Questions and Answers

Identifying Information:Tax base for taxable construction services.
Tax Type:Kansas Retailers' Sales Tax
Brief Description:Tax base for taxable construction services.
Approval Date:07/20/2011


QUESTION: What authority supports K.A.R. 92-19-66b and its application of sales tax to taxable construction services?

ANSWER: Kansas sales tax is levied on retail sales of tangible personal property ("TPP" or "goods") and on retail sales of the services listed in K.S.A. 79-3603. "Retail sale" means a sale to the final user or consumer. See K.S.A. 79-3602(jj) ("Retail sale" or "sale at retail" means any sale, lease or rental for any purpose other than for resale, sublease or subrent.") One important rule for the construction industry is a construction contractor that improves real property is considered the final consumer of the construction materials, supplies, and equipment it buys. Since sales to a contractor are sales to the final consumer, such sales are taxable.

A construction contractor is considered the final consumer of the materials and supplies it buys because a contractor's job is to apply its labor and skill to transform construction materials into buildings, structures, and other real property improvements. The last transfer of construction materials as tangible personal property (TPP) is the sale to the contractor. This is reflected in Black's definition of "general contractor" as "[o]ne who contracts for the completion of an entire project, including purchasing all materials, hiring and paying subcontractors, and coordinating all the work." Blacks Law Dictionary, p. 351, Eighth Ed. 2004.

Once construction material becomes part of a building or structure, it is no longer TPP but is part of real property. Kansas sales tax is not imposed on the sale or transfer of real property. Accordingly, acceptance of a completed construction project by a property owner or property buyer's is not subject to sales tax. The taxable transfer of TPP occurs when the materials are sold to the contractor/purchaser.

Forty-five states and the District of Columbia impose sales tax. These laws tax sales of materials to contractors with remarkably few exceptions. This is because the final sale of the materials as TPP is the sale to a contractor. Acceptance of this principle by courts early in the development of state sales tax laws is reflected in the following discussion in Duhame v. State Tax Commission, 65 Ariz. 268, 179 P.2d 252, 171 A.L.R. 684 (1947)(reversed on other grounds):

The treatment of contractors as final consumers is codified by K.S.A. 79-3603(l) and its imposition on:

The next important sales tax concept is codified in the definition of "sales or selling price" in K.S.A. 79-3602(ll). It provides: For sales tax purposes, the "measure of tax" or "tax base" is the amount multiplied by the sales tax rate that results in the amount of tax charged to the consumer. When several goods are sold as part of a single retail transaction, such as at a grocery store or a fast-food restaurant, the tax base is the sum of the taxable charges. The sales tax rate is the sum of the Kansas state rate and all applicable local sales tax rates.

The definition of "sales or selling price" in K.S.A. 79-3602(ll) requires a Kansas retailer to charge sales tax on the total amount it bills to a customer for taxable goods or services. A retailer may not reduce that amount by deducting its expenses, which can include its material and labor costs, the interest it pays on borrowed operating capital, its tax and insurance expenses, delivery and installation charges, and any other cost or expense born by the retailer. K.S.A. 79-3602(ll)(B). The requirements in this definition apply to merchants that sell goods and to service providers that provide taxable services. K.S.A. 79-3602(ll) ("'Sales or selling price' . . . means the total amount . . . for which . . . services are sold. . . .")

When a service provider seeks reimbursement of its expenses from a customer, the reimbursement is part of the "sales or selling price" the provider is billing for its services. A service provider may seek reimbursement of its travel expenses, meal costs, lengthy telephone calls made to a manufacturer's service experts, a surcharge billed for service work performed on weekends or holidays, a surcharge billed as a mileage or zone charge, additional wages assigned as a job cost because addition employees are called in, and so forth. The definition of "sales or selling price" makes all charges for reimbursement billed by a service provider to its customer part of the tax base for the provider's taxable services.

For example, assume a computer technician travels from Chicago, Illinois to Johnson County, Kansas to service and repair a large business computer. The work takes several days. Computer service and repair charges billed to the business are taxable under K.S.A. 79-3603(p) and (q). When the Chicago service technician bills the business, the technician will seek reimbursement for its travel expenses, room charges, and meal costs.

The technician may seek reimbursement of its expenses by charging services at a higher rate for work done outside the Chicago area, by billing the travel, meal, and room costs as separate line-item charges, or by billing them on a separate invoice. The technician may seek reimbursement of its expenses based on its cost or by marking up its cost. Regardless of how the service technician recovers its job expenses from its customer, the expenses incurred by the technician and reimbursed by the customer are part of "sales or selling price" charged by the technician for its services and are part of the tax base. K.S.A. 79-3602(ll)(B). These amounts are taxable since the repair services performed by the technician are taxable.

