2013 COST SALT BASICS
SCHOOL
Module 13: Exempt &
Non-Taxable Transactions
Donna-Marie Daday
Jeff Lemmons
PricewaterhouseCoopers LLP
1
Council On State Taxation
Exemptions and Exclusions - Introduction
Exclusions
-
Exemption
-
-
transactions not included
within the state’s tax base;
Burden on the government
transactions normally
subject to tax, but
conditions exist which
create exemption
Burden on the taxpayer
2
Council On State Taxation
Exemptions and Exclusions –
Representative Exclusions
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
3
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
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
4
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
Product Based Exemptions





Food for Home Consumption (generally excludes
prepared meals)
Clothing
Prescription Drugs
Other Medical (Durable Medical Equipment,
etc.)
Newspapers
5
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
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
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
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
Council On State Taxation
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?
10
A. Sale for resale
B. Taxable Sale
Sa
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Exemptions and Exclusions –
Types of Exemptions
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
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
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
Council On State Taxation
Exemptions and Exclusions –
Types of Exemptions
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
Council On State Taxation
Manufacturing Exemption Concepts –
Direct Use
 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.
12
Council On State Taxation
Manufacturing Exemption Concepts –
Direct Use
 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
13
Council On State Taxation
Manufacturing Exemption Concepts –
Integrated Exemption
 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
14
Council On State Taxation
Manufacturing Exemption Concepts –
Integrated Exemption
 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
15
Council On State Taxation
Manufacturing Exemption Concepts –
Related Exemptions
 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
16
Council On State Taxation
Exemptions and Exclusions –
Exemption Certificates
 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
17
Council On State Taxation
Exemptions and Exclusions –
Exemption Certificates
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)
18
Council On State Taxation
Exemptions and Exclusions –
Exemption Certificates
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
Council On State Taxation
Exemptions and Exclusions –
Exemption Certificates
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
Council On State Taxation
Exemptions and Exclusions –
True Object Test
Mixed Transactions



Sale 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
21
Council On State Taxation
Exemptions and Exclusions –
True Object Test
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
Council On State Taxation
Exemptions and Exclusions –
True Object Test
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
Council On State Taxation
How do you determine the true object?
Artist paints a portrait on canvas
10
1. Taxable
2. Exempt
pt
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How do you determine the true object?
Attorney drafts a contract on paper
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1. Taxable
2. Exempt
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How do you determine the true object?
Equipment lease with an operator
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1. Taxable
2. Exempt
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0%
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How do you determine the true object?
Rental of “customized” mailing list on CD
1. Taxable
2. Exempt
10
pt
0%
Ex
em
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xa
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0%
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Exemptions and Exclusions –
Real Property
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
28
Council On State Taxation
Exemptions and Exclusions –
What Is Real Property?
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
29
Council On State Taxation
Exemptions and Exclusions –
Cross-Border Transactions
The Constitution places limitations on states to impede
interstate or foreign commerce and most states provide
exemptions to reflect these Constitutional limitations
Interstate 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
30
Council On State Taxation
Exemptions and Exclusions –
Government Transactions
Government Transactions
 Constitution prohibits states from taxing the federal
government
 Most states also exempt sales to their own state
agencies and local governments
31
Council On State Taxation
Exemptions and Exclusions –
Government Contractors
Government Contractors
 Construction contractors for the government usually do not
enjoy any exemptions, but there are exceptions in some
states
 Contractors reselling TPP to the government may enjoy a
resale exemption
 Overhead or other items consumed by a contractor are
normally taxable to the contractor
 Exceptions: California
32
Council On State Taxation
Exemptions and Exclusions – Miscellaneous
Issues
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
33
Council On State Taxation
Case Study
Sales Tax Exempt and Non-Taxable
Transactions Case Study
34
Council On State Taxation
Please select a Team.
1. Team 1
2. Team 2
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2
0%
Te
am
Te
am
1
0%
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It is primarily the responsibility of the
taxpayer to prove that an exclusion from the
tax exists on a particular transaction.
1. True
2. False
5
0%
Fa
ls
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Tr
ue
0%
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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:
Subject to the tax
Exempt from the tax
Excluded from the tax
Both answer 2 and 3
3
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1.
2.
3.
4.
5
37
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?
