Case Study: Does Kansas' Attempt to Provide Clarity on When Reimbursement Costs Are Subject to T(1)

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By Jéanne Rauch-Zender  

In a decision that addresses the complications of how to compute sales and use tax, the Kansas Court of Appeals scrutinized the state's taxing statutes to clarify that reimbursement of travel expenses were exempt from sales tax because they were not sold at retail. In its effort to shed light on the issue, however, the court may have muddied the waters and created an opportunity for the government to impose what some would argue is nothing short of double taxation.

In In Re Cessna Employees Credit Union,1 Cessna contracted with Jack Henry and Associates (JHA) to purchase taxable computer upgrade services and goods. To fulfill this contract with Cessna, JHA incurred travel expenses in its purchase of transportation, meals, and lodging for its employees. JHA provided Cessna with two separate invoices, one for the goods and services in upgrading Cessna's computers, and the second for travel expenses. Both invoices included Kansas sales tax on the total. Following its payment to JHA, Cessna filed a refund claim for the sales tax it paid to JHA for JHA's travel expenses, arguing JHA was the ultimate consumer of the travel expenses, and as such, the bearer of any sales tax on those travel expenses.

Sales Tax Is Paid Only Once

Kansas sales tax is to be imposed one time only on the ultimate consumer of the goods and services. However, resolving who the ultimate consumer is can be challenging.

Under the Retailers' Sales Tax Act, Kansas imposes sales tax on gross receipts from the sale of goods and certain services.2 The statute defines gross receipts as “the total selling price or the amount received . . . in money, credits, property or other consideration valued in money from sales at retail within this state.”3 The total selling price is, in turn, defined as the total amount of consideration for which property or services are sold, “without any deduction for . . . the cost of materials used, labor or service cost, interest, losses, all costs of transportation to the seller, all taxes imposed on the seller and any other expense of the seller.”4 The rules are intended to apply only to the ultimate consumer of the goods or services.5

The Kansas Supreme Court in Southwestern BellTel. Co. v. State Commission of Revenue and Taxation6 “identified the controlling factor” in determining the ultimate consumer to be who controls the tangible goods when they come to their final resting place.

In Cessna, JHA paid sales tax on its employees' travel expenses. Although the parties stipulated that title to JHA's travel expenses remained with JHA, the Kansas Department of Revenue argued that Kansas sales tax should be imposed on the total selling price JHA charged Cessna, which included the cost of the travel expenses. The department claimed that JHA was not passing its costs of the travel purchases to Cessna; rather it was adding the costs of those items it incurred into the costs of the goods and services it sold to Cessna. Thus, Cessna, as the consumer of the goods and services, was responsible for paying the tax on the total selling price, “without any deduction for all costs of transportation to the seller, all taxes imposed on the seller and any other expense of the seller,”7 the department explained. The case involved two different sales transactions with two different consumers, with each being taxed on their total selling price of goods and services purchased.

The Kansas Court of Tax Appeals (COTA)8 agreed, finding that, although the ultimate consumer of the travel expense was JHA, “the reimbursement of these expenses was part of the total amount of consideration given by Cessna in the transaction for which taxable goods and services were sold by JHA.” The expense reimbursement was, therefore, properly included in the gross receipts for sales tax purposes.

Determining Who the Ultimate Consumer Is

Cessna appealed, arguing JHA was the ultimate consumer of the travel expenses; JHA paid sales tax on said expenses, and taxing Cessna on those same travel expenses amounted to nothing short of double taxation.

Upon review, the court of appeals embarked upon deciphering who is “the ultimate consumer,” the sales tax treatment of sales vs. reimbursement of expenses, and the growing conflict questioning whether the reimbursement of separately invoiced expenses can be deemed part of the consideration from a sale at retail.

At issue was whether JHA was the ultimate consumer of the travel expenses and, if so, did its payment of tax prevent the imposition of tax on Cessna under double taxation principles.

