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Council On State Taxation
Module 13: Exempt &Non-Taxable Transactions
Donna-Marie Daday Jeff Lemmons
PricewaterhouseCoopers LLP
2013 COST SALT BASICS SCHOOL
1
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
Product Based Exemptions
Food for Home Consumption (generally excludes prepared meals)
Clothing Prescription Drugs Other Medical (Durable Medical Equipment,
etc.) Newspapers
Exemptions and Exclusions – Types of Exemptions
5
Council On State Taxation
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
Exemptions and Exclusions – Types of Exemptions
6
Council On State Taxation
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?
Exemptions and Exclusions – Types of Exemptions
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
e fo
r res
ale
Tax
able
Sal
e
0%0%
10
Council On State Taxation
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.
Exemptions and Exclusions – Types of Exemptions
9
Council On State Taxation
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.
Exemptions and Exclusions – Types of Exemptions
10
Council On State Taxation
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
Exemptions and Exclusions – Types of Exemptions
11
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Exemptions and Exclusions –Exemption Certificates
19
Council On State Taxation
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)
Exemptions and Exclusions –Exemption Certificates
20
Council On State Taxation
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
Council On State Taxation
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?
Exemptions and Exclusions – True Object Test
22
Council On State Taxation
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
Exemptions and Exclusions – True Object Test
23
How do you determine the true object? Artist paints a portrait on canvas
1. Taxable2. Exempt
24
Tax
able
Exe
mpt
0%0%
10
How do you determine the true object? Attorney drafts a contract on paper
1. Taxable2. Exempt
25 T
axab
le
Exe
mpt
0%0%
10
How do you determine the true object?Equipment lease with an operator
1. Taxable 2. Exempt
26 T
axab
le
Exe
mpt
0%0%
10
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Council On State Taxation
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
Exe
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%
5
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
e
Fal
se
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...
Exe
mpt s
ale
to a
not-.
..
Exe
mpt s
ale
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
60
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
Subje
ct to
sal
es ta
x
Exe
mpt f
rom
sal
es ta
x
Exc
luded
from
sal
es ta
x
None o
f the a
bove
0% 0%0%0%
5
Enterprise zones always includes exemptions at both the state and local
level:
1. True2. False
62
Tru
e
Fal
se
0%0%
5
Team Scores
63
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
70
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