Council On State Taxation Module 13: Exempt & Non-Taxable Transactions Donna-Marie Daday Jeff Lemmons PricewaterhouseCoopers LLP 2013 COST SALT BASICS

Council On State Taxation

Module 13: Exempt &Non-Taxable Transactions

Donna-Marie Daday Jeff Lemmons

PricewaterhouseCoopers LLP

2013 COST SALT BASICS SCHOOL

1


Exclusions - transactions not includedwithin the state’s tax

base; - Burden on the government

Exemption - transactions normally subject to tax, but conditions exist which create exemption- Burden on the taxpayer

Exemptions and Exclusions - Introduction

2


Real Property - generally nontaxable

Services- generally nontaxable

Note: But every states taxes at least one service, e.g., hotel and motel accommodations, repairs, data processing or information services, security, personal services (hair dressers, barbers, etc.), and many others

Exemptions and Exclusions – Representative Exclusions

3


Entity Based Exemptions

Exempt Organizations – IRC Section 501(c)(3)− Religious, Charitable, Educational

Government Agencies – U. S. Constitution− Federal Government/Chartered Institutions− State and Local Government− Government Contractors

Exemptions and Exclusions – Types of Exemptions

4


Product Based Exemptions

Food for Home Consumption (generally excludes prepared meals)

Clothing Prescription Drugs Other Medical (Durable Medical Equipment,

etc.) Newspapers


5


Use Based Exemptions Sales for Resale Occasional, Isolated, or Casual Sales

− Business Reorganizations− Bulk Sales

Manufacturing− Pollution Control− Research and Development

Interstate Commerce Foreign Commerce


6


Sales for Resale - “food for thought” Is the sale of napkins and straws to a fast

food restaurant a sale for resale or a taxable sale?

Is the sale of paper to an attorney who uses the paper to draft contracts and other legal documents turned over to the client a sale for resale or a taxable sale?


7

Assume that admissions to sporting events are subject to sales tax

The Dallas Mavericks distribute hats with the team’s logo on them to the first 10,000 people who enter the arena with a ticket for the

game. Is the team’s purchase of the hats from a local vendor a sale for resale or a taxable sale?

A. Sale for resaleB. Taxable Sale

8 Sal

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r res

ale

Tax

able

Sal

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0%0%

10


Occasional, Isolated or Casual Sales – Business Transfers

The occasional sale exemption often covers the transfer of tangible personal property in a reorganization, merger or consolidation. The exemption may also apply to the transfer of property to a commencing corporation.


9


Occasional, Isolated or Casual Sales Successor Liability

Requires a purchaser of a business to withhold certain amount of purchase price to cover any potential outstanding tax owed by seller, until the seller produces document evidencing no tax is due.


10


Manufacturing Property used or consumed “directly” in the

manufacturing process

Concept is to exempt production inputs in order to avoid “pyramiding” of the tax

Exemption may also cover similar production activities like processing or mining or research and development


11


Most states require exempt property to be “used directly” in production

Definitions of direct use tend to stress that the property is essential to the production process and actually touches the in-process product

Direct use items typically include raw materials, machinery and tools, repair parts, process-related materials handling equipment (conveyers, etc.), computerized production systems, etc.

Manufacturing Exemption Concepts –Direct Use

12


Indirect use (taxable) items typically include structural materials (bricks/mortar/steel), administrative items (furniture, non-manufacturing computers, etc.); distribution-related items, and depending on state may include routine maintenance items

Mixed-use items: Many states require that the item be used primarily in exempt production activities (>50%); some require that the item be used exclusively in production to be exempt

Manufacturing Exemption Concepts –Direct Use

13


Many states apply the “integrated plant site concept” to define the parameters of the exemption

Integrated exemptions frequently cover all production-related activities on the plant site, starting with the handling and storage of raw materials and ending with the conveyance of finished products to initial storage at the plant site, including product packaging activities

Manufacturing Exemption Concepts –Integrated Exemption

14


Integrated exemptions also may include activities that do not actually touch in-process products or “one-step removed” activities, such as: Production line product testing / quality control activities Generation of power, steam, and the like, used in the

production process Other sub-processing activities such as fabrication of

equipment or tools used directly in the production process

Specialized cleaning / maintenance activities that ensure product integrity

Manufacturing Exemption Concepts –Integrated Exemption

15


R&D: Some states exempt research and development activities, some as part of the manufacturing process, others exempting the activity even if conducted independent of manufacturing

