General contractors, subcontractors, and builders providing construction services in North Carolina should be aware that labor charges on certain of their projects may now be subject to sales tax under the state's new repair, maintenance, and installation ("RMI") rules. While the RMI rules largely became effective on January 1, 2017, the rules provide a grace period where the North Carolina Department of Revenue will not generally assess sales tax due for filing periods between March 1, 2016 and January 1, 2019 where the service provider fails to collect it on RMI services. Contractors should consult their tax advisors or attorney now to determine how the RMI rules will impact their business, including North Carolina sales tax registration, collection, reporting, and documentation obligations.
Under the RMI Rules, services to real property are RMI services subject to sales tax unless the service provider can substantiate the transaction is: (1) a “real property contract” for a “capital improvement” to real property (“capital improvement”); (2) a non-taxable “mixed transaction contract”; or (3) exempt or excluded from the North Carolina sales tax.
The RMI-Capital Improvement dichotomy is central to the North Carolina sales tax regime for taxation of real property services. Notwithstanding their catchall nature, RMI services specifically include work to install, apply, connect, adjust, or set into position tangible personal property, including floor refinishing and the installation of carpet, flooring, floor coverings, windows, doors, cabinets, countertops, and other installations where the item being installed may replace a similar existing item. On the other hand, and as a general matter, new construction, reconstruction, remodeling (i.e., a transaction comprised of multiple services performed by one or more persons to restore, improve, alter, or update real property that may otherwise be subject to tax as RMI services if separately performed), landscaping, work that requires the issuance of a permit under the North Carolina Building Code, replacement or installation of roads, driveways, parking lots, patios, decks, and sidewalks, and any service for an addition or alteration to real property that is permanently affixed or installed and that is not specifically listed in the definition of RMI services are among the activities considered Capital Improvements not subject to sales tax. However, the repair or replacement of electrical components, gas logs, water heater, and similar individual items that are not part of new construction are considered taxable RMI services. The determination of whether a real property service is subject to North Carolina sales tax under the RMI Rules depends on the facts and circumstances of the particular transaction. As it stands, the full scope of the RMI Rules is unknown as a result of broad and complicated provisions that have yet to be interpreted by the courts.
If a real property service is a RMI service, then the service is subject to sales tax, payable by the purchaser (e.g., real property owner, lessee, or general contractor) (“purchaser”) and collected and remitted to the state by the service srovider. Absent determining whether the particular service is a RMI service, this is a straightforward application of the sales tax rules to a service transaction.
A capital improvement, on the other hand, is not subject to the sales tax and therefore requires substantiation to establish its special status. Service providers should request the purchaser provide certification on Form E-589CI, Affidavit of Capital Improvement that the transaction is properly treated as a capital improvement for sales tax purposes. The instructions to Form E-589CI provide three scenarios in which the form may be used:
- A property owner hires one or more subcontractors to complete the capital improvement. The property owner issues a Form E-589CI to each subcontractor.
- A property owner hires a general contractor to oversee a capital improvement where the general contractor hires one or more subcontractors to perform all or part of the capital improvement. The general contractor issues a Form E-589CI to each subcontractor.
- A lessee or tenant of a property owner hires a general contractor to perform capital improvement services. The lessee/tenant issues Form E-589CI to the general contractor.
Form E-589CI is a useful and important risk allocation tool for service providers because, absent egregious activity or fraud, the form (1) provides adequate substantiation that the services provided were in connection with a capital improvement and (2) shifts the potential sales tax liability for misclassification of those services from the service provider to the purchaser via the purchaser’s acknowledgement that it, not the service provider, will be liable for payment of the sales tax if it is later determined that the services were in fact RMI services. Records other than Form E-589CI may be used to establish that real property services were rendered in connection with a capital improvement; however, in a transaction where subcontractors are involved, as in Scenario 2, above, the purchaser and each service provider (e.g., the real property contractor, subcontractor, and owner) are jointly and severally liable for the sales tax until the respective non-purchasing party receives an affidavit from the purchaser certifying that the tax has been paid. Parties to real property contracts for capital improvements will need to communicate about and agree on how to present sales and use taxes on proposals and expectations regarding Form E-589CI to ensure correct application of sales tax laws and to prevent under or over collection of tax.
Documentation substantiating a real property service transaction is a capital improvement, non-taxable mixed transaction contract, or otherwise exempt from sales tax is essential to the Department respecting the classification of the real property service as exempt if challenged upon audit. Service providers unable to produce adequate records establishing the transaction is properly exempt from the sales tax are liable for the tax on the transaction. Similarly, service providers failing to separate taxable and exempt items on any invoice will generally be subject to sales tax on the entire sales price of that transaction, without deduction for the exempt items. Because service providers are ordinarily liable for the sales tax, failure to maintain proper documentation can be a costly mistake. Similarly, service providers should take steps to ensure accuracy in their sales tax collection and remittal to the state because consequences for over and under collection of sales tax include interest and penalties and may give rise to criminal penalties in some circumstances. The RMI Rules provide a grace period where the Department will not assess sales tax due for a filing period beginning on or after March 1, 2016 and ending prior to January 1, 2019 for certain failures to collect sales tax on RMI services.
Real property service providers should consult their tax advisors to determine how the RMI Rules will impact their business, including North Carolina sales tax registration, collection, reporting, and documentation obligations. Please contact Spilman’s Construction and State and Local Tax practice groups with any questions or for more information.
Disclaimer: This article is for general information only and should not be interpreted as specific tax advice. This article does not, and is not intended to, provide legal, tax, or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations.
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