In Part II of our initial NC sales tax update, we stated that more clarification will be released concerning what qualifies as a Capital Improvement and what qualifies as Repair, Maintenance, and Installation (RMI) Services by the NC Department of Revenue (NC DOR). The NC DOR released Directive SD-16-4 on November 15, 2016, to address this issue, as well as other items.
In an effort to simplify the analysis, the NC DOR released a list of services that qualify as RMI services.Thus, it may be easier for us to first look to this list to see if the service qualifies as an RMI service. If it is not listed, then further analysis will be required to determine if it rises to the level of a capital improvement. We have reproduced the list below from SD-16-4. Note that the NC DOR states in SD-16-4 that a more comprehensive list will be released in the future.
- HVAC repair for an air conditioning or heating unit that is not working properly.
- Re-key locks for real property by a locksmith.
- Repair water pump motor.
- Repair to correct a jammed garage door.
- Electrical repair due to a light switch or receptacle not working properly.
- Plumbing services to unclog a drain.
- Plumbing services to identify and repair a leak in a pipe.
- Services by a roofing company to identify and repair a roof leak.
- Replace damaged exterior bricks.
- Replace or repair a storm door or garage door.
- Repair or replace countertops.
- Replace or re-face kitchen cabinet doors.
- Repair or replace a water heater.
- Repair a liner for a swimming pool.
- Repair or replace a single light fixture.
- Carpet or linoleum install for a single room.
- Repair or replace single plumbing fixture (i.e., toilet or sink).
- Replacement of plate glass window.
If the service is not listed above or in the more comprehensive list that is forthcoming from the NC DOR, then we must look to Directive SD-16-3 for the definition of a capital improvement. Please reference SD-16-3 for the full definition of “Capital Improvement” but, in essence, a capital improvement is an addition or alteration to real property that is (1) new construction, (2) reconstruction, or (3) remodeling of a building, structure, or fixture on land that is permanently installed to the real property itself so that removal would cause material damage to the property or article itself. There will likely be less confusion in classifying new construction and reconstruction so we will focus our attention on remodeling.
If a job is classified as remodeling, then it results in a capital improvement. The contractor will pay sales tax on the materials incorporated into the job and the customer will not be liable for sales tax on the sales price of the contract. If the job is classified as RMI services, then sales tax must be assessed on the sales price of the contract. So what is considered “Remodeling”?
SD-16-3 provides the following definition: The process of improving or updating a permanent building, structure, or fixture on land or major portions thereof. The term includes renovation.
The NC DOR provides further guidance in the section of the directive entitled “Advanced Application ofCapital Improvement”. In this section, two different transactions with corresponding examples are provided to help us interpret what the NC DOR considers to be remodeling. We have reproduced the descriptions along with the examples from the directive below of services that would likely qualify as remodeling.
A transaction, comprised of multiple repair, maintenance, and installation services to real property that is not a mixed transaction, and that if separately performed are taxable, single repair, maintenance, and installation services, is likely “remodeling”. Example: A homeowner decides to update the homeowner’s kitchen. The activities include the following: installation of new kitchen cabinets including cabinet boxes, tile flooring, interior walls painted, and a new sink. Upon completion, the appearance of the room is substantially different. The transaction is remodeling.
A service where the internal structure of a single room is substantially changed and property is installed or applied and becomes part of real property. Example: A property owner decides to hire another person to relocate the kitchen sink, range, refrigerator, and dishwasher within the same physical room. The service requires that electrical and plumbing systems be altered and, to some degree, relocated to other areas of the room. Therefore, applicable permits are required. The transaction is a real property contract with respect to a capital improvement.
In the first scenario presented above, the NC DOR inserts the term “likely” in the last sentence of the description. So we are told that multiple RMI services performed in unison will “likely” be considered remodeling, but this remains a substantial gray area for taxpayers. In the example that follows, the room, upon completion, appears substantially different. We feel the gist of this example is that if the RMI services that are performed in unison result in a substantial change in the real property, then the services will be considered as a whole and qualify as a remodeling job; however, we are not told what is considered substantial by the NC DOR. We know from the list provided in SD-16-4 concerning RMI services that solo repair jobs are considered RMI services. But what if two or three are combined into one contract? We would not interpret the list in SD-16-4 too strictly and assume that two unrelated RMI services aggregated into one contract automatically qualifies the job as remodeling. We must admit though that the further we move to the middle ground between RMI services and remodeling, the tougher it will be to classify the service.
Moving on to the second scenario, we see that a substantial change has once again occurred as a result of the service. What makes the second example more black and white is that applicable permits were required to perform the work. If you review the full definition of a capital improvement in SD-16-3, it states that the term includes performance of work that requires issuance of a permit under the State Building Code, other than repair or replacement of electrical components, gas logs, water heater, and similar individual items that are not part of new construction, reconstruction or remodeling. Thus, because changes in the internal structure of the room required permits to be issued, the service is by default considered to result in a capital improvement and is, therefore, considered remodeling.
In summary, we feel that we have a long way to go before we can fully digest and interpret the new laws applicable to services performed on real property effective January 1, 2017. Having said that, the directives (SD-16-3 and SD-16-4) released by the NC Department of Revenue have provided some much needed additional clarification and guidance that will prove essential in the compliance efforts of those affected. There is much more information in the directives themselves that we have not presented in this sales tax update.
We urge all those that feel they will be affected to visit the links provided below to the two directives mentioned in this update and start to familiarize yourselves with these sweeping changes that will likely impact every person engaged in a real property transaction beginning in 2017.