Pollution Control: Most states exempt pollution control equipment; statutes may or may not require that the equipment be used by a manufacturer

“Specialized” Exemptions: Some states have enacted narrowly focused exemptions for certain projects, e.g., pharmaceutical or semiconductor clean rooms, shipyards, auto assembly plants, etc., which may even include exemptions for real property components

Manufacturing Exemption Concepts –Related Exemptions

16


Burden of proof is on the seller to demonstrate that a transaction is exempt unless the seller receives an exemption certificate from the customer

Exemption certificates must be accepted in good faith. Failing to exercise due care could result in the seller being held liable for tax But Streamlined Sales Tax states apply a more relaxed

good faith requirement Certificates must be fully completed Some states place time limits on obtaining certificates

Exemptions and Exclusions – Exemption Certificates

17


MTC – Uniform Certificate Used by wholesalers, retailers, manufacturers,

lessors and others Includes purchases for resale, lease, or use in

manufacturing Thirty-eight states accept the multi-jurisdiction

certificate (45 states impose sales tax)

Exemptions and Exclusions –Exemption Certificates

18


Direct Pay Permits Purchasers acquire property for many reasons, including for

both taxable and exempt purposes Normally, the administrative burden to figure out when to

collect/pay tax is on the vendor Direct pay permit allows purchasers to self-assess use tax

on taxable transactions rather than pay sales tax to the vendor

Direct pay permits often used in conjunction with single rate agreements


19


No certificate?

All is not necessarily lost Exemption certificate simply relieves the seller from the

burden of proving the transaction exempt Seller can still present evidence that the purchaser was

exempt (e.g., a governmental or nonprofit organization) or that the transaction itself was exempt (e.g., a sale for resale)


20


Mixed TransactionsSale of ordinarily taxable tangible personal property bundled with ordinarily nontaxable services is typically governed by the “True Object Test”True Object Test seeks to determine the purchaser’s motive in engaging in the transaction – did the purchaser intend to purchase the tangible personal property itself or was the purchaser really seeking the expertise of the service provider?The entire transaction is taxable if the true object is the tangible personal property; conversely, the transaction is exempt if the true object is the service

Exemptions and Exclusions – True Object Test

21


True Object? What did the parties bargain for? What did the buyer actually want? What did the buyer actually get? Would the buyer have purchased the service without the

tangible personal property provided by the service provider?

Is the tangible personal property consequential to the transaction?


22


True Object Test– taxable or exempt?

Artist paints a portrait on canvas Attorney drafts a contract on paper Equipment lease with an operator Rental of “customized” mailing list on CD


23

How do you determine the true object? Artist paints a portrait on canvas

1. Taxable2. Exempt

24

Tax

able

Exe

mpt

0%0%

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How do you determine the true object? Attorney drafts a contract on paper

1. Taxable2. Exempt

25 T

axab

le

Exe

mpt

0%0%

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How do you determine the true object?Equipment lease with an operator

1. Taxable 2. Exempt

26 T

axab

le

Exe

mpt

0%0%

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How do you determine the true object?Rental of “customized” mailing list on

CD1. Taxable2. Exempt

27 T

axab

le

Exe

mpt

0%0%

10


Real Property Transactions

The transfer of Real Property is excluded from sales/use tax in most states (no need for exemption since the tax generally applies to TPP and select services)As such, construction contractors and others performing services with regard to real property (e.g., HVAC contractors, electricians, plumbers, etc.) generally do not charge sales tax on their invoices – instead they are the taxable users or consumers and should build the tax into their bid prices

Exemptions and Exclusions – Real Property

28


Three-part test: The nature of the object annexed -- is it an integral, necessary and

expected part of real property? The mode of annexation -- is it permanently affixed and would its

removal cause significant damage to the underlying real property? The purpose for which it was annexed – was it intended to serve a

temporary purpose or does it have a long term use by a future tenant?

“Trade fixtures” and specialized equipment often remain tangible personal property as they are merely adapted to the present use of the building

Exemptions and Exclusions – What Is Real Property?