The department recommends that when a service provider seeks reimbursement of an expense, the provider invoice the expense (or a marked-up amount) as a lump sum amount rather than as one line-item charge for the cost of the goods or service and a second line-item charge for the sales tax paid by the provider on the charges listed for the goods or services. See EDU-27, Sales Tax Guidelines for Contractors and Contractor-Retailers; Recovering your expenses from your customer.

A service provider's erroneous bifurcation of its costs into one charge for goods or services and a second charge for the sale tax paid on that charge does not mean the service provider is charging and remitting the sales tax being invoiced as separate line-item charge. This erroneous billing practice only shows the provider is seeking reimbursement of its costs and expenses, which include the sales taxes it paid on taxable goods or services. Such erroneous billings practices are neither double taxation nor an unlawful tax on a tax.

Double taxation exists “only where there is the imposition of the same tax by the same taxing power upon the same subject matter.” Waterbury Motor Lease, Inc. v. Tax Com'r, 174 Conn. 51, 381 A.2d 552 (1977); Spencer v. Snedeker, 361 Pa. 234, 238, 64 A.2d 771, 772, Ramco, Inc. v. Director, Department of Revenue, 248 N.W.2d 122, 124 (Iowa). Where there are two separate taxpayers and two separate transactions, even though a single subject matter is involved, any taint of double taxation is removed. Boise Bowling Center v. State, 93 Idaho 367, 370, 461 P.2d 262; Lakewood Lanes, Inc. v. State, 61 Wash.2d 751, 380 P.2d 466; Gandy v. State, 57 Wash.2d 690, 359 P.2d 302.

Under Kansas sales tax law, a retailer is considered the "taxpayer" because the law requires the retailer to collect sales tax on its taxable retail charges, and report and remit that tax to the State of Kansas. When the Chicago technician bills the Johnson Country business for the computer services it provides, the technician is the "taxpayer" and is required to collect, remit, and report Kansas sales tax on the services it performs in Johnson County. K.S.A. 79-3702(h)(1)(C). When the restaurant bills the technician for meals, the restaurant is the taxpayer and collects, reports and remits sales tax on the meal charges billed to the technician. There are two separate and distinct transactions (the providing of computer service to the business and the sale of meals to the technician) and two separate and distinct taxpayers (the service technician and the restaurant). Therefore, there is no double taxation even when the technician itemizes the taxes it paid on its meals as separate line-item amounts on the invoice it issues to the Johnson County business for computer services.

The separate and distinct nature of the two transactions is highlighted if the technician paid Missouri sales tax on meals it purchased. If this happened, there were two separate and distinct taxpayers, two separate and distinct transactions, and two separate and distinct taxes involved. (Missouri sales tax and Kansas sales tax). This example helps to show there are no concerns with double taxation when a service provider seeks reimbursement of its costs and erroneously lists the taxes it paid on a customer invoice.

Another important concept is how contractors calculate tax on their taxable services. Kansas sales tax was first imposed in 1937. Sales of tangible personal property were taxed as well as four services: intrastate telephone and telegraph services; utility services (gas, water, electricity, and heat); meals and drinks furnished at restaurants and establishments open to the public, and admissions to places of amusement, recreation, or entertainment. See Michael Lennen, The Kansas Retailers' Sales Tax: An Overview, The Journal of the Kansas Bar Association, p. 24 (December 1993).

1970 Kansas Senate Bill No. 423 enacted the first Kansas sales tax imposition on a service provider's charges for installing, servicing, or repairing property. SB 423 imposed sales tax on gross receipts from "the installation, maintenance, servicing and repairing of tangible personal property" except when the services are "rendered in installing [tangible personal] property in connection with the original construction of a building or structure, which when installed will become a part of such building or structure." 1970 Kan. Sess. Laws Chap. 389, Sec. 2(p); Senate Bill No. 423. This statutory language taxed construction services because contractors affix TPP to buildings or structures that becomes part of the building or structure and, as a result, becomes part of real property. Construction services were not taxed when done in connection with "new" construction. SB 423 did not tax repair and other services performed on property held for resale by a retailer or wholesaler.

Before SB 423 became law, repairmen who serviced and repaired TPP, such as motor vehicles or outboard motors, were required to charge and collect sales tax on repair or replacement parts and on lubricants, oil, filters or other articles of TPP supplied with their services. These repairmen found it easy to implement SB 423 because they simply began charging sales tax on the total amount invoiced to customers for services and TPP, instead of totaling the line-item charges for TPP and applying sales tax to that total.

