Over the past three years, the Florida Department of Revenue has targeted a growing number of businesses for sales-tax audits.  While the state has always taken a hard line in identifying tax fraud, it has recently stepped up its enforcement efforts and narrowed its focus on specific businesses and industries, including, but not limited to, convenience stores, used car dealers and VoIP service providers. Not only do targeted businesses face stiff penalties for under-reporting sales tax, but owners and managers also face criminal prosecution and the possibility of imprisonment for five to 30 years.

On the surface, sales tax appears to be a fairly simple and straightforward concept.  However, laws governing state and local taxes are often changing, and the interpretation of them can be rife with hidden dangers. Some of the most problematic gray areas of sales tax compliance involve commercial real estate rentals, manufacturing, and Internet and cloud computing.

Commercial Real Estate Rentals

Florida is the only state that levies a sales tax on commercial real estate rentals.  In fact, this tax is the number one revenue generator for the state. Revenue generated from sales tax imposed on commercial rental exceeds total revenue generated by Florida’s corporate income tax.

The state’s laws have several unique nuances that, to the surprise of many business owners, can prompt tax requirements. The most common sales tax triggers are those that involve interrelated companies.

For example, business owners may assume they are limiting their financial risk by establishing special purpose entities to lease property they own back to their businesses. However, in these cases, the state of Florida considers both parties separate entities engaged in an implied intercompany agreement that is, in fact, subject to rental sales tax.  The same holds true for property owners renting space to businesses in which they own stock.  State law requires the related business tenants to pay sales tax to the property owners on the rent, as well as on all other fees detailed in the lease agreement, which can include maintenance fees, property taxes and even predetermined improvement costs paid by the landlord and credited back to the lessee.

The Florida court system has weighed in on issues relating to leasehold improvements.  Traditionally it has held that the Department of Revenue may consider the amount tenants agree to pay for improvements as “rent in kind” and therefore subject to sales tax.  However, in 2011, the court ruled that money tenants spend on office build-outs are not always subject to sales tax, specifically when lease agreements do not include predetermined spending amounts for such improvements.

Manufacturing

Due to a general lack of uniformity in tax laws across different states, business owners are often surprised to learn about incentives and exemptions available to manufacturers operating in Florida.

For example, the most common exemption that Florida businesses overlook involves repairs to manufacturing equipment.  Unlike repairs to automobiles, repairs to fix or replace equipment required for production are exempt from sales tax.  Specific equipment purchased by manufacturers starting or expanding a business may also be exempt from sales tax.  This includes machinery used for pollution control, research and development, and any equipment that the manufacturer can later prove led to a measurable increase in production. Currently, manufacturers must prove a 5 percent increase in product output or sales.  However, the state legislature recently proposed to eliminate this requirement and make the tax exemption for expanding businesses the same for new businesses entering the state: businesses need only prove they purchased the equipment for use in Florida.  A final decision in this matter is expected on June 30, 2013.

Internet and Cloud Computing

Unlike many states across the country, Florida takes a very liberal approach to its tax treatment of Internet and cloud-computing services. Because the state does not consider remote data storage and third-party applications in the cloud (i.e. Software as a Service) as tangible assets, it does not subject them to sales tax.  Similarly, Florida does not tax purchases of electronically downloaded software and information services.  However, if customers purchases software via CD, DVD or other tangible format, they become subject to sales tax.

Avoiding Pitfalls

While Florida’s Department of Revenue continues its aggressive, criminal enforcement of sales tax fraud, business owners in all industries need to take a proactive approach to compliance.  This includes maintaining accurate and detailed records and relying on professional tax advisors who are up-to-date and knowledgeable about the many nuances of sales tax regulations.  A sales tax advisor can help businesses plan strategies, and structure agreements and corporate systems for collecting, reporting and minimizing tax liabilities.