Sales Tax on Warranties Navigating Divergent State Treatment of Product and Service Warranties and Software Maintenance Contracts

Transcription

1 Presenting a live 110 minute teleconference with interactive Q&A Sales Tax on Warranties Navigating Divergent State Treatment of Product and Service Warranties and Software Maintenance Contracts THURSDAY, FEBRUARY 9, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Tom Johnson, Director, Ryan, Fort Lauderdale, Fla. Linka Gomez, State and Local Tax Supervisor, McGladrey & Pullen, Miami Sean Evans, Director, Tax Advisory Services, DuCharme McMillen and Associates Inc., Overland Park, Kan. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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5 Sales Tax On Warranties Seminar Feb. 9, 2012 Tom Johnson, Ryan Linka Gomez, McGladrey & Pullen Sean Evans, DuCharme McMillen and Associates Inc.

6 Today s Program General State Tax Issues With Warranties [Tom Johnson] Slide 7 Slide 27 Complex Issues With Warranties [Linka Gomez] Slide 28 Slide 37 Tax Treatment Of Warranties In Various States [Sean Evans and Tom Johnson] Slide 38 Slide 59 Options For Multi-State Tax Compliance [Sean Evans] Slide 60 Slide 65

7 Tom Johnson, Ryan GENERAL STATE TAX ISSUES WITH WARRANTIES

8 Outline For This Section I. General state tax issues with warranties A. Mandatory vs. optional warranties and maintenance agreements 1. Nexus issues 2. What should be stated on an invoice? B. Physical products vs. software C. Special issues with extended warranties D. Taxability or exemption parts and labor 1. Purchases of parts for warranty E. Inventory related issues 1. Tracking inventory internally, to properly allocate use tax 2. Establishing taxable basis of inventory taken out 8

9 Mandatory Vs. Optional Warranties Example: Mandatory vs. optional software maintenance agreements Maintenance agreements for canned software packages often include: Customer services, i.e. telephone consultations Software updates (tangible): Updates on disks, CDs, tapes, etc. Software updates (intangible): In the form of remote downloads or telecommunications Program enhancements (add-ons, new features, etc.) 9

10 Mandatory Vs. Optional Warranties (Cont.) Example: Mandatory vs. optional software maintenance agreements (Cont.) These can be automatically included with the program/software purchase (mandatory warranties) or can be added with the choice or discretion of the customer (optional warranties). The tax treatment of both differs across various states and jurisdictions. But, in general, mandatory warranties are almost always taxable (precluding any exemptions). 10

11 Mandatory Warranties Mandatory maintenance agreements/warranties Generally, most states tax mandatory software maintenance if the original software package was taxable. Many states consider mandatory software maintenance to be services that are part of the sale of tangible personal property. There may be exemptions if the software purchase qualifies for them (e.g., R & D, manufacturing, economic incentive, etc.) 11

12 Mandatory Warranties (Cont.) Several states exempt mandatory maintenance contracts/warranties from tax. Arkansas: Software maintenance contracts are exempt; however, hardware is taxable. Georgia: Software maintenance contracts are exempt if delivered electronically. Vermont: Exempt if charges are separately stated 12

13 Optional Warranties Optional maintenance agreements/warranties The taxabiliy of optional software maintenance agreements is much more complex. Those states that do impose a tax on optional software maintenance have adopted varying policies as to when and how to tax it. Some examples are: Minnesota: If only one charge in the optional software maintenance contract for both upgrades/enhancements and support services, then 20% of contract price subject to tax Virginia: 50% of the total charge for optional software maintenance Iowa: 50% of gross receipts from sale of software maintenance if the fee for the taxable personal property (the software itself) is not separately stated California: 50% if updates are considered tangible personal property Alabama: If non-taxble portions of a maintenance agreement are separately stated, then only the portion representing upgrades or enhancements and new operating manuals are subject to tax. 13

14 Optional Warranties (Cont.) Optional maintenance agreements/warranties In those states where optional maintenance contracts are exempt from tax (in about half of the states), there are generally two conditions that must be met: (1) The optional maintenance contract must be separately stated. (2) There must not be a transfer of tangible personal property. 14

15 Mandatory Vs. Optional Warranties (Cont.) In many states, charges for new software and/or upgrades are taxable, whereas services are not. (Example: Nebraska) This applies to both mandatory and optional warranties and to service agreements. 15

16 Nexus Issues In every single state, t warranty repairs establish nexus for a seller in that state. Examples Arizona: If employee is present in the state for more than two days per year California: If person performing repair is an employee (i.e., not independent unrelated contractor) Utah: If seller regularly services products in that state 16

