State to Taxpayers: “Do You Even Lift, Bro?”
Washington’s dojo owners won’t likely be asking the legislature to spot them on the bench press in the near future. Beginning Jan. 1, 2016, Washington State will broaden its sales tax base to explicitly define more types of services as taxable “amusement, recreation, and physical fitness services.” (2015 Wash. H.B. 1550, effective Jan. 1, 2016.) Among those services include services provided at, for example, batting cages, bowling establishments, golf courses and martial arts studios.
That might sound pretty tame, but in fact it’s a big change. Currently, Washington imposes sales tax and B&O tax on “physical fitness services,” but the legislature does not define that term by statute. However, as H.B. 1500’s legislative analysis explains, a Department of Revenue rule defines “physical fitness services” to include all exercise classes, use of exercise equipment and personal training. The definition excludes instructional lessons, however, because instructional lessons and exercise classes exist for different purposes. Namely, instructional lessons exist for educational purposes, whereas exercise classes exist for physical fitness purposes.
Instructional Lessons vs. Physical Fitness Services
As you could surmise, that last distinction creates a big gray area. In other words, it’s not always clear whether a business is providing an instructional lesson, an exercise class, or both. For example, under current law, would karate classes be tax-exempt educational lessons or taxable physical fitness services? Arguably, people practice karate to learn how to master the art form, but surely some people practice karate because it helps them stay physically fit. Perhaps the answer lies somewhere between. In any event, soon that distinction will be irrelevant because the new law will classify both “martial arts” and “mixed martial arts training” as taxable physical fitness services.
The Washington Department of Revenue characterizes the change as “simplify[ing] the taxation of physical fitness services by clarifying that all charges for the use of athletic or fitness facilities are retail sales.” Perhaps it’s true that the tax code will be simpler, but affected business are none too happy about the change. For example, in local news coverage, King5 News (an ABC affiliate) recently interviewed a martial arts dojo owner about the impending change. During the interview, a voice-over stated that “none of these people are working out” and that “exercise is merely an effect of what’s really happening: the practice of . . . martial arts.” Like many in his field surely would, the owner contended that physical fitness is “merely a byproduct” of martial arts training.
Martial arts isn’t the only area where the instructional–exercise distinction has been vague historically. Instead, other businesses have found creative ways to self-classify as providing instructional lessons rather than exercise classes. Let’s turn to an administrative decision published about a month ago. (Washington Tax Decision Det. No. 15-0039 (Sept. 30, 2015).) That decision addressed a dispute between the Department of Revenue and an unnamed “provider of cross-training classes.” The company had claimed that its cross-training classes were not physical fitness services, but rather that the classes were instructional lessons intended to instruct students in cross-training “techniques and philosophy.” Curiously, though, the stated underlying philosophy was merely to use “constantly varied functional movements performed at high intensity.”
The Administrative Law Judge disagreed with the company’s assertion. Examining the primary purpose behind the transactions, the ALJ characterized the cross-training classes as taxable physical fitness services. The Administrative Law Judge employed the “primary purpose” test and concluded that the cross-training classes were taxable physical fitness services. Said the ALJ:
Learning how to become physically fit is different than actually becoming physically fit. A class where the students learn how to exercise their muscle groups without actually exercising them is different than a class where they learn how to and actually exercise muscles. The former is a purely instructional activity. The latter has components of instruction and physical fitness. . . . [I]n circumstances like this the Department looks to the primary purpose of the activity when determining how tax it. While Taxpayer has submitted a significant amount of material emphasizing the instructional component of its activities, we do not find this to be the primary purpose of the majority of its [cross-training] program.
That’s a fair distinction, and to me it seems pretty clear that the cross-training company was straining a commonsense understanding of its own services to achieve a desired result. And perhaps that strained understanding was the impetus behind H.B. 1500, at least in part. Regardless, taxpayers are seeing the impending change as some bad kung fu.
Should We Tax Services More Consistently?
Here’s one last thought: even after the amended law takes effect on January 1st, it will still take some digging to actually determine which services are taxable and which aren’t. Why forcibly redefine the nature of a particular service when one could cast a much broader net—and perhaps a fairer one, too—by taxing all service transactions? Maybe I should check in with my Shaolin sensei on this one, but I think this entire situation is a case study in the value of having a broad sales tax base. But I guess we’ll have to make do with what we have. After all, aren’t we all just trying to get that C.R.E.A.M. anyway?
Continue the discussion on LinkedIn: Should states impose sales and use tax on martial arts studios? Should we tax deadlifting differently than karate-chopping? And what ever happened to Tae Bo?
For more information about state tax issues, sign up for a free trial on Bloomberg BNA’s Premier State Tax Library.
By Ryan J. Voorhees
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