A Shift in the NC Sales Tax Landscape: Service Contracts & Repairs, Maintenance & Installation Services

Transcription

1 A Shift in the NC Sales Tax Landscape: Service Contracts & Repairs, Maintenance & Installation Services Tony Buffkin, CMI Director Dixon Hughes Goodman LLP Charlotte, NC Brian Reder Tax Accountant II Belk Store Services, Inc. Charlotte, NC Michael Hannah, Esq., CPA Michael A. Hannah, Attorney at Law Bear Creek, NC

2 But First.. WHY DID NORTH CAROLINA CONSIDER SALES TAX REFORM NECESSARY? 2

3 How North Carolinians spend $100 of their income as a % of items subject to Sales Tax THE SALES TAX BASE HAS SHRUNK SIGNIFICANTLY!! 3

4 A Nationally Recognized Sales Tax Expert Says: Sales tax should be a tax on consumer spending American sales tax is, and historically has been, essentially a tax on the sale of tangible personal property at retail But the absence of sales tax on services is more the product of historical accident than logic many fewer services existed when sales taxes enacted There is no difference between tangible personal property and services that would warrant a different (sales) tax treatment Sales Taxation of Services: An Overview of Critical Issues by Walter Hellerstein 4

5 History of Calls to Expand NC Sales Tax Base 1951 Revenue Commissioner Eugene Shaw eliminate all exemptions except those on business inputs and expand the base to include services 1991 Economic Future Study Commission expand base to more retail services, eliminate exemptions except those for business inputs 2002 Governor s Commission to Modernize State Finances expand base to more retail services 2005 N.C. Budget & Tax Center Study expand base to more retail services 2006 State & Local Fiscal Modernization expand base to more retail services See a Trend here? 5

6 With repeated recommendations to expand the sales tax base to more retail services from so many sources during the last 66 years, Why is it that more sales tax base expansion has not already occurred???? 6

7 Latest Trends in North Carolina Sales Taxes 7

8 Overview of Sales Tax Changes Expansion of tax base Entertainment charges Service contracts Repair, Maintenance, and Installation (RMI) services Electricity and piped natural gas Elimination of exemptions Installation Sales tax holidays Income threshold for farm exemption Cap on nonprofit refunds Local sales tax redistribution 8

9 2016 Session Highlights The NC General Assembly s response to taxpayer confusion & consternation regarding 2015 sales tax changes 9

10 Quick Summary 2016 Sales Tax changes Broadened the sales tax base to include more Repair, Maintenance and Installation (RMI) services Clarification of application of sales tax to transactions involving RMI services Expansion of exemption from sales tax for purchases of machinery by certain industries (recyclers, precious metal extractors, metal fabricators, repair parts for port equipment) 10

11 Sales Tax on RMI Services Section 38.5 S.L Is this job subject to sales tax or not??? 11

12 Evolution of RMI Tax Changes Expansion of Sales Tax Base 2013 Service contracts 2014 Service contract clarification 2015 Installation charges RMI of TPP taxable, unless only provides RMI service A retailer could not be a real property contractor if engaged in retail trade (51% test) Service contract, regardless of whether TPP becomes part of real property Retailer-Contractor 2014 DIFFERENT ISSUE Clarify who the end user is for sales tax Is a transaction a retail sale of TPP plus installation OR a performance contract? 2015 Expansion of sales tax base reversed much of the sales tax application law enacted in 2014 Effective 3/1/16 12

13 Unintended Consequences of March 2016 changes Similar transactions treated differently, based on Classification of provider (retailer v. solely a contractor) OR Whether the RMI service was for real property or tangible personal property Create no new retailers. was the theory in 2015 But this theory proved difficult to apply in a statute 13

14 Unintended Consequences of March 2016 changes (cont d) Confusion about how to apply the tax Uneven playing field for some taxpayers (retailers v. solely RMI providers) Revenue Laws Study Committee reviewed the issue & determined: Treat similar transactions the same Identify taxable transactions more clearly Provide a grace period for retailers because of confusion 14

