FLORIDA SALES TAX ON PUBLIC WORKS CONTRACTS - A TRAP FOR CONTRACTORS

FLORIDA SALES TAX ON PUBLIC WORKS CONTRACTS – A TRAP FOR CONTRACTORS

Are you a contractor working on a contract for the state or local municipality? Perhaps you are working for a university. If you are, then you need to become familiar with the phrase "public works contract." Public works contracts have special sales tax rules in Florida that can be a trap for the uniformed contractor. Specially, your normal rules for what is a real property contract (on which you pay use tax) or a tangible personal property sale (on which you collect tax from your customer) do not apply when you have a public works contract.

The short version of the difference is that anything attached to real property is going to be considered real property in a public works contract, requiring the contractor to pay use tax on the materials. A simple example is blinds. In a contract for a private company, installed blinds are considered tangible personal property that require the contractor to collect sales tax from the customer (in most cases). However, in a public works contract, the blinds are considered to be affixed to the real property and must be treated as a real property improvement (aka fixture). The concept can go to the extreme, such as treating mobile trailers used for classrooms as real property in a public works contract. Yes, that extreme. At the end of this article, there is a link to another article that goes much more in depth into the differences between public works contract and other types of construction contracts.

Just because a contract is considered a public works contract, it does not mean that the contractor is forced to pay use tax on everything. To the contrary, if the general contractor follows specific guidelines and the client (public entity) follows specific proceedures, then both the contractor and public project can save significant sales and use tax on the project. The purpose of this article is to address the rules of how subcontractors may also take advantage of the rules.

For subcontractor calculating their bid, one may be provided a sales tax exemption certificate from the governmental entity. But is that exemption transferable to you when you go out to buy tangible personal property for the project?

That is exactly the question asked in the October 9, 2015, Technical Assistance Advisement ("TAA")[1]. In TAA 15A-013, the Taxpayer, a contractor, contracted to complete an 86,000 square foot remodel and 11,000 square foot expansion of an existing municipal hospital. The contractor and hospital agreed to follow the public works contract rules to minimize the sale tax and use tax of the project, thereby lowering the overal cost of the project to taxpayers. As such, the contractor was assigned the tax-exempt status of the hospital. Worried that the project was not, in fact, tax exempt, the contractor and its subcontractors paid all applicable Florida sales and use taxes for the project. It is likely, therefore, that the Taxpayer did not make as much on the project as initially anticipated.

When the Taxpayer began negotiations for additional work for the hospital, the hospital reasserted that it was tax exempt and that such an exemption was assignable to Taxpayer. Taxpayer then submitted its question to the TAA to clarify the rule and determine if any potential refund was available for the taxes previously paid.

The TAA ultimately concluded that the Taxpayer, not the governmental entity, was the purchaser of all the materials used in the project. Therefore, the Department stated that no refund was due to Taxpayer. In other words, the contractor did not actually follow the rules and procedures set up for public works contracts.

Section 212.08(6),[2] specially excludes from the public works exemption provided by 212.08(6)(a) sales of tangible personal property made to contractors employed directly to or as agents of any such government or political subdivision when such tangible personal property goes into or becomes a part of public works owned by such government or political subdivision. However, a government entity can obtain a certificate of entitlement, which will allow the exemption of sales tax and relieve a contractor of all liability.

If it comes out later that sales tax was due, the only entity from whom the Department can collect is the government entity who provided the certificate of entitlement. It is in the best interest of a contractor, therefore, to require the government entity to obtain and provide a certificate of entitlement before excluding sales tax from a bid.

Otherwise, the Department may go after you for any unpaid sales tax. Good luck trying to go back and get those taxes from a government entity. Governmental immunity is only waived in particular circumstances[3] and none of them include recovery for unpaid taxes, particularly when they were not included in the bid in the first place.

In theory, requiring a certificate of entitlement or charging sales tax is the perfect way to avoid liability. But liability won't be a problem if you can't win a bid because other companies take a risk that you won't.

