Recent Changes to Sales and Use Taxes - What is the New Rule and Its Impact?
by Cynthia Lande Brian Rickert
Friday, June 10, 2016
During the last legislative session, the Iowa Legislature passed and Governor Branstad signed House File 2433 into law. HF 2433 addressed a number of tax-related issues, including certain rules regarding sales tax exemptions for manufacturers. One of these changes may impact how contractors collect and pay sales tax on large manufacturing facility projects and consumables for those projects. This article addresses that change.
Iowa’s sales and use tax laws are complicated and twisted. Generally, under Iowa’s laws, when contractors sell real property (i.e., a completed structure) to owners, the contractors are not required to collect sales tax. To the contrary, when contractors sell machinery or equipment that does not become part of the real property, they must generally collect and remit sales tax on those sales. When a contractor purchases materials or supplies for use in the completion of a construction contract (i.e., tangible personal property such as lumber, nails, etc.), the contractor usually must pay sales tax on that purchase. However, if a contractor purchases machinery or equipment and resells it to the owner as part of a construction project, the contractor’s purchase may be exempt from sales tax under a resale exemption.
A contractor’s sale of machinery and equipment (including replacement parts) is exempt from sales tax if the machinery and equipment is directly and primarily used in processing by a manufacturer. This exemption is typically referred to as the “Manufacturer’s Machinery and Equipment Exemption,” or “MM & E Exemption.” When construction projects include machinery or equipment, the MM & E Exemption may excuse the contractor from collecting sales tax from the purchaser.
HF 2433 made two significant changes with respect to the MM & E Exemption. First, it expanded the applicability of the MM & E Exemption for certain replacement parts and supplies used by manufacturers. Additionally, it repealed certain administrative rules that made it easier for purchasers of particularly large, complex, and expensive machinery and equipment to qualify for the MM & E Exemption.
Following enactment of HF 2433 in March 2016, whether property in Iowa is real property and not subject to tax or personal property that is subject to tax will be determined based on the following factors:
- The degree of architectural and engineering skills necessary to design and construct the structure;
- The overall scope of the business and the contractual obligations of the person designing and building the structure;
- The amount and variety of materials needed to complete the structure, including the identity of materials prior to assembly and the complexity of the assembly;
- The size and weight of the structure;
- The permanency or degree of annexation of the structure to other real property which would affect its mobility;
- The cost of building, moving, or dismantling the structure.
Under this framework, property such as silos, boilers and furnaces, and tanks constructed on-site are considered real property because they are large, complex, fixed in place, and difficult to move. When a contractor is selling property deemed to be real property under this framework, the contractor must pay sales tax to their supplier when they purchase the materials and supplies, but they are not required to collect and remit tax on the sale of the completed structure to the owner even though that completed structure incorporates consumables on which the contractor had to pay sales tax.
While HF 2433 is particularly significant for manufacturers, it is also significant for contractors who work on projects involving real and personal property. Because HF 2433 makes it more difficult for sales to manufacturers to qualify as exempt personal property, contractors need to make sure they are considering the tax consequences of their purchases when bidding projects and drafting construction contracts. One thing has not changed – if a contractor relies on the MM & E Exemption or any other sales tax exemption to avoid collecting sales tax on a sale to a customer, the contractor should always request a fully completed sales tax exemption certificate from the purchaser.
The rules relating to sales and use tax in the context of construction contracts are complex and unique to certain factual situations, and this article provides only a general overview of those rules as updated by the recent legislation. If you have any questions regarding how the rules apply to your particular project or business, feel free to contact Brian Rickert, Cynthia Lande, or your BrownWinick attorney.