15 Changes Effective 3/1/16 Performance of a repair or maintenance service subject to NC sales tax Retail sale of RMI services became subject to sales tax if the service provider was deemed to be engaged in a retail trade as opposed to only providing services NCDOR issued several interpretative directives in an attempt to clarify the statutes 15

16 Changes Effective 3/1/16 (cont d) Statutory test established for determining if a person is engaged in a retail trade >50% of revenue derived from retail sales of TPP, Digital Property or Taxable Services In practice this was difficult to apply resulting in taxpayer confusion despite several detailed directives issued by NCDOR When/How should the 51% test be applied? Yearly? Monthly? Average? 16

17 Controlled Chaos? In response to the complexity of the sales tax law changes effective 3/1/16 and resulting taxpayer confusion, the General Assembly enacted additional changes to the RMI service and other sales tax statutes which became effective January 1, As a result, taxpayers have been required to determine their potential sales tax liability under three separate statutory structures: Pre - 3/1/16 3/1/16 through 12/31/16 & 1/1/17 forward. 17

18 S.L , Sec Changes effective January 1, 2017 DOR provided initial written guidance on November 15, 2016 Directive SD s/directives/sd-16-3.pdf Directive SD s/directives/sd-16-4.pdf 18

19 S.L , Sec (cont d) Grace period provisions Not liable for undercollection of sales or use tax arising from RMI transactions if good faith effort to comply March 1, 2016, through December 31, 2016 Authority for Secretary of Revenue to compromise tax liability of assessment from 3/1/16 through 12/31/22 19

20 Key Changes Effective 2017 Removed retail trade test (>50% of revenue from retail) Retailer-Contractors Person whose only business activity is retail trade Expands application of RMI service rules to: Digital property Real property Clarifies definition of RMI service Clean, wash, or polish property Connect, adjust, or set into position property Inspect or monitor property 20

21 Key Changes Effective 2017 (cont d) Real property contract between real property contractor and a person for a capital improvement (CI) is NOT a taxable RMI service Specific exemptions from sales tax for some RMI services by defining by statute as CI Significant changes to definitions of real property contract and capital improvement It is extremely important to distinguish between the definitions for pre- and post- 1/1/17!! 21

22 Key Definition Changes Effective 2017 Real property contract - A contract between a real property contractor and another person to perform construction, reconstruction, or remodeling with respect to a capital improvement to real property. Real property contractor - A person that contracts to perform a real property contract in accordance with G.S H. The term includes a general contractor, a subcontractor, or a builder for purposes of G.S H. 22

23 Key Definition Changes Effective 2017 Repair, maintenance & installation services (RMI) includes activities involving TPP, vehicles, digital property and real property, UNLESS applied by real property contractor pursuant to real property contract. 23

24 RMI Service: What it IS G.S (33i) Keep in working order to avoid breakdown, deterioration, repairs Clean, wash, polish Calibrate, refinish, restore to proper working order or good condition Replacing or putting together what is torn or broken Troubleshoot or identify the source of a problem Install, apply, connect, adjust, or set into position To inspect or monitor 24

25 RMI Service: What it is NOT The term includes the activities listed in this subdivision and applies to tangible personal property, digital property, and real property EXCEPT tangible personal property or digital property installed or applied by a real property contractor pursuant to a real property contract By definition, the tax does not apply to a contract by a real property contractor to perform construction, reconstruction, or remodeling with respect to a capital improvement 25

26 So, What is a Capital Improvement (CI)? Generally Addition or alteration to real property Permanently installed or applied so removal causes material damage Does NOT include replacement of a fixture unless it is part of remodeling Does NOT include a single RMI service Specific List of CI items: Removal of waste & debris Building permit Installation of underground utilities Installation of equipment or fixtures capitalized for income tax or GAAP or IFRS Painting & wallpapering Landscaping & roads Replacement or installation of HVAC unit or system; roofing, septic, plumbing, electrical, commercial refrigeration, irrigation, sprinkler, or similar system 26

