A couple of weeks ago we introduced the general guidelines surrounding taxability of services. Because taxability varies by state, we wanted to share a few examples of how selected states determine if a company is responsible for sales and use tax on their services.
Arizona’s Take on Taxability of Services
In Arizona, transactions that include both tangible personal property and services may be subject to sales and use tax collection (note that AZ has what is called the Transaction Privilege Tax, which is similar to a sales tax for purposes of this example). So, for example, a company that sells a physical widget and then operates it for you would need to charge taxes on the entire transaction.
However, if the tangible property is considered an inconsequential element of the service, such as in the performance of personal services, the transaction is often not subject to sales and use tax. An example of this would be if you get your hair cut and colored. Your stylist applies color, washes your hair with products and then styles and applies hairspray at the end. The cost of those items is included in your service and billed at one lump sum price and sales tax does not apply. The definition of “inconsequential” will be key. Arizona states that three requirements must be met for must be met in order for the sales to qualify as inconsequential:
(a) the price which the service provider paid for the tangible personal property must be less than 15% of his or her charge to the customer;
(b) when transferred to the customer, the tangible personal property cannot be in a form subject to separate retail sale; and
(c) the charge for the tangible personal property cannot be separately stated on the customer’s invoice.
And note that every situation is different, so we recommend companies look at this very carefully if they have this situation.
Yet, if the service provider sells tangible personal property that’s used or consumed in performance of the service, then the transaction is subject to sales tax. An example of this would be if a mechanic sells you a part for your car and then installs it for you. Also, to follow up on the hair stylist example above, if your stylist sells you a bottle of shampoo or hairspray in the process – that IS subject to sales tax and would be separately stated on an invoice.
California’s Approach to Sales Tax and Services
In California, most services are not subject to the state’s sales and use tax. However, to prevent the tax base from eroding, the Golden State does tax specific stand-alone services that might otherwise be included in the sales price of a tangible product to the end consumer. Examples include book printers or processing plants.
If a transaction includes a transfer of both tangible personal property as well as services, the entire sales price may be subject to tax if the object of the transaction is tangible personal property. An example of this would be a mobile store selling a customer a new phone as well as a service contract. They’re providing a physical item as well as a service, however the object of the transaction is the phone, making the entire transfer subject to sales and use tax. However, if the true object is the service, the entire transaction is nontaxable.
Businesses with nexus in California that provide services also need to pay tax on tangible personal property they purchase to perform nontaxable services. So if a dentist buys new equipment to be able to provide a service to a patient, the new equipment is taxable.
Although California hasn’t adopted a uniform approach to bundled transactions, one interesting area the state has a unique approach is in regards to packages that contain nontaxable food items and taxable non-food items (such as a picnic basket full of cheese, crackers and fruit alongside plates, silverware and napkins). If the retailer doesn’t have the records available to separate out the contents and tax only the taxable items, and the retail value of the taxable items is more than 10 percent of the entire package, the entire package is subject to tax. The exception to this is if the retail value of non-food items is 10 percent or less of the package’s entire value and if the container’s retail value is 50 percent or less of the entire package’s value.
How New York Approaches Services and Taxability
New York only imposes sales and use tax on specific services, such as interior decorating and designing services, renting safe deposit boxes, protective and detective services or transporting persons within New York State.
When it comes to mixed transactions, the seller needs to separate the items or collect tax on the entire selling price. If tangible personal property is transferred incidentally in connection with a nontaxable service, the transaction remains nontaxable. An example of this is an architect providing renderings of the design along with the service.
In New York, if a seller bundles taxable and exempt items into one unit, then the transaction is subject to sales tax on the entire sales price. However, the state has specified special rules for telecommunication services. The Internet Tax Non-Discrimination Act allows telecommunication service providers to state the charges for internet access separately from taxable services.
What About SaaS and Sales Tax?
It’s worth noting that Software as a Service (SaaS) is an interesting product because some states, like Texas, view it as a taxable service, whereas others view it as a taxable product. And then other states, such as California, don’t tax SaaS at all.