29


The Constitution places limitations on states to impede interstate or foreign commerce and most states provide exemptions to reflect these Constitutional limitationsInterstate Commerce:when goods shipped from seller in state A to a customer in state B, generally by common carrier, mail, etc. (state A cannot tax the transaction because it crosses state lines; only state B has the right to tax)Foreign Commerce:treated similarly to transactions in interstate commerce

Exemptions and Exclusions – Cross-Border Transactions

30


Government Transactions

Constitution prohibits states from taxing the federal governmentMost states also exempt sales to their own state agencies and local governments

Exemptions and Exclusions – Government Transactions

31


Government ContractorsConstruction contractors for the government usually do not enjoy any exemptions, but there are exceptions in some statesContractors reselling TPP to the government may enjoy a resale exemptionOverhead or other items consumed by a contractor are normally taxable to the contractor

Exceptions: California

Exemptions and Exclusions – Government Contractors

32


Sales Tax Incentives

Stimulate economic activity by offering full or partial exemptions on the purchase of specified property and services

Example: Call Centers, Manufacturing plants

Exemptions and Exclusions – Miscellaneous Issues

33


Sales Tax Exempt and Non-Taxable Transactions Case Study

Case Study

34

Please select a Team.

1. Team 12. Team 2

35

Tea

m 1

Tea

m 2

0%0%

5

It is primarily the responsibility of the taxpayer to prove that an exclusion from the

tax exists on a particular transaction.

1. True2. False

36

Tru

e

Fal

se

0%0%

5

In a state where the definition of a taxable service includes repairs to tangible personal property,

which by definition excludes aircraft; would the repair of the aircraft be:

1. Subject to the tax2. Exempt from the tax3. Excluded from the tax4. Both answer 2 and 3

37

Subje

ct to

the

tax

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mpt f

rom

the

tax

Exc

luded

from

the

tax

Both

answ

er 2

and 3

0% 0%0%0%

5

In a state that considers the true object of the transaction and does not tax any services, but taxes the sale of tangible personal property, would a separately stated charge for ink that is used to

address a customer-provided envelope as a part of a mailing service most likely be subject to tax?

1. Yes2. No

38 Y

es No

0%0%

5

Team Scores

39

0 Team 10 Team 2

Food is always exempted from the tax

1. True2. False

40

Tru

e

Fal

se

0%0%

5

In states that exempt food products they will typically exempt food sold in restaurants as well.

1. True2. False

41

Tru

e

Fal

se

0%0%

5

The sale of a cash register by a jewelry store could possibly qualify for an occasional sale exemption

for which of the following reasons:

1. Jewelry store is not in the business of selling cash registers

2. Jewelry store sold all of their assets including the cash register

3. Both answers 1 and 24. Neither answers 1 or 2

42 J

ewelry

sto

re is

not i

...

Jew

elry s

tore

sold

all

..

Both

answ

ers

1 an

d 2

Nei

ther

answer

s 1

or 2

0% 0%0%0%

5

Would the purchase of a screwdriver by a contractor who uses the screwdriver to provide a taxable real property contractor service be tax free for resale?

1. Yes2. No

43 Y

es No

0%0%

5

Team Scores

44

0 Team 10 Team 2

It is primarily the responsibility of the taxpayer to prove that an exemption from the tax applies to a

transaction.

1. True2. False

45

Tru

e

Fal

se

0%0%

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If a question exists as to the applicability of an exclusion to a particular transaction, the courts should apply the

statute liberally in favor of the taxing authority.

1. Yes2. No

46

Yes N

o

0%0%

5

Team Scores

47

0 Team 10 Team 2

If a question exists as to the applicability of an exemption to a particular transaction, the courts would

likely apply the statute strictly against the application of the exemption.

1. True2. False

48

Tru

e

Fal

se

0%0%

5

Services are generally subject to tax unless specifically excluded or exempt.

1. True2. False

49

Tru

e

Fal

se

0%0%

5

Tangible personal property is generally subject to tax unless specifically excluded or exempted.

1. True2. False

50

Tru

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0%0%

5

An example of an “entity based status exemption” would be:

1. Exempt sale by a boy scout troop to the general public

2. Exempt purchase by a not-for-profit hospital

3. Exempt sale of manufacturing machinery and equipment to a chemical plant

4. An exempt sale of a prescription drug to a physician practice

51

Exe

mpt s

ale

by a

boy...