Construction contractors that improved real property found it difficult to compute sales tax on their taxable services when the same Kansas sales tax law that required them to collect and remit sales tax on their service charges required them to pay sales tax on their purchases of construction materials and supplies. Despite the sales tax law's treatment of contractors as final consumers, some contractors claimed a resale exemption on their purchases and charged sales tax on the total amount billed to their customers. Others who entered into time-and-materials contracts, paid sales tax when they purchased materials and charged customers sales tax based on the time they billed.

The department addressed this compliance issue by issuing the following Bulletin to explain how construction contracts would be taxed:

Materials $14,500.00
Sales tax paid on those materials $435.00
Total cost of materials (at time of purchase) $14,935.00

Total contract bid . $50,000.00
total cost of materials . Less $14,935.00
Total cost for the service . $35,065.00 (includes labor, overhead, profit, etc.)
3% state sales tax . $1,051.95

Total cost of service plus sales tax . $36,116.95
Plus total cost of materials. $4,935.00

Total bid for contract includes appropriate $51,051.95
sales tax

This same approach is used today. K.A.R. 92-19-66b provides:
The only material difference between the directives in the 1972 bulletin and those in the current regulation stems from K.S.A. 79-3648. This statute allows a construction contractor to forgo issuing invoices that state the amount of taxes charged on services and instead issue invoices that state: "All applicable sales tax is included." K.S.A. 79-3648 was enacted after contractors complained that invoicing the sales tax amount allowed a customer to determine how much the contactor was charging for services. This sometimes resulted in conflicts between contractors and their customers. This perceived shortcoming was remedied by enacting K.S.A. 79-3648.

The approach taken in the 1972 bulletin for taxing construction services has been followed ever since, except for K.S.A. 79-3648. The directives in the 1972 bulletin have been followed and applied in spite of the fact the Kansas Supreme Court struck down the 1970 imposition on construction services as being so vague in its meaning and application it denied contractors due process of law. Kansas City Millwright, Inc. v. Kalb, 221 Kan. 658, 562 P.2d 65 (1977). The Kansas legislature quickly addressed the due process shortcomings noted in Millwright by enacting 1977 Senate Bill 49. See In re Black dba Black's Welding Service, 9 Kan.App.2d 666, 684 P.2d 1036 (1984); 1977 Kan. Sess. Laws, Chap. 337, Sec. 3.

1977 Senate Bill 49 rewrote the problematic sections of K.S.A. 79-3603(p) by taxing gross receipts from "the service of installing or applying tangible personal property" except when the services were done in connection with the "original construction of a building or facility or the reconstruction, restoration, replacement or repair of a bridge or highway." New section K.S.A. 79-3603(q) was added and taxed gross receipt from "the service of repairing, servicing, altering, or maintaining tangible personal property," including "tangible personal property which has been and is fastened to, connected with or built into real property." New section K.S.A. 79-3603(r) taxed gross receipts from maintenance agreements for services taxable under (p) or (q). None of the impositions applied when goods held for resale were serviced or repaired or to the "original construction" of a building or "facility." The terms "original construction" and "facility" were defined in K.S.A. 79-3603(p). In In re R & R Janitor Service, 9 Kan.App.2d 500, 683 P.2d 909 (1984), the Kansas Court of Appeals rejected the taxpayer's argument that K.S.A. 79-3603(p), (q), and (r) were unconstitutionally vague despite the enactment of SB 49.

After SB 49 was enacted, K.SA. 79-3603(p), (q), and (r) have been amended a number of times. In 1988, the words "windstorm, hailstorm, rainstorm, [and] snowstorm" were stricken and the word "tornado" was added to the definition of "original construction." 1988 Kan. Sess. Laws, Chap. 386, Sec. 1. In 1992, original construction labor services were taxed at 2.5%. 1992 Kan. Sess. Laws Chap. 280, Sec. 58. This 2.5% imposition was repealed in 1995. In 1998, "residential construction" services were exempted. The law continued to exempt "original construction" services. 1998 Ks. Sess. Laws, Chap. 130, Sec. 30. In 2007, labor services performed to install or repair "utility structures" damaged by a "windstorm" was added to non-taxable original construction and residential construction services. 2007 Kan. Sess. Laws 195, Sec. 58.

When the state sales tax rate was increased, the Kansas legislature sometimes enacted provisions to allow contractors, who had entered into written construction contracts well before the effective date of the rate increase, to pay sales tax on materials and supplies and to charge sale tax to customers, at the lower rate in place when the contract was signed by the parties. See e.g. 1986 Kan. Sess. Laws, Chap. 386, Sec. 1; 1992 Kan. Sess. Laws Chap. 280, Sec. 58. Other tax rate increases were enacted without provisions for pre-existing, written construction contracts. See e.g the 1967, 1989 and 2002 Kansas session laws.

