It never ceases to amaze me, the wide variety of companies that state agencies attempt to extort money from. Most states impose a sales tax on the sale or rental of tangible personal property. But what happens when the sale is part tangible personal property, part service (“known to the sales and use tax attorney as a “mixed transaction”)? Is the entire transaction subject to tax? Many states take the incredibly helpful, “it depends” approach and look to an even more helpful “object of the transaction” test. In reality, it truly seems like state agencies and courts reach a conclusion and fill in the reasons later.
By way of brief background, since the mid-1900’s, when states enacted their first versions of a sales tax, many courts created this “object of the transaction” test. The test attempted to formulate what the customer was really buying, product vs service. If it was a service then it is generally not taxable, but if it is a product then it typically is subject to sales tax. For example, if you went to a lawyer for advice and left with a tangible document, like a will, then you were obviously buying a service and the will was incidental. Conversely, if one goes to a restaurant, they are clearly buying the food, not the service involved in a chef using his or her expertise to put a well tasting meal together. Viewing everything in this light, one can make an argument in virtually any item it buys. If you buy a photo are you buying the tangible photo or the artistic service involved in taking or creating the picture? At the dentist’s office are you buying a professional service or the tangible cavity filling when you get your tooth fixed? The list can go on and on.
In a 2014 example, a portable toilet company found itself in the middle of a true object argument. In Boggero’s Portable Toilets v. DOR (S.C. Admin Ct. 2014), a company provided portable toilet installation, sinks, pick-up, and waste removal services. The company also provided for holding tanks, trash containers, delivery, and servicing, soap, toilet paper, towels, and other toiletries as the customer requests. In addition, upon entering into a contract with a customer, the company calculates the estimated number of units needed based on its experience and the number of individuals using the units. In this case, is the business providing a service or the rental of tangible property?
Of course, South Carolina, through its auditor, determined that this was clearly the rental of tangible property and assessed sales tax of about $129,000 for the audit period. As available in most states, the business took advantage of its assessment appeal rights and protested the auditor’s assessment within the Department of Revenue. After shockingly losing on appeal, the business filed suit in the agency court before a neutral judge in South Carolina.
Similar to many states, South Carolina, attempts to determine the “true object” of the transaction to determine whether a service is provided or if the business is renting TPP. South Carolina reviewed a well written 1947 law review article to examine what is meant by the “true object” test. From there, it looked to a Supreme Court case in which a bingo-house took wagers and provided its patrons with bingo cards. Clearly, in that case the customer was provided an incidental bingo card and bought the intangible wager, and, therefore, the transaction was not subject to tax.
Despite not having the word rental anywhere in the “Service Agreement” the court took the position that the “true object” of the deal was for a tangible portable bathroom. The court said:
The customer pays the [business] for the use and possession of the portable toilet unit – for privacy, the four walls, the floor, and the facility.
The court didn’t just stop there. In addition, to finding the tax was due, the court imposed the penalties assessed by the DOR. In short, the result for the toilet company just stinks all around.
Although this particular case was a loss all around, I commend the taxpayer for fighting for what it believed was right. If your company or your client’s company is faced with a situation in which it is unclear whether it is providing for a product and a service then it may be worth getting creative to fight the taxability of that issue. Even better, it may be worthwhile to separate the services portion of your business into a separate legal entity and charge less for the taxable product. That may reduce your tax burden and allow you to make a higher profit. The opportunities for planning are endless if you know the rules under which you are playing.
About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email JerryDonnini@Floridasalestax.com or phone at 954-642-9390.