17 Nexus Issues With Warranties Examine the particular state t for the rules on dealing with warranties and support agreements Services/support only are generally not taxable, whereas tangible personal proprety is. One must evaluate under what category a warranty/support agreement falls in a particular state. 17

18 What Needs To Be Stated On Invoice? In general, for warranties and maintenance/support t agreements: Charges must be separately stated to be exempt. The agreements must be optional rather than madatory, in order to be exempt. There must only be service and support provided, and no tangible personal property transferred. 18

19 Physical Products (Hardware) Vs. Software The treatment t t of warranties and maintenance agreements for hardware is almost identical to those for software, as well as for hardware/software bundles. In general, taxable if: Mandatory If not separately stated Involves the transfer of tangible personal property 19

20 Special Issues With Extended Warranties Extended d warranties are generally considered d optional warranties. Accordingly, they fall under the same treatment discussed earlier (i.e, taxable or non-taxable depending on their nature and jurisdiction). 20

21 Taxability Or Exemption Of Parts And Labor Parts purchased for use in performing service under mandatory maintenance contracts are exempt in most states. Examples South Carolina: Parts are exempt if, at the time of original purchase of the defective property, (1) the maintenance contract was given without charge; (2) the tax was paid on the sale of the defective part or on the sale of the property of which the defective part was a component; and (3) the waranty is not charged for any lb labor or materials. il Nebraska: If agreement provides full coverage, the amount charged for parts is exempt. 21

22 Taxability Or Exemption Of Parts and Labor (Cont.) Exceptions Arizona Georgia Hawaii Illinois Kentucky Vermont In these states, repair parts are taxable. 22

23 Taxability Or Exemption Of Parts and Labor (Cont.) Parts purchased for use in performing service under optional contracts t are also exempt in most states. However, there are several states that do tax parts under optional agreements, even if they do not tax parts under mandatory agreements. Examples: Missouri, Maryland, North Carolina 23

24 Taxability Or Exemption Of Parts and Labor (Cont.) In general, for both optional and mandatory service agreements, the issue of taxability is determined by the following: Coverage level: Does the agreement provide full coverage? If not, the repair parts are likely taxable. Timing: Was the sale of the service agreement/warranty purchased at the same time as the tangible property or after? If the contract is sold after (i.e., no tangible property transfered), then the parts for repair are likely exempt. Nature: Are the parts integral to the functioning of the tangible property? If not, they are likely taxable. 24

25 Inventory Related Issues 1. Tracking inventory 2. Establishing taxable basis of inventory taken out 25

26 Inventory Related Issues (Cont.) Tracking inventory Inventory should be carefully tracked internally to properly allocate use tax Use tax complement of the sales tax Charged by one state for the use of purchases from another state Applies in situations where sales tax does not apply Example where use tax may apply: Company purchases inventory items in Georgia to use in Florida (and thus does not pay Florida sales tax) 26

27 Inventory Related Issues (Cont.) Etblihi Establishing taxable basis for inventory Important to properly allocating use tax 27

28 Linka Gomez, McGladrey & Pullen COMPLEX ISSUES WITH WARRANTIES

29 Outline For This Section I. Complex Issues with warranties A. States that impose true object tests B. Third-party warranty administrators iit t C. Handling inventory withdrawals of repair parts D. Taxability of deductibles 29

30 True Object Tests True object test: t Many states t use the true object test t to determine if a transaction that involves both the rendering of services and the provision of tangible personal property is considered an exempt service or a taxable service (bundled services). If the true object of the transaction is to obtain the tangible personal property provided to the customer, then the transaction most likely is a taxable service. If the true object of the transaction is to obtain the service, and the transfer of tangible personal property is incidental to the performance of the contract, the transaction most likely is an exempt service. 30

31 True Object Tests (Cont.) The true object test t is mostly used in sstates t that t do not tax services. In states where services are taxable, the issue becomes less important. Considerations in true object test: Buyer s intent (service, TPP) The relative value of the elemets in question (service, TPP) The ability to identify and separate the elements (service, TPP) 31

32 True Object Tests (Cont.) Example Custom Hardware Engineering & Consulting, Inc. v. Director of Revenue,, Supreme Court of Missouri No. SC91415 (01/17/2012) 32

33 Third Party Activity: i Nexus Typically, sales and use tax nexus is created if a taxpayer has physical presence in a state. In most states, if a business is using an independent third-party contractor to perform services (repairs, maintenance, installation) on behalf of the business, nexus is created with that state. The state views the indepent third party as an agent acting on behalf of the business. Common activities creating nexus Repair or maintenance services Installation Warranty repairs (separately charged and not separately charged) Example: Texas Comptroller s Hearing No. 100,984 33

