PA Tax Law News -- December 2013: PA Issues On Appeal - Sales and Use Tax (Part 1)

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In our last issue of PA Tax Law News, we provided a list of arguments raised in Pennsylvania Corporate Net Income Tax, Capital Stock Tax and Franchise Tax appeals recently filed with the Commonwealth Court. The purpose of this was to apprise readers of issues that are commonly raised in appeals to court, to help them identify issues for which there may be an opportunity to obtain additional tax relief through a court appeal (or, in some cases, through a compromise agreement implemented at the administrative appeal level). As with corporate taxes, there are numerous Sales and Use Tax issues that are commonly not resolved until after an appeal has been filed with the Commonwealth Court. Many issues raised before the Commonwealth Court can be resolved through negotiated settlement. In addition, issues that proceed to formal argument before the court provide opportunities for the filing of protective refund petitions by taxpayers with similar issues.

The list below identifies issues that are pursued in appeals to court. Pennsylvania’s Sales and Use Tax laws are very complex, and this is by no means an exhaustive list of every issue that could possibly arise in an appeal. Obviously, some arguments are stronger than others, and the ultimate outcome of a particular case may depend on the specific facts involved and the adequacy of the supporting documentation submitted in support of the taxpayer’s position.

  1. Computer Services:  Many cases contest the taxability of various “computer-related services.” Services under appeal include separately-stated software support service fees, software support services included in software maintenance fees, computer consulting services, computer programming services, computer integrated systems design services, data processing services, information retrieval services, implementation and training services, web hosting services, remote help desk services, web design services, laptop encryption services, and others.
  2. Computer Software:  Arguments on appeal include the improper imposition of tax on “custom” software, software used in tax-exempt production operations, software hosted on servers located outside of PA and accessed remotely by PA users, and software loaded on a server in PA but accessed remotely by out-of-state users.
  3. Taxation of Employee Cost Component of Help Supply Services and Interior Office Building Cleaning Services:  Many taxpayers seek relief for tax imposed on the “employee cost” component of these services, in situations where relief is not granted at the administrative boards because such costs are not separately stated on the vendor’s invoice and the vendor is not willing to disclose the “employee cost” and “service fee” percentages.
  4. Other Services Not Specifically Enumerated as Taxable Services:  Taxpayers regularly contest the taxability of a myriad of services on the basis that such services are not among those services that are specifically enumerated as taxable by the tax statute. The following list includes examples of services under appeal, but is by no means a comprehensive list of services which are arguably not subject to tax:

    - Advertising Services (market research services, design
    services, media advertising, etc.)

    - Landscaping Services (other than taxable lawn care services)
    - Snow Removal Services

    - Engineering and Other “Professional” Services

    - Waste Disposal Services (including charges for portable
    toilets)

    - Moving/Delivery/Hauling Services (not provided by a
    vendor in conjunction with the sale of taxable property)

    - Human-health Related Services

    - Security Monitoring and Security Services

    - Video Production Services

    - Digital Photography Services

    - Medical Transcription Services

    - Inspection and Testing Services

    - Public Relations Services

    - Storage and Warehousing Services (other than self-storage
    services)

    - Disaster Recovery Services

    - Installation Services (for property not purchased from
    installer)