Precedent tells us that the Kansas department's9 and COTA's10 approach to this issue is to apply the principle that “impermissible double taxation does not occur when the same sales tax is imposed on separate privileges subject to the tax.”11 Rather, impermissible double taxation arises when the frequency of the tax occurs twice on the end user in the same transaction.

Employing this principle in the Cessna case, COTA determined that although JHA was the ultimate consumer of the travel, and paid sales tax on the travel services, the reimbursement of the travel expenses was part of the total amount of the consideration given by Cessna in the transaction for which taxable goods and services were sold. COTA advised that Cessna was not being taxed on travel services as the consumer of the travel; more accurately, the sales tax was levied upon the total amount of consideration given by Cessna in the transaction with JHA for providing computer goods and services.12 Thus, the travel was an anticipated expense incurred by the seller who, instead of contracting for a definite total selling price, made the selling price dependent, in part, on the expenses of the seller by requiring the reimbursement of the expenses, COTA reasoned.13

However, the Kansas court of appeals disagreed.

Examining the “Gross Receipts” Definition

Amounts received in money, credits, property, or other consideration from sales at retail within Kansas, are subject to sales tax.14

Applying these principles to the case, the court of appeals reversed COTA's decision, finding there was no retail sales comprising of travel expenses, so no retail sales tax may be applied to those expenses.15 JHA's travel expenses, which were not sold at retail, not a part of the sale of goods and services, and not part of the selling price of the goods and services, were reimbursement of an associated cost incurred by JHA.16 Under a goods and services contract “with a provision for reimbursement of travel expenses consumed by, taxable to, and taxes paid by a seller, with those expenses separately invoiced to the party reimbursing the same,” the reimbursement amount is not again subject to retail sales tax in Kansas, the court of appeals ruled.17

Yet, fundamental to the court of appeals' reasoning is its unmistakable message that if JHA had chosen to increase the price of its goods and services so as to recover these travel expenses rather than seek reimbursement, its ruling would be different. The significance here is the reverse argument, inadvertent or not, that warns taxpayers and the department, separately state these reimbursement expenses and be prepared for the limitations on sales tax that will follow.

Inconsistent Application of Principles

Just one month after the Kansas Court of Appeals' ruling in Cessna, the Kansas Department of Revenue issued an opinion letter that appeared, at first glance, to contradict the Cessna ruling.

In Opinion Letter O-2012-002,18 the department ordered costs and expenses a leasing company paid to a repair shop and billed to lessees be included in the tax base used to determine the amount of sales tax due on the leasing company's taxable lease charges. It also required that sales tax be computed on the total amount of each lease charge billed to the lessee without any deduction for fees, charges, or expenses, whether paid by the lessor or lessee.

The vehicle leasing company, as part of its leasing services, agreed to pay its customers' repair/service bills directly to the repair shop and then seek reimbursement from its customer by including them on the customer's monthly bill. The leasing company did not charge a separate fee for this service.

In determining the imposition of tax, the department first explained that there were two separate transactions subject to Kansas sales tax: the retail sale of services and parts that were billed by the repair shop to the leasing company; and the taxable lease entered into between the leasing company and its lessee. Consequently, the legal incidence of these two impositions of sales tax fell on two different entities, with two separate taxable transactions--the lease, and the sale of repair parts at retail, and as a result, impermissible double taxation did not occur, the department said. Retailers' sales tax must be passed on to the purchaser or consumer buying the goods or services at retail, the department noted, and no impermissible double taxation results from the vehicle leasing company simply recovering the cost it incurred.

In Cessna, the court of appeals ruled that JHA's reimbursement of travel expenses was not subject to sales tax because they were not “sold” at retail, and therefore not includable in the total selling price. However in the opinion letter, the department found reimbursement of repair or service payments must be included in the tax base and subject to sales tax.

How do we reconcile the department's decision above with the court of appeals decision in Cessna, which prohibited the inclusion of reimbursement expenses in the total selling price?

The Devil Is in the Details

Upon detailed review of the facts, perhaps the two decisions are not necessarily in conflict. Instead, making sense of the different outcome lies in delving into the facts to determine who the ultimate consumer is.