5
1. Yes
2. No
0%
No
Ye
s
0%
38
Team Scores
0
0
Team 1
Team 2
39
Food is always exempted from the tax
1. True
2. False
5
0%
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ls
e
Tr
ue
0%
40
In states that exempt food products they will
typically exempt food sold in restaurants as well.
1. True
2. False
5
0%
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ls
e
Tr
ue
0%
41
The sale of a cash register by a jewelry store could
possibly qualify for an occasional sale exemption for
which of the following reasons:
an
er
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2
an
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s
1
or
2
Ne
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Je
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ry
3.
4.
st
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e
2.
5
Jewelry store is not in the
business of selling cash
registers
Jewelry store sold all of
their assets including the
cash register
Both answers 1 and 2
Neither answers 1 or 2
Je
w
el
ry
1.
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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?
5
1. Yes
2. No
0%
No
Ye
s
0%
43
Team Scores
0
0
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Team 2
44
It is primarily the responsibility of the taxpayer to
prove that an exemption from the tax applies to a
transaction.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
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.
5
1. Yes
2. No
0%
No
Ye
s
0%
46
Team Scores
0
0
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Team 2
47
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.
5
1. True
2. False
0%
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ls
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Tr
ue
0%
48
Services are generally subject to tax unless
specifically excluded or exempt.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
49
Tangible personal property is generally subject to
tax unless specifically excluded or exempted.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
50
An example of an
“entity based status exemption” would be:
p.
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al
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pt
s
2.
5
Exempt sale by a boy
scout troop to the general
public
Exempt purchase by a notfor-profit hospital
Exempt sale of
manufacturing machinery
and equipment to a
chemical plant
An exempt sale of a
prescription drug to a
physician practice
Ex
em
1.
51
An example of a
“use based exemption” may include
manufacturing equipment.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
52
Team Scores
0
0
Team 1
Team 2
53
Resale certificates are always required to be
collected at the time of purchase in order to be
valid.
5
1. True
2. False
0%
No
Ye
s
0%
54
What is a term commonly used for a certificate that
will cover more than one exempt purchases?
10
A good one
A big one
Complete
Blanket
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1.
2.
3.
4.
55
Every state accepts a “Uniform Sales and Use
Tax Certificate - Multi-jurisdiction”.
5
1. True
2. False
0%
No
Ye
s
0%
56
A seller accepts a resale or exemption certificate in
“good faith” and is typically relieved from further
sales tax collection responsibilities.
5
1. True
2. False
0%
No
Ye
s
0%
57
Which are common elements required for a
valid resale certificate in most states?
Signature
Contemporaneous
Renewable
Notarized
ed
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No
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at
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1.
2.
3.
4.
5
58
Team Scores
0
0
Team 1
Team 2
59
Most taxpayers would qualify for a direct pay
permit.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
60
The sale of an intangible like common
stock is generally:
Subject to sales tax
Exempt from sales tax
Excluded from sales tax
None of the above
ab
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1.
2.
3.
4.
5
61
Enterprise zones always includes
exemptions at both the state and local
level:
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
5
62
Team Scores
1800
1150
Team 2
Team 1
63
Enterprise zone exemptions are
enacted to restrict economic
development.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
64
Real property is generally taxable
unless a specific exemption is available.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
65
Tangible personal property that is
purchased for resale is generally
excluded from tax.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
66
The true object of the transaction addresses
whether the object of the transaction is an excluded
service or an enumerated service.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
67
Team Scores
0
0
Team 1
Team 2
68
Interstate transactions are typically excluded
due to constitutional restrictions on state
governments.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
69
Local jurisdictions are precluded from
allowing enterprise zone exemptions.
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
70
Which of the following is most likely to be
excluded from tax:
5
1. The sale of an item
for resale
2. The sale of an item in
interstate commerce
3. The sale of a service
4. The sale of an
enumerated service
e.
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71
Which of the following is likely to be exempt
from tax:
5
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
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72
Team Scores
0
0
Team 1
Team 2
73
Resale exemptions protect taxpayers from:
5
1. An undue administrative
burden
2. Undue cost of taxation
3. Double taxation
4. All of the above
An
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74
Entity based exemptions are based upon
who the seller is
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
75
Use based exemptions address who the
purchaser is
5
1. True
2. False
0%
Fa
ls
e
Tr
ue
0%
76
And the winner is….!
0
0
Team 1
Team 2
77