    - Enhanced Telecommunications Services (voicemail
    services, email services, electronic publishing services, etc.)
  5. Purchase of Nontaxable Construction Services:  Many appeals assert that tax was improperly assessed or paid on property installed by a vendor on the basis that the property was installed pursuant to a construction contract because the property became a permanent part of the real estate upon installation (and is therefore taxable to the installer and not the purchaser). This argument can apply to numerous items installed by a vendor. Examples of transactions appealed by taxpayers to court as nontaxable “construction services” include, among other things, the installation of cabling for computer and communication systems, HVAC equipment, alarm systems, cabinets, lighting fixtures and equipment, refrigerated display cases and other types of installed equipment.
  6. Repairs to Real Estate:  Tax was improperly assessed or paid on nontaxable repairs to real estate. This issue could also be raised in conjunction with building maintenance contracts that include both taxable maintenance services and nontaxable repair services or other nontaxable services.
  7. “Building Machinery and Equipment” Used in Contract Performed for Tax-Exempt Entity:  The scope of items which qualify as tax-exempt “building machinery and equipment” (“BME”) when used to perform a construction contract for a tax-exempt entity is often a subject of appeal. A determination as to whether a specific item constitutes “BME” under the sales tax statute is not always a “black and white” issue. One issue currently under appeal is whether nuts, bolts and washers qualify as “BME” because they are an indispensable part of exempt components or whether they constitute “fittings,” which are specifically excluded from the definition of “BME.”
  8. Property Installed In Projects Where Owner is Entitled to Claim Production Exclusion:  Contractors who provide foundations for exempt production equipment or who construct public utility facilities or other property (e.g., solar systems for the production of electricity) that qualifies for a production exclusion may be entitled to purchase materials on a tax-free basis by claiming the exclusion to which the purchaser is entitled. Exemptions are also claimed by taxpayers for materials used in the construction of property (e.g., sanitary sewer systems and water lines) for a non-exempt purchaser where the sewer system, etc. is ultimately transferred to a public utility.
  9. Financial Institution Security Equipment:  Numerous financial institutions regularly file appeals for tax assessed or paid on computer hardware and software, imaging systems and many other items on the basis that such items constitute tax-exempt “financial institution security equipment” because the items are used by the financial institution “for its protection or convenience in conducting financial transactions.”
  10. Outdoor Advertising Signs:  It is commonly asserted that the Department of Revenue’s regulation stating that “the erection of outdoor advertising boards or signs ‘by permanent or semipermanent construction’ is a construction activity” applies to various types of building signage.
  11. Real Property Improvements Included in Capital Lease:  Taxpayers have contested the imposition of tax on lease payments including charges for the lease of items which may qualify as part of the “real estate” for sales tax purposes.
  12. Out-of-State Transactions:  Many cases assert that tax was improperly imposed or paid on property that was delivered to a location outside PA or on services obtained outside PA or for which the “benefit” of the services was outside PA. In addition to property shipped to locations outside PA, examples include computer software “used” outside PA, remote access to computer hardware outside PA, placement services for an employee who will be working outside PA and printing services performed outside PA in certain circumstances.
  13. Resale:  Many cases assert that tax was improperly assessed or paid on property purchased for the purpose of resale. The resale exclusion includes more than straight sales of property or services (e.g., raw materials incorporated into products). One current issue which may be argued to the court is whether a subcontractor can claim the resale exclusion to obtain a refund of tax paid on property transferred to a prime contractor on the basis that the property retained its character as tangible personal property when installed by the subcontractor.
  14. Special Resale:  Companies that take delivery of materials or equipment in PA, and do something to those items before sending them to an out-of-state location may qualify for the “Special Resale” exclusion. The items do not have to be resold to a third party. Examples include delivery of computers in PA for the addition of memory or software before being sent to company locations outside PA and materials used to fabricate building components to be installed in buildings outside PA.
  15. Manufacturing, Processing, Farming, Public Utility, Mining and R&D Exclusions:  Numerous cases claim tax exclusion for machinery, equipment and supplies used to produce a tangible product or used in other activities that qualify for a production exclusion. Sometimes there is an issue as to whether a particular activity qualifies for a production exclusion (which is not always obvious). Even when a company’s operations obviously qualify for a production exclusion, many appeals involve issues as to whether specific items are eligible for the exclusion – e.g., whether the taxpayer has proven that various items are used “directly” and “predominantly” in production operations. Commonly contested items include packaging equipment, process control hardware and software, forklifts and other material handling equipment, electricity and natural gas used in production operations, pollution control equipment, and safety equipment and supplies. Also, disputes often arise as to when a particular production process begins and ends.
  16. Contractors Performing Services for Production Companies:  A contractor performing services for a business engaged in manufacturing, processing, public utility, farming or mining operations may be able to claim the applicable production exclusion for equipment used to perform services for the production company when the production exclusion would apply if the services were performed directly by the production company.
  17. In-House Printing/Photography/Imaging Operations:  Appeals seek relief for tax assessed or paid on equipment used in “in-house printing” operations, when the taxpayer has a central copying area that handles high-volume copy jobs.
  18. In-House Production of Electricity:  Similarly, taxpayers can claim the manufacturing exclusion for equipment used to produce electricity for their own use (whether or not they are otherwise engaged in tax-excluded production activities).
  19. Pallets and Other Wrapping Supplies:  This exemption applies to supplies used to deliver personal property, such as pallets, nonreturnable containers, wire, mailing labels, etc. Pending court appeals include claims that hangers, paper covers and plastic wraps for clothing and modular housing frames or “undercarriages” qualify as wrapping supplies. Another issue on appeal is whether a company that is not in the business of selling personal property (e.g., a warehouse operator or a taxpayer using the supplies to deliver property for its own use) can claim the exemption.
  20. Direct Mail Advertising Literature or Materials:  Many cases claim this exemption for items that are sent through the United States Postal Service and are intended to create goodwill. Examples of items for which taxpayers claim an exemption include annual reports, calendars, pens, newsletters, brochures and other promotional materials, and event invitations, including envelopes and mailing list charges.
  21. Subscriptions:  Taxpayers often claim an exemption for subscriptions for materials that are published at regular intervals not exceeding three months and circulated among the “general public.” The exemption also applies to printed advertising material circulated with a periodical regardless of where or by whom the advertising material was produced. Exemptions are claimed for publications that are not delivered in “paper” form, such as those delivered on a CD.

    Due to space limitation, additional Sales and Use Tax issues will be discussed (as Part 2 of this article) in the next issue of PA Tax Law News.