In Cessna, JHA's purchases of airline tickets, meals, lodging, and rental car services were necessary travel expenses incurred by JHA to fulfill its contractual obligations of providing computer services and goods to Cessna. For that reason, JHA was the ultimate consumer of these travel expenses, not Cessna.

On the other hand, in Opinion Letter O-2012-002, even though the leasing company was billed for the retail sale of services and parts by a repair shop, the ultimate consumer of the repaired and serviced car was the leasing company's customer who leased the vehicle.

So what should taxpayers be concerned with when attempting to collect or recover costs?

Recovering Costs

In Cessna, the court of appeals explains that JHA cannot expect to collect sales tax from Cessna “when its travel expenses are invoiced for reimbursement.”19

Alternatively, to recover all costs, the court in Cessna seems to advocate simply increasing the price of goods and services by the amount of reimbursement sought, rather than constructing the transaction in two parts, i.e., the sale of goods and services as well as a reimbursement of travel expenses. “If JHA had chosen to increase the price of its goods and services so as to recover these costs rather than seek mere reimbursement, this would be a different transaction for sales tax purposes,” the Cessna court explained.20

The department shares this same reasoning, recommending “whenever a leasing company bills a lessee to recover costs the company incurred when it paid for goods, services, and associated sales tax, the company should bill the lessee a single lump-sum amount for the total amount it paid rather than stating each amount as a separate line-item charge.”21

Of course for some taxpayers, demanding items be separately stated may be the only way to ensure tax continues to be paid by the ultimate consumer.

On May 1, 2012, the department filed a petition for review of the Cessna decision to the Kansas Supreme Court. This issue has not been laid to rest in Kansas, as well as other states. Although Kansas has been at the center of this article, it is by no means the only state thrashing through these muddy waters.22

1 Kan. Ct. App., No. 105,139, April 6, 2012.

2 Kan. Stat. Ann. §79-3603.

3 Kan. Stat. Ann. §79-3602(o).

4 Kan. Stat. Ann. §79-3602(ll)(1)(B).

5 Kan. Stat. Ann. §79-3604. See also, Kansas Power and Light Co. v. Aarens, 16 Kan App. 2d 620, 827 P.2d 74 (1992).

6 212 P.2d 363 (1949).

7 Kan. Stat. Ann. §79-3602(ll)(1)(B).

8 COTA is an administrative court within the executive branch of state government and is the highest administrative tribunal for matters involving state and local taxation. Kan. Stat. Ann. §74-2438. Under Kan. Stat. Ann. §74-2426, all final orders issued by COTA, with certain exceptions not relevant here, are reviewable by the court of appeals.

9 Kan. Dept. of Rev., Opinion Letter O-2012-002, May 11, 2012.

10 In Re Cessna, Kan. Ct. App., No. 105,139, April 6, 2012.

11 Florida Hotel and Motel Assoc. v. Fla. Dept. of Rev., 635 So.2d 1044 (1994).

12 In Re Cessna, Kan. Ct. Tax App., No. 2009-8166-DT, Aug. 27, 2010.

13 Id.  

14 Kan. Stat. Ann. §§ 79-3603 and 79-3602(o).

15 In Re Cessna, Kan. Ct. App., No. 105,139, April 6, 2012.

16 Id.  

17 In Re Cessna, Kan. Ct. App., No. 105,139, April 6, 2012.

18 Kan. Dept. of Rev., Opinion Letter O-2012-002, May 11, 2012.

19 In re Cessna, Kan. Ct. App., No. 105,139, April 6, 2012.

20 Id.  

21 Kan. Dept. of Rev., Opinion Letter O-2012-002 (May 11, 2012).

22 Va. Dept. of Rev., Ruling of the Commissioner PD 96-88 (May 14, 1995) (the Virginia Tax Commissioner subjects reimbursable expenses for employee travel and accommodation to sales and use tax because when the purpose of the trip was for on-site installation of a computer system sold to a customer, all of the reimbursable costs incurred for an employee's travel and accommodations are considered part of the selling price of the tangible personal property).