One option to avoid this problem is to create two separate companies. One company would buy tangible personal property and then resell it to the government entity directly. By only reselling the tangible personal property, the first company could use the government entity's exemption certificate and eliminate sales tax on those items from the bid. The second company would be responsible for the labor of construction and everything that goes along with it. As services are nontaxable, this company would not even have a sales tax certificate and the Department would have no way to go after it for the taxes that it could, in fact, collect if there was only one company.

This option may run into some trouble if the government entity won't take a bid from separate companies. But while under federal law, the "substance over form" theory allows the IRS to break down corporate entities to hold separate companies jointly liable, there is no such case law in Florida. If you want to win the bid and the government agency is willing to accept a joint bid from your two separate companies, then this is your best bet of eliminating all sales tax from the bottom line.

It is worth mentioning that some states, such as Wisconsin, have begun adopting different versions of the substance over form approach used by the IRS. In Sullivan Brothers, Inc. v. Wisconsin DOR, No 2013-AP-818 (Wis. Ct. App. 2014)[4], the court upheld the Department's consolidation of both companies for purposes of assessing tax. Fortunately, there is no case law in support of this in Florida. But that could always change.

If making a separate company is either not an option or undesirable in light of the circumstances, you may still find a way to apply the government entity's exempt status to tangible personal property if you clearly understand the requirements as highlighted in Rule 12A-1.094, F.A.C.,[5] which explains that supplies or materials purchased by a public works contractor are taxable because the contractor technically is the one who consumes the materials during the performance of their service. In short, the contractor cannot purchase the materials it uses in its services.

12A-1.094(4)(b), F.A.C., lists five criteria for determining whether a governmental entity or a contractor is the purchaser of the materials: (1) if the governmental entity issued its purchase order directly to the vendor supplying the materials the contractor will use; (2) if the vendor's invoice is issued to the governmental entity or the contractor; (3) whether the governmental entity made payment directly to the vendor form public funds; (4) whether the government takes title to the tangible personal property from the vendor at the time of purchase or delivery; and (5) who has the assumption of risk of damage or loss at the time of purchase of the property.

If a contractor contracts with the vendor to sell directly to the governmental entity and pay a kickback to the contractor, this could benefit everyone. But this would only really work in unusual circumstances in which a close relationship exists between vendor and contractor. The vendor would have to sell the property at a mark-up for the contractor to make any money off the transaction and the vendor, of course, would need to be incentivized for its role. For example, the vendor could sell the items at a 20% mark-up, take 10% of that as profit and give the other 10% markup to the contractor. If the contractor is going to make enough money off the service side of the project, they may have no problem taking a loss on the total profit on the materials if it means the bid is low enough for them to win it.

Ultimately, the cleanest and most secure way for a contractor to avoid adding sales tax to a bid on a project for a government entity is to divide up their work into two companies: one that sells tangible personal property and one that provides services. Once divided, the government entity's sales tax exemption is transferable, because the contractor would be buying the tangible personal property for resale, and the bid can be calculated with absolutely zero sales tax due.

About the Author: Jeanette Moffa is an associate attorney with Moffa, Sutton, & Donnini, PA, joining the firm in 2015. Jeanette earned her law degree from Florida International University College of Law. Previously Jeanette was an adjunct professor at Palm Beach State College where she teaches a variety of English courses as well as at both Broward College and Miami-Dade College. Prior to law school, she received a Master of Fine Arts in Creative Writing with a specialization in creative nonfiction from Florida Atlantic University. Before that, she attended the University of Florida for her B.A. in English.

ADDITIONAL RESOURCES

FLORIDA CONSTRUCTION ON TAX EXEMPT PROJECTS - MINIMIZING/ELIMINATING SALES AND USE TAXES, published December 4, 2011, by James Sutton, CPA, Esq.

FL CABINET COMPANIES WITH SALES TAX PROBLEMS, published October 5, 2013, by James Sutton, CPA, Esq.

IS RENT SUBJECT TO FLORIDA SALES TAX?, published January 26, 2015, by Jerry Donnini, Esq.

FLORIDA COMMERCIAL PROPERTY OWNERS GET BLINDSIDED BY SALES TAX, published December 31, 2011, by James Sutton, CPA, Esq.