The amendments to K.SA. 79-3603(p), (q), and (r) over the years, including the treatment of pre-existing construction contracts, show the Kansas legislature has been immersed with issues that involve application of sales tax to construction contracts. While the Kansas legislature expanded and contracted the scope of the imposition on construction services, it has never changed the requirements for how sales tax is calculated on taxable construction services, other than enacting K.S.A. 79-3648. These requirements remained in place after remedial legislation was passed in 1977 to correct the unconstitutional version of K.S.A. 79-3603(p) enacted in 1970.

If the Kansas legislature wanted to change how contractors determine the tax base for taxable construction services, it had numerous opportunities to do so after the department published Bulletin Vol. V, No. 1 on January 1, 1972. The Kansas legislature has not changed the department's policy announced in the bulletin other than to allow contractors to bill customers "All applicable sales tax included." Today, the department policy is codified in K.A.R. 92-19-66b and discussed at length in a number of information guides and other publications. See Pub. KS-1525 (Rev, 10/10), Kansas Sales Tax for Contractors, Subcontractors, & Repairmen; Taxable labor Services; EDU-26, Sales Tax Guidelines for Contractors and Contractor-Retailers; Recovering your expenses from your customer; EDU-27, Sales Tax Guidelines for Fabricators; EDU-28, Sales Tax Guidelines for Businesses that Sell and Service Appliances and Electronic Products; EDU-29, Sales Tax Guidelines for Contractor-Fabricators and Contractor-Manufacturers; EDU-30, Sales Tax Guidelines for Lawn Care, Pest Control, Fertilizer Application and Landscaping.

"Operative construction" is "the doctrine that the interpretation of a statute by an administrative agency charged with enforcing it is entitled to judicial deference unless it is arbitrary and capricious." Black's Law Dictionary, p. 1125, Eighth Ed. (2004). The Kansas supreme court discussed this doctrine in In re Tax Appeal of Harbour Brothers Constr. Co., 256 Kan. 216, 221-22, 883 P.2d 1194 (1994):
An agency's construction of a statute it implements is entitled to additional weight when the agency's construction has been endorsed by the legislature by implication. Endorsement by implication happens when the legislature reenacts a statute in the same or substantially same terms without changing the construction applied by the agency. 82 C.J.S. Statutes, Sec 359, p. 769; Gorup v. Kansas Public Emp. Retirement System, 3 Kan.App.2d 676, 600 P.2d 1161 (1979). Here, the policy announced in the department's 1972 bulletin for taxing construction services has remained in place unchanged ever since, except for K.S.A. 79-3648. See K.A.R. 92-19-66b, quoted above. K.S.A. 79-3648, which allows contractor to issue invoices that state: "All applicable sales tax is included," could only have been enacted if the Kansas legislature understood how the department applies Kansas sales tax to construction contracts.

Legislative endorsement by implication has added force when the legislature reenacts a statute and changes requirements in the statute without changing other requirements to force an agency to change its policy. Gorup, supra; Hamby v. McDaniel, 559 S.W.2d 774 (Tenn. 1977). K.S.A. 79-3603(p) has been amended a number of times since 1972 since the department published the bulletin in 1972. Some of the statutory changes broadened the scope of the imposition on construction services, while others restricted it. KS.A. 79-3603(p) was amended by adding the residential exemption and the exemption for repair of utility structures damaged by windstorms. While these amendments changed what services K.S.A. 79-3603(p) taxed, nothing was enacted to change the way tax is computed under K.S.A. 79-3603(p) on construction services.

Legislative endorsement of an agency policy by implication is more clearly shown if the legislature makes detailed changes to a statute but does not change it in a way that forces the agency to revise its construction of the statute and its policy statements. Palmore v. Superior Court of District of Columbia, 169 U.S.App.D.C. 323, 515 F.2d 1294 (D.C.Cir.1975). Several times when the sales tax rate was increased, the Kansas legislature enacted provisions that allowed contractors with written contracts to pay and collect sales tax at the earlier lower rate after the effective date of the rate increase. These amendments enacted for pre-existing contracts are "detailed changes" that were made to K.S.A. 79-3603(p) without changing how sales tax is computed on taxable construction services. The detailed and complex amendments for preexisting contracts suggest Kansas legislators understand how sales tax has been computed on taxable construction contracts and have chosen not to change the policy first announced in a department bulletin published on January 1, 1972.

Date Composed: 07/20/2011 Date Modified: 07/20/2011