We all know that a government contractor’s sale to the government is not a transaction subject to sales tax, but that is where the uniformity ends for contractors performing services in multiple states. Contractors making purchases of tangible personal property used in the performance of a contract for a governmental body need to know the sales tax rules of each state where they take possession of those purchases to prevent a potential tax assessment.
The most recent example a contractor being victimized by the lack of uniformity comes from Illinois. A ruling issued by the Illinois Department of Revenue concluded that a contractor’s purchases were not tax exempt from sales tax as sales for resale because the contract did not have a provision indicating that title of the tangible personal property passed to the government body (Illinois Private Letter Ruling No. ST 13-0001-PLR, 07/31/2013). In Illinois, as well as in a number of other states, the existence of such a provision acts as an exception to the general rule that a contractor must pay sales tax on purchases of items used in the performance of its services. The general rule stems from the principle that the government’s exemption from sales tax does not extend to independent contractors of the government.
Ensuring that a title-passing provision is included in the contract seems like an easy fix, and it may be for states such as Illinois, but many states take the position that the existence of such a provision is irrelevant. While Illinois allows a contractor to have some ability to dictate the taxability of its purchases by changing the structure and form of the contract, states like Virginia look to the substance of the transaction. Regardless of the language in the contract, Virginia engages in the subjective undertaking of applying the “true object” test in determining if a contractor has to pay sales tax on its purchases. Essentially, if the true object of the contract is the provision of a service then the contractor must pay sales tax on its purchases. On the other hand, if the true object of the contract is a sale to the government of tangible personal property, then the contractor can make its purchases as tax exempt sales for resale.
The varying sales tax rules in different states can make it difficult for contractors when bidding on contracts, but a large number of states do have significant guidance in this area. It’s just a matter of taking the time to know what the rules are. Ensuring the proper treatment upfront can prevent an unwanted tax assessment years later.