Business owners know that what worked five years ago will not necessarily work today. The challenge for any business is to adapt its business model and its products and services to current and expected realities to pivot, grow, and maintain a thriving business. If a business doesn’t do so, it will fail.
Jeff Bezos, Amazon’s founder, confirmed this when he stated: “Amazon is not too big to fail. . . . In fact, I predict one day Amazon will fail. Amazon will go bankrupt. If you look at large companies, their lifespans tend to be 30-plus years, not a hundred-plus years. If we start to focus on ourselves, instead of focusing on our customers, that will be the beginning of the end.”
These changing business models and offerings have implications in many areas, including state and local taxes. For companies that provide a combination of services and tangible products (including the use of tangible products), a change in business model or product lines can have a significant difference in tax results.
A key consideration for sales and income taxes is whether a company is selling a tangible product or a service. Often company products are a combination of the sale of services and tangible products. From a state tax perspective, a determination needs to be made as to what type of sale it is, because it normally won’t be considered as both.
A key consideration for sales and income taxes is whether a company is selling a tangible product or a service. Often company products are a combination of the sale of services and tangible products. From a state tax perspective, a determination needs to be made as to what type of sale it is, because it normally won’t be considered as both.
Since the taxation of the sale of tangible products is normally much different from the sale of services, the tax impact can be significant.
Department of Revenue Guidance Distinguishes Sales of Services From Sales of Tangible Products.
There is significant caselaw across the country dedicated to distinguishing the sale of services from the sale of tangible products. A common test used by state courts for this purpose is the “true object” test. Using this test, courts try to determine whether the true object of a mixed transaction, in which both property and services are provided, is the sale of property or services. Courts may also use the test to classify transactions in which multiple types of property are sold (one of which is taxable and the other exempt) or transactions in which multiple types of services are sold (again one of which is taxable and the other exempt).
In Rev. Rul. 1-08-6, the Nebraska Department of Revenue announced it would apply a similar test to evaluate mixed transactions, which it labelled as the “incidental-to-service” test. This test is intended to look objectively at the entire transaction in determining whether a transaction is principally the provision of a service or the transfer of tangible personal property. If the rendition of services is the principal object of the transaction, then any tangible personal property transferred is deemed to be incidental to the services provided. Consideration is given to the following six factors:
- The object sought by the buyer;
- The seller’s type of business;
- Whether the tangible personal property was provided as a retail enterprise with a profit-making motive;
- Whether the tangible personal property could be sold without the service;
- The extent the services have contributed to the value of the tangible items transferred; and
- Any other factors relevant to the particular transaction.
Department of Revenue May Combine Sales of Related Products or Services—Even If Separate Prices Exist for Each.
Business owners also need to be aware of the potential that sales of related products or services at the same time could be treated as one product or service by the Department of Revenue—and taxed accordingly. Consider the recent decision by the Lancaster County District Court in Enterprise Rent-A-Car v. Nebraska Department of Revenue. In addition to simply renting cars, a rental car agency allowed customers to purchase insurance and fuel. While the agency collected sales tax on the car rental fees themselves, it did not collect tax on the charges for insurance and fuel. The agency believed that those transactions were separate transactions, not subject to sales tax.
A Nebraska court, at the urging of the Department of Revenue, disagreed. That court reasoned that the insurance and fuel were necessary parts of renting a car. One could not operate a car without insurance and fuel. Therefore, even though there were separate charges for the insurance and fuel, the agency should have collected sales tax on the insurance and fuel charges. This was in spite of the fact that insurance and fuel were not subject to tax when purchased on their own.
Conclusion
As companies look at the tax implications of their existing offerings or develop new business offerings, it is crucial to make sure these offerings are correctly classified for both income and sales tax purposes.
In our practice, we see these questions arrive both in the planning phase and during Nebraska tax audits and appeals, where the Department of Revenue may challenge a company’s tax practices and seek to impose retroactive taxation. In certain circumstances, it may be advantageous to request a ruling from the Department of Revenue on the implications of a business offering.
Nick Niemann and Matt Ottemann are partners with McGrath North Law Firm. As state and local tax and incentives attorneys, they collaborate with CPAs to help clients and companies evaluate, defend, and resolve tax matters and obtain various business expansion incentives. For more information, visit www.NebraskaStateTax.com and www.NebraskaIncentives.com. For a copy of their full publication, The Anatomy of Resolving State Tax Matters, or their Nebraska Business Expansion Decision Guide, please visit their websites or contact Nick or Matt at (402) 341-3070 or nniemann@mcgrathnorth.com or mottemann@mcgrathnorth.com, respectively.