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ale

to a

not-.

..

Exe

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of man

uf...

An e

xem

pt sal

e of a

p...

0% 0%0%0%

5

An example of a “use based exemption” may include

manufacturing equipment.

1. True2. False

52

Tru

e

Fal

se

0%0%

5

Team Scores

53

0 Team 10 Team 2

Resale certificates are always required to be collected at the time of purchase in order to be

valid.

1. True2. False

54

Yes N

o

0%0%

5

What is a term commonly used for a certificate that will cover more than one exempt purchases?

1. A good one2. A big one3. Complete4. Blanket

55

A g

ood one

A b

ig o

ne

Com

plete

Bla

nket

0% 0%0%0%

10

Every state accepts a “Uniform Sales and Use Tax Certificate - Multi-jurisdiction”.

1. True2. False

56

Yes N

o

0%0%

5

A seller accepts a resale or exemption certificate in “good faith” and is typically relieved from further

sales tax collection responsibilities.

1. True2. False

57

Yes N

o

0%0%

5

Which are common elements required for a valid resale certificate in most states?

1. Signature2. Contemporaneous3. Renewable4. Notarized

58

Sig

nature

Conte

mpora

neous

Ren

ewab

le

Nota

rized

0% 0%0%0%

5

Team Scores

59

0 Team 10 Team 2

Most taxpayers would qualify for a direct pay permit.

1. True2. False

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Tru

e

Fal

se

0%0%

5

The sale of an intangible like common stock is generally:

1. Subject to sales tax2. Exempt from sales tax3. Excluded from sales tax4. None of the above

61

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f the a

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0% 0%0%0%

5

Enterprise zones always includes exemptions at both the state and local

level:

1. True2. False

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Tru

e

Fal

se

0%0%

5

Team Scores

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1800 Team 21150 Team 1

Enterprise zone exemptions are enacted to restrict economic

development.

1. True2. False

64

Tru

e

Fal

se

0%0%

5

Real property is generally taxable unless a specific exemption is available.

1. True2. False

65

Tru

e

Fal

se

0%0%

5

Tangible personal property that is purchased for resale is generally

excluded from tax.

1. True2. False

66

Tru

e

Fal

se

0%0%

5

The true object of the transaction addresses whether the object of the transaction is an excluded

service or an enumerated service.

1. True2. False

67

Tru

e

Fal

se

0%0%

5

Team Scores

68

0 Team 10 Team 2

Interstate transactions are typically excluded due to constitutional restrictions on state

governments.

1. True2. False

69

Tru

e

Fal

se

0%0%

5

Local jurisdictions are precluded from allowing enterprise zone exemptions.

1. True2. False

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Tru

e

Fal

se

0%0%

5

Which of the following is most likely to be excluded from tax:

1. The sale of an item for resale

2. The sale of an item in interstate commerce

3. The sale of a service4. The sale of an

enumerated service

71

The

sale

of a

n item

fo...

The

sale

of a

n item

in...

The

sale

of a

serv

ice

The

sale

of a

n enum

e...

0% 0%0%0%

5

Which of the following is likely to be exempt from tax:

1. The sale of common stock

2. The sale of an entire business

3. The sale of real property

4. The sale of preferred stock only

72

The

sale

of c

omm

on ...

The

sale

of a

n entir

e ...

The

sale

of r

eal p

roper

ty

The

sale

of p

refe

rred...

0% 0%0%0%

5

Team Scores

73

0 Team 10 Team 2

Resale exemptions protect taxpayers from:

1. An undue administrative burden

2. Undue cost of taxation3. Double taxation4. All of the above

74

An u

ndue ad

min

istra

ti..

Undue

cost

of t

axat

ion

Double

taxa

tion

All

of the

above

0% 0%0%0%

5

Entity based exemptions are based upon who the seller is

1. True2. False

75

Tru

e

Fal

se

0%0%

5

Use based exemptions address who the purchaser is

1. True2. False

76

Tru

e

Fal

se

0%0%

5

And the winner is….!

77

0 Team 10 Team 2

Documents

Council On State Taxation Module 13: Exempt & Non-Taxable Transactions Donna-Marie Daday Jeff Lemmons PricewaterhouseCoopers LLP 2013 COST SALT BASICS