34 Third Party Activity: i Nexus (Cont.) Exceptions California: The use of a third party for repair and warranty services does not create nexus,,provided the third party is not under common control with the subject retailer. Wisconsin: The use of third party does not create nexus, provided the third party is not under the retailer s authority. In these states, the use of a third party does not create nexus for the business. 34

35 Inventory Parts Withdrawal Typically, a service provider must pay tax when purchasing tangible personal property (parts) to be used in the performance of non-taxable services (i.e., optional warranty). Mandatory warranty: Parts are considered sold with the original product. A repairer may purchase parts tax exempt for resale (part can be taken out of inventory with no use tax liability). Caution: If the part is taken out of inventory (purchased for resale, no tax paid on purchase), then the use tax is due when part is used to performed non-taxable service (optional warranty). The business must accrue the use tax on the item taken out of inventory. The item is not afforded the sale-for- resale exemption. 35

36 Taxability Of Deductibles Two types of service warranty No out-of-pocket expense for the warranty holder Out-of-pocket expense: Deductible paid by warranty holder when warranty used (i.e, $100 deductible on the vehicle repair). Depending on the state and the nature of the service warranty (taxable or exempt at time of sale), the deductible can be considered tax exempt or a taxable payment. Example: In Florida, a motor vehicle warranty is subject to sales tax. In addition, sales tax applies to any deductible paid by the warranty holder of a taxable service warranty. 36

37 Taxability Of Deductibles (Cont.) California i - Mandatory and optional warranties offered by dealer When the customer is required to pay a deductible, tax applies to the portion of the deductible for the charges of part. Unless the warranty states otherwise, the person providing the warranty contract is liable for the tax amount. The dealer/repairer will owe sales tax on a portion of the deductable. 37

38 Sean Evans, DuCharme McMillen and Associates Inc. TAX TREATMENT OF WARRANTIES IN VARIOUS STATES

39 Texas: Software Canned and custom computer programs are taxable. Texas sales tax law defines software as tangible personal property. popety. Software is subject to tax, whether delivered in tangible or electronic form. Unless otherwise provided, the sale or use of a taxable item in electronic form instead of on physical media does not alter the item s tax status. Texas Tax Code Texas sales/use tax is due on a charge to download software to a computer in Texas, regardless of whether the software is downloaded from a server situated in or outside of Texas. 39

40 Texas: Software Related Services Services connected with the sale of software are also taxable. Tax Code defines sales price to include a service that is part of the sale. Charges for certain services are considered part of the sales price of the software, if the software vendor charges for the services. Such services are taxed in the same manner as the software, regardless of whether they are separately stated. Examples: Installation, warranties and delivery charges 40

41 Texas: Taxable Services Tax Code defines taxable services to include software repair, remodeling, modification, restoration or maintenance services provided by the software vendor. Maintenance = Providing error correction, improvements, or technical support These services are not taxable if purchased directly from a thirdparty service provider that did not sell the software. 41

42 Software Installed On Texas Server Comptroller s Decision No. 44,127 (2005): Taxpayer purchased software and installed it on a server situated in Texas. The software was used by employees based in other states. Taxpayer s argument: The treatment of software as TPP is a legal fiction, and the legal fiction should be extended to where the users actually use the software. Comptroller s ruling: Installing software on a server situated in Texas is a use in Texas. The software is taxable in Texas, regardless of whether users in other states can access the software. 42

43 California: i Software Canned and custom computer programs 43 California taxes the sale of canned computer software, which is software designed and manufactured for general retail sale and not under the specifications or demands of any individual client. Tax does not apply to sales of canned software that are transmitted electronically from the seller s place of business to or through the purchaser s computer, as long as the purchaser does not obtain possession of any tangible personal property in the transaction. Custom-ordered modifications to existing, pre-written programs are exempt, provided that such charges are separately stated.

44 California: Software Maintenance And Warranties Optional vs. mandatory If the purchase of the maintenance contract is optional to the purchaser, and there is a single lump-sum charge for the contract, then 50% of the lump-sum charge for the contract is subject to California sales and use taxes as a taxable sale of tangible personal property. If the contract is optional and is for support only, then the charge is tax-exempt. If the contract in optional and for upgrades received in physical form, then the charge is taxable. If the contract in optional and for upgrades received in electronic form, then the charge is non-taxable. Mandatory maintenance and warranty contracts t are taxable. 44

45 Florida: Software Canned and custom computer programs The sale of pre-packaged software for use with computer equipment is subject to sales tax when the software, as purchased by the customer, is fully usable without modifications by the vendor and when the vendor does not perform a detailed analysis of the customer s requirements in selecting or preparing the programs. In Florida, software delivered electronically is not considered an exchange of tangible personal property and is not subject to tax. The sale of software is exempt as a service transaction if the vendor, at the customer s request, modifies or alters the prepackaged program to the customer s specification and charges the customer for a single transaction. 45

46 Florida: Software Maintenance And Warranties If the purchase of the maintenance/warranty contract includes both upgrades, then repairs and support are fully taxable in the state of Florida. It makes no difference if such charges are mandatory or optional. Agreements that provide telephone support only are not taxable. 46

47 North Carolina Technical Bulletin Sect Optional maintenance agreement A maintenance agreement is optional within the meaning of this bulletin when the purchaser is not required to purchase the maintenance agreement from the seller or lessor, and he is free to contract with anyone he chooses. Mandatory maintenance agreement A maintenance agreement is mandatory within the meaning of this bulletin when the purchaser, as a condition of the sale or lease, is required to purchase the maintenance agreement from the seller or lessor. 47

48 North Carolina (Cont.) Lump-sum maintenance agreements on the sale or lease of computer hardware Optional maintenance agreement With the furnishing of parts, materials and labor necessary to maintain the hardware (whether the agreement is a separate contract or a part of the sale or lease of the hardware), tax is not due on the receipts derived from the maintenance agreement. The vendor or repairer is deemed to be using the repair parts and other materials in the performance of a service, and tax is due on the cost price of the repair parts and other materials used in performing the service. If, however, the vendor makes a charge for parts or other materials not covered by the maintenance agreement and bills his customer for the parts or other property, then the vendor is liable for collecting and remitting the tax on such transactions. ti 48

49 North Carolina (Cont.) Lump-sum maintenance agreements on the sale or lease of computer hardware (Cont.) Mandatory maintenance agreement If the maintenance agreement is mandatory as a condition of the sale or lease of the computer hardware (whether it is a separate agreement or a part of the sale or lease of the hardware) the charge for the maintenance agreement is subject to the general rate of state tax and any applicable local sales or use tax. 49

50 North Carolina (Cont.) Lump-sum maintenance agreements on the sale or lease of computer hardware (Cont.) Mandatory maintenance agreement If the maintenance agreement is mandatory as a condition of the sale or lease of the computer hardware (whether it is a separate agreement or a part of the sale or lease of the hardware) the charge for the maintenance agreement is subject to the general rate of state tax and any applicable local sales or use tax. 50

51 North Carolina (Cont.) Lump-sum maintenance agreements on the sale, lease or license of taxable computer software (Cont.) Optional maintenance agreement If a separate optional maintenance agreement is executed (in addition to the agreement providing for the sale, lease or license of the property), and it provides only for the maintenance of the property being sold, leased or licensed, then the separate maintenance agreement represents a sale of services and its receipts are not subject to tax. The agreement might include support services such as consultants or personnel to train employees. The vendor is liable for sales or use tax on the cost price of any software enhancements or updates or other property used in fulfilling such separate maintenance agreements. 51

52 North Carolina (Cont.) Lump-sum maintenance agreements on the sale, lease or license of taxable computer software (Cont.) Mandatory maintenance agreement 52 If a vendor sells, leases or licenses taxable computer software for use in this state; and, as a requirement of the contract maintains the property p (whether the maintenance agreement is a separate document or a part of the sale, lease or license agreement), he is required to collect and remit sales or use tax on the total charge to his customers, notwithstanding that the maintenance charges may be separately stated on the invoices to his customers. Such maintenance might include support services such as consultants or personnel to train employees.

53 Georgia Optional maintenance contracts t and warranties Will depend upon the taxability of the product being sold Example listed in GA Regulations Chap Customer purchases an irrigation controller carrying the Water Sense label for $1, and an optional maintenance contract or extended warranty for $ The items are purchased together, and the charges are separately stated on the seller s invoice. The purchase qualifies for the exemption. The sales price of the irrigation controller is less than $1,500.00, because the amount charged for the optional maintenance contract or warranty was separately tl stated ttd on the seller s invoice. i 53

54 Georgia (Cont.) However, if the charge for an optional maintenance contract or warranty is not separately stated on the seller's invoice, the purchase does not qualify for the exemption, because the combined sales price of $1, exceeds $1,

55 Minnesota: Software Canned and custom computer programs Sales of pre-written computer software are taxable. The tax also applies when the software is delivered ed electronically, by load-and-leave, or otherwise. Sales, leases and licenses of custom software programs are exempt. 55

56 Minnesota: Software Maintenance And Warranties If the maintenance agreement for a pre-written software program is required by the vendor as a condition of the sale, lease or license to use the pre-written software, then the price of the maintenance agreement is taxable. If the maintenance agreement for pre-written software is optional, then separately stated charges are taxed as follows: Upgrades or enhancements: Information and directions, received in any format, that provide new or significantly improved function to a computer program are taxable. This includes information and directions that dictate the function performed by the computer. It also includes updated tables, such as employee withholding tables, and postage rates. Support services: Corrections received in any format, consultation services, or technical or telephone support for computer programs are not taxable. Combination charges: If there is only one charge for both upgrades or enhancements and support services, tax applies to 20% of the entire price of the optional maintenance agreement. 56

57 Massachusetts: Software Canned and custom computer programs Pre-written software is included in the definition of tangible personal property. Sales of pre-written (canned) computer software, regardless of the method of delivery, and reports of standard information in tangible form are generally subject to the Massachusetts sales tax. Taxable transfers of software include, but are not limited to, the following: Licenses and leases of pre-written software Granting the right to use pre-written software installed on a remote service Upgrades to pre-written software, including upgrades delivered pursuant to maintenance contracts, regardless of whether the software was taxable when initially transferred to the retail customer License upgrades for pre-written software Sales of custom software are generally exempt from tax as professional service transactions, regardless of the method of delivery. 57

58 Massachusetts: Software Maintenance And Warranties Charges for optional software maintenance contracts (which are defined as those in which the customer is not obligated to purchase as a condition to acquiring the software) that do not include upgrades are generally not taxable, if separately stated. If the charges for upgrades and services are not separately stated, tax applies to 50% of the sales price of the maintenance contract. If an upgrades plus service contract separately and reasonably charges for the service and upgrades portion of the contract, then charges for the upgrades are taxable, and charges for the service portion are not taxable. 58

59 South Carolina The South Carolina Revenue Department has issued a revenue ruling to remind taxpayers that, effective Sept. 1, 2011, a warranty or maintenance contract purchased after the tangible personal property is purchased is no longer taxable, with limited exceptions. If the warranty or maintenance contract is purchased at the same time as the tangible personal property, p it remains taxable unless the sale is otherwise tax-exempt. South Carolina Revenue Ruling No concerning Software and Software Maintenance Contracts has been reinstated and is effective for sales of software and software maintenance contracts occurring on or after Sept. 1,

60 Sean Evans, DuCharme McMillen and Associates Inc. OPTIONS FOR MULTI STATE TAX COMPLIANCE

61 Tax Strategy For Dealing With Maintenance And Warranty Contracts I. Documentation is critical. II. What does the contract cover? A. Mandatory vs. optional? B. Upgrades only? C. Service only? D. Support only? E. How will the upgrades will delivered? III. Do those in purchasing include details on the purchase orders as to the specifics of the contract? 61

62 ERP: Friend Or Foe? I. The key under a sales and use tax audit is to be able to show that the terms of the warranty and maintenance contracts state clearly how tax has been paid. II. Review and confirm if your current ERP systems can handle the trend of states taxing only a portion of the total warranty and maintenance charged. Examples would be states like Minnesota, California. III. Are there options in your purchase order systems to flag such details needed for correct tax determination (i.e., optional vs. mandatory)? IV. In the states where allocation is required, can this be accomplished electronically with your ERP? 62

63 Exempt Sales Of Warranties There are many different types of exemption certificates. There are state-proscribed forms issued for several purposes. The Multistate Tax Commission (MTC) issued a certificate for resale purposes. Purposes of exemptions Resale Industry Property Exempt organization Direct pay permit holders Must be taken in good faith Obtained in a timely fashion 63

64 Good Faith: ih Requirements Non-SSTP full member states have two requirements. Must have the appropriate certificate on file under the correct time frame required Must be believable A. If both of these are not proven, the state can refuse the exemption under audit. B. Burden of proof of exemption is on the SELLER States using the SSTP exemption form A. Must have the appropriate certificate on file under the correct time frame required B. Burden of proof of exemption is on the BUYER 64

65 Full Member States Of The SSTP Arkansas Georgia Indiana Iowa Kansas Kentucky Michigan Minnesota Nebraska Nevada New Jersey North Carolina North Dakota Oklahoma Rhode Island South Dakota Vermont Washington West Virginia Wisconsin Wyoming 65