27 And, Who is a Real Property Contractor? G.S H Consumer of the TPP, digital property, or RMI service used to fulfill a real property contract Definition has changed over time 2014 law change If item installed became part of real property Applied equally to retailercontractors 2015 law change Retail trade distinction Retailer-contractor could not be a real property contractor 2016 law change Applies equally to retailers & contractors Used to fulfill real property contract involving a capital improvement 27

28 Real Property Contracts Mixed Transactions Contracts with both: Capital improvement RMI service 10% Rule Does RMI exceed 10% of the contract? If Yes, allocated amount for RMI is taxable If No, treat all of contract as exempt real property contract Exemptions Separately stated installation charges provided by real property contractor are exempt: Part of the sales price of TPP purchased and used to fulfill real property contract Part of the sales price derived from RMI services purchased by real property contractor to fulfill RPC Charged by retailercontractor when performing real property contract 28

29 Service Contract: What it IS G.S (38b)---Service Contract Obligor under a contract agrees to: maintain, monitor, inspect, or repair digital property or tangible personal property for a period of time or some other defined measure, regardless of whether the property becomes part of or is applied to real property Includes service contract for pool, fish tank, or other aquatic features Does NOT include a single RMI service Bundling of two or more services, one of which is taxable---allocate price for taxable service 29

30 Statutory Exemptions: Certain RMI Services Fee for inspection required by law Services provided by a related member Services performed to resolve an issue that was part of a real property contract Cleaning of real property Alteration and repair of clothing Self-service car washes Services on roads, driveways, parking lots, and sidewalks Removal of waste, trash, debris (except portable toilets) Home inspections related to sale of property Landscaping Pest control Moving services 30

31 Service Contracts for Motor Vehicles G.S I A service contract on an item exempt from sales tax is also exempt March 1 December 31, 2016 Motor vehicle is exempt from sales tax What about component parts? They are not exempt from sales tax January 1, 2017 Exempts motor vehicle service agreement from sales tax per I(b)(6) G.S (23a) Sold by a MV dealer or by or on behalf of a motor vehicle service agreement company For the vehicle or for one or more components, systems, or accessories for a motor vehicle 31

32 What Are the Grey Areas for RMI Services? 32

33 General Statutory Rules No sales tax on receipts from RMI from a real property contract for capital improvements If transaction is not a capital improvement OR not exempt by statute, the RMI service is subject to sales tax But statutory definitions leave many unanswered questions regarding: What is a capital improvement? 33

34 North Carolina Department of Revenue to the rescue!!!!... with more detailed guidance on how the sales tax on RMI works. The List was issued on 3/20/17 and includes 261 specific examples of how to treat many RMI transactions mirmi.pdf 34

35 RMI Rules of the Road NCDOR Notice specifically refers taxpayers to Directives SD-16-3 and 16-4 and Form E589CI Transactions on the list will generally constitute a real property contract when performed for new construction, reconstruction or remodeling. Initial installation means work performed in connection with new construction. 35

36 RMI Rules of the Road cont d Some installations qualify as a capital improvement by statute even if NOT new construction, reconstruction or remodeling Lessee improvements must be permanent and title must vest with building owner to be considered a capital improvement/real property contract. (this changed!!!) Replacement of fixtures is NOT a capital improvement unless part of remodeling. 36

37 RMI Rules of the Road cont d A single RMI service is NOT a capital improvement UNLESS specifically designated as such by statute The new definitions of repair, maintenance and installation services effective on January 1, 2017, apply to the transactions listed on NCDOR notice released in March The list is NOT specific tax advice, is not allinclusive and may be (will be!) updated in the future by NCDOR 37

38 THE LIST List of RMI transactions divided by category with columns that indicate whether RMI is a capital improvement & exempt, OR RMI subject to sales tax OR statutorily exempt RMI 261 very detailed transactions for different industries including: refrigeration, electrical, HVAC, building exterior, doors, kitchens, landscaping, plumbing, roofing, walls, windows, etc. mirmi.pdf 38

