NC House Bill 1030 (HB 1030), effective January 1, 2017, will bring more changes regarding sales tax to business owners in real property trades or businesses. Most are aware of the sales tax changes that became effective March 1, 2016. Fewer taxpayers may know that sales tax changes in HB 1030 will eliminate or change dramatically some of these rules that just became effective March 1, 2016.
Let’s begin with one of the more dramatic changes in the law concerning the definition of a “Retail Trade” and then cover the new definition of a “Real Property Contract.” Effective January 1, 2017, the definition of a “Retail Trade” will be repealed. What does this mean for business owners in real property trades or businesses exactly? Let’s back up and review what it means to be in a “Retail Trade” with respect to sales/use tax effective March 1, 2016.
A business deemed to be in a “Retail Trade” on or after March 1, 2016, must treat transactions with consumers as retail sales even if the business met the definition of a real property contractor or retailer-contractor prior to March 1, 2016. A “Retail Trade” is a trade in which the majority of revenue is from retailing tangible personal property, digital property, or services to consumers. So if the majority of the revenue of a business was derived from retailing on or after March 1, 2016, the business was deemed a “Retailer” with respect to all of its activities and must now charge sales tax on all of its activities that are not otherwise specifically exempt under other sections of the NC General Statutes.
Real property contractors that also have substantial retail operations, carpeting, and flooring contractors being a prime example, are now required to charge sales tax on the gross sales price of a real property contract. Before, the same contractor would have been considered the consumer of the tangible personal property incorporated into that contract and pay sales/use tax to the vendor(s) on any materials. So before March 1, 2016, the labor and other charges associated with the same type of contract were exempt from sales/use tax.
Now back to the changes in HB 1030, effective January 1, 2017. By repealing the definition of a “Retail Trade”, the same real property contractor with the substantial retail operations will not have to treat real property contracts as retail sales. This real property contractor will once again become a retailer-contractor. The contractor will collect sales tax on any retail sales and will once again become the consumer of tangible personal property with respect to any real property contracts. The definition of a “Retailer” has been amended to exclude real property contractors.
This repeal will be welcome news for most contractors that must now charge sales tax on real property contracts because of their retail operations; however, do not be misled into thinking that all activities of real property contractors will be exempt from sales/use tax effective January 1, 2017. Next, we discuss the definition of a “Real Property Contract,” which will become essential in determining what contracts are subject to sales tax.
Real Property Contracts
As mentioned in Part I of this update, the definition of a “Real Property Contract” will become essential in determining what contracts are subject to sales tax in 2017. Effective January 1, 2017, “Real Property Contracts” will not be subject to sales tax. Real property contractors will remain the consumers of tangible personal property incorporated into a contract. They will pay the sales/use tax on the materials and no sales tax will be assessed on the end consumer. But what is a “Real Property Contract” under the new rules effective January 1, 2017?
A “Real Property Contract” under N.C. Gen. Stat. Section 105-164.3(33e) is a contract between a real property contractor and another person to perform construction, reconstruction, or remodeling with respect to a capital improvement to real property. Within the new definition of a “Real Property Contract”, we stumble upon another new term, “Capital Improvement”, in the N.C. General Statutes that is crucial in determining whether a contract is subject to sales tax. If the service agreed upon in the contract results in a “Capital Improvement”, then sales tax will not be assessed on the price of the contract to the end consumer. If the services result in something other than a “Capital Improvement”, then the services will be considered “Repair, Maintenance, and Installations Services” (RMI). If the contract is considered an RMI contract, then sales tax will be required to be assessed on this contract effective January 1, 2017.
A “Capital Improvement” is defined in N.C. Gen. Stat. Section 105-164.4H(e)(1) as an addition or alteration to real property that is new construction, reconstruction, or remodeling of a building, structure, or fixture on land that becomes part of the real property or is permanently installed or applied to the real property so that removal would cause material damage to the property or article itself. Removal of debris, construction materials, asbestos, and excavation are included in the “Capital Improvement” category. Painting, wallpapering, and landscaping services are less obvious examples but are nevertheless considered “Capital Improvements” under the new definition.
The definition of the term “Repairs, Maintenance, and Installation Services” has been amended and now applies to tangible personal property installed or applied to real property except if it is pursuant to a “Real Property Contract” by a real property contractor. So contracts that do not result in a “Capital Improvement” are going to be subject to sales tax assessment on or after January 1, 2017, unless specifically exempted under other sections of the N.C. General Statutes. A non-exhaustive list of services exempt from sales/use tax follows; however, please reference N.C. Gen. Stat. Section 105-164.13(61a) and Form E-505 available on the N.C. Department of Revenue’s website for a more comprehensive list:
- A fee or charge for an inspection required by law;
- Services performed to resolve an issue that was part of a real property contract if the services are performed within six months of completion of the real property contract or, for new construction, within twelve months of the new structure being occupied for the first time
- Cleaning of real property, except where the service constitutes a part of the gross receipts derived from the rental of an accommodation subject to tax under N.C. Gen. Stat. Section 105.164.4 or for a pool, fish tank, or other similar aquatic feature;
- Home inspections related to the preparation for or the sale of real property;
- Landscaping services (See N.C. Gen. Stat. Section 105-164.3(16e) for definition); and
- Pest control services
In summary, the changes in sales tax rules incorporated within HB 1030 will significantly impact business owners in real property trades or businesses. Many real property contractors that have substantial retail operations will find relief in the repeal of the definition of a “Retail Trade.” This repeal, discussed above, means they will no longer have to assess sales tax to the end consumer on real property contracts just because their retail sales produce the majority of their revenue. The new rules will, however, subject many contracts to sales tax assessment on or after January 1, 2017, which were previously not subject to sales tax if the services do not result in a “Capital Improvement.” Knowing the difference between a “Capital Improvement” and “Repair, Maintenance, and Installation Services” will become critical to sales/use tax compliance if you are in a real property trade or business.
More clarification is needed in this area and the N.C. Department of Revenue has stated that it is forthcoming. The Department has stated that it will release additional information concerning these new rules on or before November 15, 2016. In the meantime, for more information, please reference Form E-505 posted on the N.C.Department of Revenue’s website for a more comprehensive overview of the upcoming sales tax changes.
You can find that information here at http://www.dornc.com/downloads/e505_9-16.pdf.