Sales Tax Slice: States’ Contractor Rules May Require Nuanced Construction

Construction Job

Under Rhode Island’s decades-old contractor regulation, a contractor is generally treated as the end consumer subject to tax on materials that it uses in fulfilling a lump-sum contract, a cost-plus contract, a time and material contract with an upset or guaranteed price, or any other kind of construction contract. Among a few exceptions, Rhode Island provides that this treatment does not apply if the contractor “contracts to sell materials or supplies at an agreed price and to render services in connection therewith, either for an additional agreed price or on the basis of time consumed.” In this case, the contractor is treated as a retailer required to collect tax on its material charges and may purchase the materials exempt from tax under Rhode Island’s resale exemption. 

Until now, it was not clear what this exception means. Is it describing a particular type of cost-plus or time and material contract? If so, how are these distinguished from cost-plus and time and material contracts generally? Apparently, I am not the only one who has been puzzling over this. The state recently released an administrative decision providing long-needed clarification of this issue. 

In the recent decision, a contractor entered into a cost-plus contract to install flooring, vents, and base boards. The contractor added 15 percent to its material and subcontractor costs and billed its contractee accordingly. The Division of Taxation argued that based on the billing structure the taxpayer made a retail sale of the materials and should have collected tax on its charge for the materials including the 15-percent markup. The contractor disagreed with the division’s interpretation, which would seem to require that material charges under all cost-plus and time and material contracts be treated as retail sales. The hearing officer agreed and determined that separately stating material charges does not by itself require that a contractor be treated as making a retail sale of materials.

What the quoted exception above is actually getting at is whether the contractor is selling tangible personal property as such or providing a construction service. The hearing officer offered the example that if a contractor sells materials and renders the additional service of delivering the materials, this would be treated as a taxable retail sale. If the additional service is sanding, installing, staining, and painting the materials, that treatment does not apply. 

Other states have also struggled with classifying contractors’ sales as taxable sales of tangible personal property or nontaxable sales of services. Several, including Texas and Colorado, have attempted to simplify this analysis by adopting a bright-line rule under which separately stated material charges are treated as taxable charges for the retail sale of tangible personal property. It is clear now that Rhode Island is not one of them. 

Would it be easier to treat all contractors’ material purchases as sales for resale and all contractors’ sales as taxable retail sales as Arizona, Hawaii, New Mexico, and Washington do? Continue the discussion on Bloomberg Tax’s State Tax Group on LinkedIn.

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