Construction Sales Tax Liabilities: Managing the Contract
December 24, 2014
Contractors are at risk in three general areas of sales tax liability: managing the contract, purchasing items for use in the contract, and the invoicing of customers. In this first article in a series by Tim Howe, we focus on what firms need to know about drawing up contracts.
When it Comes to Sales Tax, Form Does Not Always Trump Substance
It’s a common misunderstanding that an “iron-clad” contract will protect a construction or contracting company from sales or use tax liability. In many cases and depending on the jurisdiction, contract law may not supersede tax law. Contracts are supposed to be written according to state laws and legal guidance, but these requirements can be missed, and sales tax liability and language that may be proven to be “unreasonable” at the time of contract execution should it be challenged in a court of law.
Entering into an agreement that has not been vetted – even with your oldest, most reliable customer – can put your company at risk. That customer may be completely worthy of your trust, but ultimately your customer does not decide who pays the tax. The state’s revenue collection and administration does. However, the terms of the contract can guide the definition of the “tax base” for the transaction which is sometimes dictated by the nature of the billing arrangement (Time and Materials, Cost Plus, Fixed Fee, etc.)
Regardless of Form, It’s the Agent’s Duty to Collect Sales Tax
As far as administrative agencies are concerned, the party the contract marks as responsible for paying sales tax can be held as irrelevant. Instead, the nature of the transaction, contract terminology and the guidelines provided by state legislation will determine whether or not your company acted as an “agent” on behalf of the state and who is ultimately responsible for paying the tax. If you are deemed responsible, you may be required to collect tax while performing services and to issue an invoice for those services. If you or a representative acting on behalf of your company provides a service that is deemed to be taxable in a particular jurisdiction, you are more than likely required to register, collect, and remit sales tax on that service to the jurisdiction. A contract’s “form” will not change this collection and remittance requirement; the substance and nature of the transaction overrides the language in the contract.
The Risk of the Unexamined Contract
So where can you start? By examining your agreements and ensuring you and your customers and / or vendors understand your legal responsibilities. A customer may offer or require you to enter into a master services agreement, statement of work or other standard contract template with layers of legal terminology and tax language that could attempt to indemnify them from tax collection or payments. No matter how trustworthy they may think the client is, some construction and contracting companies take unnecessary risks by signing agreements without having a lawyer or tax professional examine the contract to understand what the terms truly mean to their business. Contractors can unwittingly enter into an agreement that may shift some of the sales tax liability away from the customer and onto the contractor.
In some states and with certain types of projects, the contractor is responsible for paying sales tax when he or she purchases project materials, and in other cases they are not. Companies that lack knowledge of the contractor’s responsibilities – as set forth by the state’s specific tax guidance – leave themselves vulnerable in the contract and the business has no recourse in the case of an audit.
In Spite of What You Think the Contract Says, Your Company Is Not Really Indemnified
A more specific example of contract risk is the indemnity or “limitations of liability” clause – one of the most misunderstood paragraphs in contract law. Language that says your firm is “held indemnified against any future liabilities arising from sales use, income, property, franchise, business license, etc., etc.” sounds as if it’s covering all the bases. In fact, it may still leave the construction company completely exposed to sales tax liabilities. If the contractor doesn’t pay these taxes when required by law, it may not have an ability to invoice the customer at a future date. Furthermore, some of these laws for contractor’s tax mention that the taxpayers are “jointly and severally” liable for the taxes owed on material purchases or contract values. In this case, both parties are held responsible for the payment of the tax until someone clears the bill with the state.
How to Protect Your Company
When it comes to minimizing sales tax liability, contractors need to understand three primary objectives surrounding each customer engagement: your company’s business designation, the type of contract you are entering into with your customer, and the nature of the services that you are providing. Depending on the jurisdiction these services are being performed in, your responsibilities vary based on these factors and the parties involved in the transaction. The first task on the list to compliance is to review the contract with a tax or legal professional. Secondly, make sure you understand the types of services you could be asked to perform, the types and sources of materials you may use for a job, and the nature of any sub-contracting work that may be utilized at the job site.
Smith & Howard provides value by assessing the entire landscape of the transaction and helping contractors understand the true taxability of the materials being used and the services being performed. We help our clients find clarity on their tax liabilities and support them in strategies for minimizing risk and cost.
Please call Tim Howe at 404-874-6244 to discuss your situation and learn how we can help.
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