not qualify as a retail sale, that is, the seller is acting as a contractor, the exemption would not apply and the tangible personal property would be subject to the full 6% tax. Contractor Defined Neither the Sales Tax Act nor the Use Tax Act specifically defines a "contract" or a "contractor". However, indirectly it is defined in Section 2(g), the definition of "consumer'. Contractors are "persons engaged in the business of constructing, altering, repairing or improving real estate for others" when the material so purchased by such persons is affixed and made a structural part of the real estate or used and completely consumed in the fulfillment of a single contract. (MCL g) (g) "Consumer" means the person who has purchased tangible personal property or services for storage, use, or other consumption in this state and includes, but is not limited to, 1 or more of the following: (i) A person acquiring tangible personal property if engaged in the business of constructing, altering, repairing, or improving the real estate of others. (MCL g) "Contractor" includes only prime, general, and subcontractors directly engaged in the business of constructing, altering, repairing, or improving real estate for others. (Rule 21(1), R ) Contractors are consumers of the materials used by them. All sales to or purchases by contractors of tangible personal property are taxable, except when affixed and made a structural part of real estate for a qualified exempt nonprofit hospital, a nonprofit housing entity qualified as exempt under the sales and use tax acts, a church sanctuary or a certified exempt pollution control facility. All materials consumed in the performance of such contracts and not affixed and

3 made a structural part of real property are taxable. (Rule 21(2), R ) In order for a taxpayer to be determined to be a contractor, and lose the advantage of certain tax exemptions, the taxpayer must both affix tangible personal property to real estate and make the tangible personal property a structural part of the real estate. Other than that which was mentioned above, neither the Michigan sales tax act nor the Michigan use tax act contain a specific definition of what constitutes a contractor. The determination is usually made in the negative. That is, the statute and the definitions of a retail sale. A transfer of property may be determined to be not a retail sale but rather a consumption of tangible personal property by a construction contractor. The Michigan Supreme Court has laid out three general tests to determine realty. (Swan M. Sequest v Charles Fabiano, Michigan Supreme Court, Docket No. 73, Calendar No. 38,761, march 2, 1936) 1. Annexation to realty either actual or constructive. The court requires that the tangible personal property not only be attached to or affixed to the real estate, but that the annexation to the real estate is actual or constructive. 2. Adaptation or application to the use or purpose to which that part of the reality to which it is connected is appropriated. The court requires that the tangible personal property, which has been affixed to reality, takes on a purpose or function that is in common with the adaptation or application of the reality itself. 3. Intention to make the article a permanent assession to the freehold. All the facts and circumstances of the case must lead to the conclusion that the tangible personal property is a permanent part of the real estate and was intended to be so. The tangible personal property can easily be removed and if in fact is done so, then the implication of the court's opinion is that the property would retain its personal property nature. Retailer Defined The term "retailer" involves all persons who sell to the last or final buyer, user or consumer.

4 The term "sale at retail" means any transaction by which is transferred for consideration the ownership of tangible personal property, when such transfer is made in the ordinary course of the transferors business, and is made to the transferee for consumption or use, or for any other purpose than for resale in the form of tangible personal property. The "consumer" means the person who shall have purchased tangible personal property for storage, consumption or use. The "consumer" is clearly defined as a person who does not purchase goods for sale. The buyer, who disposes of goods in any other manner than by resale, becomes the final consumer. (Rule 205.8) The general construction of the Michigan Sales Tax Act and the Michigan Use Tax Act specifies that where a taxpayer acquires tangible personal property to be used or consumed in the performance of a construction contract, that taxpayer is the consumer of the tangible personal property. Any sales of tangible personal property to become affixed to or become a structural part of real estate are a sale to the ultimate consumer. Tax Base Controversies evolve when a potential tax exemption is at stake. A "contractor" is considered to be the consumer of all tangible personal property, that is, all materials, supplies, and equipment used or consumed in performing that contract. The tax base for the contractor that is not a manufacturer/ contractor is the purchase price of all the materials, supplies, machinery and equipment purchased. A "retailer" making a sale and transferring tangible personal property to the final and ultimate consumer is responsible to pay the 6% Michigan sales tax on the total gross proceeds, without any deduction therefore, derived from the sale of tangible personal property. The term "gross proceeds" is defined to mean the total of all sales made during a given month or period. It also means the amount received or to be received in money, credits, subsidies, property or other monies worth for the consideration of sales at retail within Michigan, without any deduction whatsoever. If the purchaser of tangible personal property at retail qualifies as an industrial processor, or an agricultural producer, or if the tangible

5 personal property purchased is to be used or consumed by a church, school, hospital, governmental agency, or non-profit organization, then the purchase can be made tax-free if the purchaser renders to the seller a valid exemption certificate. These exemptions are invalid if the seller is acting as a contractor and affixing the tangible personal property to the reality to which it becomes a structural component thereof. Audit Issues Because of new technology and the changing nature of business, the determination of Michigan tax base may also be changing. It is very important for taxpayer's, as they acquire tangible personal property for use or consumption in their businesses, to keep in mind the tax base issues involved with the purchase. It is very important that taxpayer's are competent in the Michigan sales tax and Michigan use tax issues involved with the acquisition of tangible personal property. In an audit situation, when a retail sale made to an exempt person or to be used in an exempt activity is re-determined to be an affixation to realty, the exemption is lost. Sales and Use Tax Seminars I will be leading a discussion on the application of the sales tax and use to tax to contractors as well as other relevant sales and use tax issues at a series of seminars sponsored by the Michigan Association of Certified Public Accountants (MACPA). Tuesday, May 25, Troy Wednesday, June 2, Grand Rapids Wednesday, September 29, Grand Rapids Thursday, October 7, Livonia Industry Specific Seminars Construction Industry: On Friday, October 8, 2010 in Troy, Dave Barrons and I will be presenting a seminar titled: Michigan State and Local Tax for a Contractor. Along with coverage of the Michigan Business Tax, the seminar will cover the very complicated sales and use tax issues that construction contractors face. Manufacturing Industry: On Wednesday, October 20, 2010 in

6 Plymouth, Mike Lewakowski and I will be presenting a seminar titled: Michigan State and Local Tax for a Manufacturer. In addition to coverage of the Michigan Business Tax, the seminar will devote a substantial amount of time to the industrial processing exemption. Edward S. Kisscorni, CPA-MBA Federal Square Building 29 Pearl Street, Suite 108 Grand Rapids, MI Phone: 616/ Cellular: 616/ Facsimile: 616/ Website: Ed@EdKisscorni.com Blog: