You Gotta Pay to Play Sales Tax 101 for Government Contractors

Transcription

1 You Gotta Pay to Play Sales Tax 101 for Government Contractors July 17, 2013 Presented by: Michael L. Colavito, Jr., Esq. James Fennel, CPA 2013 All Rights Reserved 805 King Farm Boulevard Suite 300 Rockville, Maryland P F

2 Aronson Overview FOUNDED 1962 Single office: Rockville, MD 29 PARTNERS 160 CLIENT SERVICE 36 OP. SUPPORT 225 TOTAL STAFF SERVICE INDUSTRIES Real Estate, Construction, Nonprofit, Government Contracting, Diversified Commercial Services and Technology SERVICES PROVIDED Assurance, Tax and Consulting 2

3 Agenda General Sales Tax Principles Purchase for Resale vs. Purchase for Use True Object Test Construction Contracts Impact of Contract Provisions Practical Considerations Recent Developments Financial Reporting and Profitability Impacts 3

4 Types of Government-Related Transactions General Principles Output Transaction (sales to the government) Input Transaction (purchase of property or services in connection with a government contract) Varies from overhead materials Property to be resold and used by the govt. Property to be used by the contractor in performing contract Materials for real property contracts 4

5 General Principles (cont.) General Taxability Rules Sales tax is a consumption tax imposed on the ultimate consumer of a taxable item Sales to the government (output transactions) generally exempt from sales tax. Supremacy Clause Art. VI, clause 2. Supremacy clause does not apply to independent contractors of the government. See Alabama v. King & Boozer (1941) 5

6 General Principles (cont.) When does a contractor have to pay tax on purchases? Depends on whether: The contractor will resell the property to the government; The contractor will use the property in the course of performing the contract; or The state has a specific exemption. 6

7 Purchase for Resale vs. Use? General Rule Sale of property to govt. = tax-free purchase for resale. Sale of service to govt. = contractor pays tax on purchases. Recurring Theme Which party is the ultimate consumer/user of the purchased product? 7

8 Am I reselling or using the equipment/materials? States generally look to which party used/consumed the property. Title-Passing Clause - Not determinative regarding whether the contractor or the government is the user of the property. Interim use Purchase for Resale v. Use? (cont.) Interim use of property may cause the contractor to be deemed the taxable user. To remain a sale for resale the interim use typically needs to be consistent with the sale of the property/equipment. E.g., Testing of the equipment or minor modifications made to, the equipment. 8

9 Sale of Services v. Sale of Tangible Personal Property Vendor Sale of property to contractor Contractor Uses property to perform service Govt. Receives service Title to prop. passes directly to govt. Contractor Selling a Service PURCHASE LIKELY TAXABLE Vendor Sale of property to contractor Contractor Resells to govt. for use by govt. Govt. Receives prop. Title to prop. passes directly to govt. Contractor Selling TPP PURCHASE LIKELY NOT TAXABLE 9

10 Sale of Services v. Tangible Personal Property (cont.) Compare a. Contract to manage, operate, and maintain government facility. Contractor purchases mops to clean floors. b. Contract to provide various materials and supplies to government related to maintenance of facility. Contractor purchases mops and provides to the government. 10

11 Notable states that follow the general rule (i.e., sales tax applies to purchases of property used by contractor in performing service for govt.) include: Virginia District of Columbia (unless construction contract) Maryland Alabama State Variations on General Rule Pennsylvania (unless building machinery and equipment w/respect to federal government contractor). Texas (unless contract w/ federal national security-related agencies) 11

12 State Variations on General Rule (cont.) Not all states follow the general rule. Some states allow government contractors to purchase materials and supplies tax-free, even though the contractor is the consumer of those goods. Generally enacted as an exception. These exceptions may be limited by: Industry (e.g., construction contractors) Agency contracted with (e.g., DOD) Structure of contract (e.g., time and materials) Required title-passing provision 12

13 State Variations on General Rule (cont.) California No tax on consumed supplies and overhead materials if title passes to government prior to contractor use. Illinois If contract requires purchaser to provide the government with the items and the title to the items is transferred to the government, then no tax due on purchase, despite contractor being the user of the property. Florida Sale for resale includes tangible personal property (including overhead items) purchased under contract for services to DOD or NASA. Title to property must pass to government. Georgia Similar to Florida, but tax applies to overhead items as of 1/1/11. 13

14 True Object Test True Object test is used by many states to determine if a mixed transaction is a sale of tangible personal property or services. True object is a service - Contractor is deemed the user of tangible personal property purchased to perform the contact. The contractor must pay sales/use on the purchase of the property. True object of is sale of TPP - Contractor may purchase the property exempt from tax as a sale for resale. Notable states applying the true object (or similar) test include AL, CA, OH, PA, TX, and VA. 14

15 True Object Test (cont.) The true object of a transaction is not always clear. Examples: Engineer designs computer network and provides network equipment. Private education service provider charges tuition for courses without separately stating charges for books, printed lessons, and training kits. Contractor provides weapons and training of the use of such weapons. Taxpayer is to design, develop, deploy, and operate a high-speed computer and communications network. 15

16 Virginia True Object Test (cont.) Pre-July 2006 True object test applied to the contract as a whole. Post-July 2006 True object test applies to each individual order. Order includes each task order, delivery order, work order, or contract line item number (CLIN). True object test only applies if the lowest level order is a mixed transaction. 16

17 True Object Test (cont.) Virginia Example Facts Contractor is to provide training courses in firearms. Contract requires the contractor to provide weapons, ammunition, and other equipment, the title to which passed directly to the government. One of the CLINs calls for the provision of instructors and weapons. The cost of the weapons far exceeds the cost of the instructors. Department s Analysis (Ruling 13-73, 5/21/13) Department applied the true object test to the CLIN and concluded that the goal of the order was the training received by the government and not the weapons themselves, despite the cost of the weapons far exceeding the cost of the instructors. Higher cost of weapons as compared to instructors was determined to be irrelevant Result Contractor was deemed the user of the weapons. Contractor was liable for sales tax on purchase of weapons 17

18 Virginia Example (cont.) Actual Contract included a CLIN that provided for both services and TPP, so the Department applied the true object test. Contract with Proper Planning CLIN 1 provide instructors CLIN 2 provide weapons and ammunition. True Object Test (cont.) RESULT no sales tax; true object test would not have been applied because neither CLIN is a mixed transaction. Separately stating property and service fees increases the predictability of sales tax application. 18

19 Generally, construction contractors must pay sales tax on purchases of materials incorporated into real property. Rationale Construction Contracts Sales tax applies to the sale of tangible personal property Ultimate customer is purchasing real property not tangible personal property. A number of states have enacted exceptions to this rule for construction contracts with exempt entities. 19

20 Construction Contracts (cont.) D.C. A contractor s purchases are tax-free if the materials are physically incorporated into realty of the government. Indiana A contractor can make tax-free purchases of materials if the ultimate recipient could have purchased the same materials tax-free. New York Purchases of materials are tax-free if they become an integral part of realty of an exempt entity. Ohio Sale of construction materials to construction contractors are tax-free if the materials are incorporated into real property of the government. 20

21 Impact of Contract Provisions, If Any Title-passing provision. Contractor as purchasing agent. 21

22 Title-passing provision Title to property passes to government immediately upon contractor s purchase of materials/equipment Impact of title-passing provision Title-Passing Provision Disregarded and analysis of sale for resale v. use must be done (as discussed above) Provision allows contractor to purchase tax-free, despite being the user. 22

23 Compare Virginia - Contractor is deemed to be the taxable user of all tangible personal property used in performing its services, even though title may pass to the government. Ohio - Same as Virginia. California - Consumable supplies charged to or allocated to a specific U.S. government supply contract will not be taxable to the purchaser if title passes to the U.S. government prior to the use of the property. Georgia ssame as California. Title-Passing Provision 23

24 Contractor as Purchasing Agent Contractor is an agent of the federal government. Authority to bind the government to pay for purchase Agent acting on behalf of the government. Equipment/materials deemed to be purchased by the government. Contractor can purchase tax-free. Purchase is deemed to be made by the government. THE CONTRACT MUST STATE THE CONTRACTOR IS AN AGENT OF THE EXEMPT GOVERNMENT ENTITY! 24

25 Resale Certificates Do I need to Register? MTC Uniform Certificate Practical Considerations Subcontractors Recordkeeping 25

26 Use of Exemption or Resale Certificates Most states require the presentation of a resale certificate that indicates the purchaser s sales tax license/permit number. Some states allow the use of the MTC s Uniform Sales & Use Multijurisdictional Tax Certificate. Purchaser can provide vendor one certificate that covers sales to multiple states. Purchaser indicates license/permit number for each state to which the vendor will deliver product. Typically only allowed for sale for resale exemption; cannot be used forother exemptions such as purchases used for research and development. 26

27 Use of Exemption or Resale Certificates (cont.) Exemption Certificates Most, but not all, states do not allow a contractor to present the exemption certificate of the exempt entity (i.e., government) unless the contractor is a designated purchasing agent of the exempt entity. Virginia The Department has concluded that there is no pass-through of exempt status to a contractor or subcontractor. District of Columbia Contractor performing a construction contract can present an exempt purchase certificate stating that all materials will become part of real property of an exempt entity. 27

28 Does a sale to a prime contractor by a subcontractor get afforded the same treatment as a sale to the government by a prime contractor? i.e., Sale from subcontractor viewed as an exempt government sale. Typically yes. Notable States Treating Subs and Primes the Same Virginia California Florida New York Pennsylvania Treatment of Subcontractors 28

29 Recordkeeping Example Virginia Prime contractor enters into a contract with a government agency for the construction of a ship. The agency issues a task order to the prime contractor for the provision of steel and other components of the ship. Prime contractor issues task order to Subcontractor 1, who issues a task order to Subcontractor 2 to provide the steel. Subcontractor 2 will be required to present vendor with a resale certificate (ST-10). Subcontractor 1 will be required to present a resale certificate to Subcontractor 2. Prime contractor will be required to present Subcontractor 1 with a resale certificate. The government agency will be required to present to the Prime Contractor a government exemption certificate (ST-12). 29

30 Recent Developments Texas Combs v. Health Care Services Corporation (Texas Supreme Court, 6/7/13). Upheld government contactor s refund claim for sales tax on purchases used by the contractor in performing nontaxable services for the government. Purchases included chairs, printers and office supplies used by the contractor. Contract stipulated that title to the property passed directly to the federal government. Impact of decision limited to back years because of 2011 legislation limiting such tax-free purchases to contractors performing services for national security-related agencies 30

31 Virginia Effective July 1, 2013, the general sales tax rate increased from 5% to 5.3%. Regional Rates Sales sourced to the Northern Virginia or Hampton Roads regions will have an additional 0.7% tax. Total sales tax rate in these regions will be 6.0% Sourcing Recent Developments (cont.) Based on location of the dealer collecting the tax Not based on the where the product is delivered. 31

32 District of Columbia Recent Developments (cont.) Sales tax rate decreasing from 6% to 5.75%. New rate will take effect on October 1, Rate decrease and new spending initiatives a result of estimated revenue increases. Fiscal year 2012 ended with a $417 million surplus. 32

33 Collection Obligation/Nexus Recent Developments (cont.) Typically a retailer needs to have a physical presence in a state in order for the state to impose a collection obligation Federal Legislation: Marketplace Fairness Act of 2013 Grants states the authority to compel remote sellers to collect sales tax, despite the remote seller having no physical presence in the state. Simplification Requirement (e.g., single collection and audit authority, uniform tax base, free compliance software) Small Seller Exception prior year s gross receipts less than or equal to $1,000,

34 Financial Reporting and Profitability Impacts There is plenty of uncertainty in the industry -- why add another element of uncertainty to your business? Financial reporting Distortion of financial data for decision makers Overstatement of working capital, assets, net income and equity Understatement of liabilities and expenses Covenant violations Certification risks Joint venture (consolidated or not) 34

35 Financial Reporting and Profitability Impacts (cont.) Profitability Contracts with Bid and proposal process Inclusive of sales tax assessment on contract Turnover in back office Commercial versus government Heightened costs for: Audit defense (includes opportunity costs) Interests and penalties 35

36 Contact Information James D. Fennel Michael L. Colavito, Jr