39 NCDOR Form E-589CI Decision Tree Property Owner New Construction or Reconstruction Working with GC No E-589CI needed Working with Sub-contractors only Issue E-589CI Remodeling Working with GC Issue E-589CI Working with Sub-contractors only Issue E-589CI General Contractor New Construction or Reconstruction Working with Sub-contractors Issue E-589CI Working with NO Sub-contractors No E-589CI needed Remodeling Working with Sub-contractors Issue E-589CI Working with NO Sub-contractors No E-589CI needed 39

40 ???But Unanswered Questions Remained??? Is a solar farm TPP or real property? (sales tax, & income tax implications!) What is a capital improvement? Mixed transactions of both RMI & remodeling? Taxpayers must determine taxability under three different statutory schemes (pre 3/16, 3/16-12/16, & 1/17 forward) Are those engaged in a licensed profession subject to tax if they perform inspection (which meets definition of RMI) on real property and issue a report? (Engineers, architects, etc.) 40

41 Proposed Senate Bill 628 NOTICE! The ensuing discussion is based on PROPOSED legislation, not enacted statutes-----stay tuned for enactment (or not) 41

42 General Assembly to the Rescue? Senate Bill 628 filed 4/4/17 Not enacted during regular session but will be reconsidered on August 3. Statutory clarification of many items appearing on the NCDOR notice and list issued on 3/20/17 Bundled transaction rules do not apply to real property and services to real property New mixed transaction rules defined 42

43 General Assembly to the Rescue? cont d Only motor vehicle service contracts sold by automobile dealer or vehicle service agreement company qualify for the sales tax exemption on service contracts excludes other retailers Real property contract re-defined and limited to capital improvement Definition of RMI services clarified 43

44 General Assembly to the Rescue? cont d Definition of capital improvement significantly changed and clarified (and hopefully simplified) An addition or alteration to real property that is permanently affixed or installed to real property and includes the following.. new construction, reconstruction, remodeling 44

45 General Assembly to the Rescue? cont d Capital improvement continues to include: equipment attached to real property that is capitalized for tax, GAAP or IFRS replacement of HVAC, electrical systems, plumbing systems, roads, driveways, patios, sidewalks, etc. HOWEVER---Sales of free-standing appliances are always taxable sales of TPP & subject to sales tax 45

46 General Assembly to the Rescue? cont d Clarification of substantiation requirements for capital improvements contractors may substantiate with records OR acceptance of E589CI Joint and several liability for unpaid taxes on RMI eliminated for person who accepts affidavit of capital improvement in good faith Mixed Transaction If individual RMI services in real property contract are 25% or less of total cost, no sales tax; If RMI more than 75%, RMI portion taxable-----reasonable allocation 46

47 General Assembly to the Rescue? cont d Painting that is incidental to what would otherwise be an RMI service (e.g. door replacement) is subject to sales tax; exempt if not incidental to the RMI Remodeling definition clarified as multiple RMI services, normally taxable if performed separately, that restore, improve, alter or update real property a single repair service is NOT remodeling; also excludes installation of carpet, windows, doors, etc. Landscaping definition clarified to include only modification of living elements of an area of land 47

48 General Assembly to the Rescue?--cont d New sales tax exemption for RMI on aircraft with take off weight over 2000 lbs. (all of them?) Boat repair shops can collect and remit use tax on behalf of boat owners Entertainment events sponsored by farmers on farmland are NOT subject to sales tax Tax amnesty for linen rentals when used to provide accommodation rentals 48

49 EPILOGUE GA leadership is aware of the issues encountered by taxpayers & is trying to help Initial reports indicate that the NCDOR notice and list of transactions has been helpful No one enjoys collecting and remitting sales tax now, or in the 1930 s when the tax was originally enacted (as a temporary tax ) NCDOR notices and sales tax statutes will evolve as taxpayer issue arise Additional statutory changes may be required 49

50 ? QUESTIONS? 50

51 Thank You! Tony Buffkin, CMI Director Dixon Hughes Goodman LLP Michael Hannah, Esq., CPA Brian Reder Tax Accountant II Belk Store Services, Inc. 51