Private Letter Ruling

Ruling Number:P-2008-013
Tax Type:Kansas Retailers' Sales Tax
Brief Description:Decorating center's transfer and installation of Venetian blinds and other window treatments.
Keywords:
Approval Date:03/30/2010



Body:
March 30, 2010

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Dear XXXX:

Thank you for your letter. You represent a decorating center that is located in Johnson County, Kansas. It does business in Kansas and Missouri. You request a letter ruling that explains how Kansas sales and use tax applies to the center's transfer and installation of Venetian blinds and other window treatments.

You assert that the decorating center should be treated as a contractor when it installs Venetian blinds in building in Kansas. Your argument runs:

The essence of your argument is that a transaction that calls for the acquisition and installation of a fixture --- in this case Venetian blinds --- should be treated as a construction contract that calls for improvements to real property rather than as a retail sale of the blinds with installation.

If your analysis were to control the application of Kansas sales tax to the installation of Venetian blinds, the decorating center would be treated as the consumer or final user of the blinds that it installs rather than as a retailer that is selling the blinds to the building owner. Under your analysis, the decorating center would be required to either: (1) pay sales tax when it purchased the blinds; or (2) if the center does business as a contractor-retailer and maintains an inventory of blinds for resale, to collect sales tax on its over-the-counter sales to walk-in customers, and accrue and report tax on the purchase price of the blinds that employees remove from its resale inventory to install in customers' buildings. See K.S.A. 79-3603(l)(2).

Under your analysis, the decorating center would not be required to collect sales tax from the building owner on the marked-up price charged for the blinds or on installation charges, if the building is a residence or a newly constructed commercial building. The taxable event would be either the retail sale to the center or the center's withdrawal of the blinds from its untaxed resale inventory. Under the Kansas destination sourcing rules, the vendor would charge local sales based on where it delivers the blinds to the decorating center or, if the center is acting as a contractor-retailer, local tax would be sourced to the location of the center's resale inventory.

State sales tax laws generally treat contractors that improve real property as consumers or final users of the materials and fixtures they buy and use to improve real property. When a contractor builds and sells a spec house, sales tax is imposed on the contractor's purchases of the materials, fixtures, and other tangible personal property that it uses to construct the spec house. The contractor's sale of the spec house is not subject to sales tax because real property is being sold rather than tangible personal property.

This sales tax treatment of contractors as consumers is appropriate since the last transfer of building materials and fixtures as tangible personal property is the sale of the materials and fixtures to the contractor. The contractor's purchases are subject to sales tax since: (1) the materials and fixtures are transformed into real property by the contractor's application of its skills and labor; and (2) sales tax applies to sales of tangible personal property and not to sales of real property. This treatment is consistent with the ordinary meaning of "retail" sale, which is: "The sale of goods or commodities to ultimate consumers, as opposed to the sale for further distribution or processing." Black's Law Dictionary, "retail," p. 1341 (8th Ed. 2004).

Because of these things, most states that impose sales taxes treat contractors as consumers or end users when they buy building materials, such as lumber, brick, concrete, floor covering, drywall, interior and exterior doors, pipe, wiring, baseboard and trim, and other items. However, some of these same states treat the same contractors as retailers of fixtures, which can include furnaces, water heaters, built-in air conditioners, built-in appliances, toilets, entertainment systems, and so forth.

States that treat a contractor's transfer and installation of a fixture as a taxable retail sale generally have a statute that lists certain fixtures and then deems the fixtures to be sold at retail when installed by a contractor. Contractors are allowed to claim a resale exemption when they buy the fixtures since they will collect the appropriate sales tax from the property owner when the fixtures are installed. The contractor is required to collect sales tax on either: (1) the marked-up price of the fixture that it bills to the property owner if the installation services are not subject to sales tax; or (2) the total amount billed to the property owner when installation services are subject to tax. Many states currently do not impose sales tax on repair, installation, or other labor services.

When the listed fixtures are repaired, the repairman is required to collect sales tax on the marked-up price charged for repair and replacement parts, in states when the repair services are not subject to sales tax. Repairmen are required to collect sales tax on the total amount charged for parts and services, when repair services are taxed

Historic treatment of contractors and taxable installation services under Kansas law.

K.S.A. 2008 Supp. 79-3603(l) requires contractors and repairmen to pay sales tax on their purchases of materials, supplies, and other tangible personal property that they use "in erecting structures, or building on, or otherwise improving, altering, or repairing real or personal property." K.S.A. 2008 Supp. 79-3603(l). This requirement has been a part of the Kansas sales tax statutes since 1947. See 1947 Kan. Sess. Laws ch. 463, sec. 1(m). Before that, it is believed that department's policy had also treated contractors and repairmen as consumers who were required to pay sales tax on their purchases. Sales tax was not imposed or collected on any mark-up that a contractor charged to the property owner or on any charges for the installation, application, or repair services that were being billed.

In 1970, the Kansas legislature broadened the scope of the Kansas sales tax act to tax more services based on recommendations made by the Hodge committee. As amended by 1970 Senate Bill 423, K.S.A. 79-3603(p) imposed sales tax on:

Under this provision, a contractor's charges for services that involved installing, maintaining, repairing, or servicing tangible personal property were taxable, except for installation services that were performed as part of the "original construction" of a "building or structure." This exception in K.S.A. 79-3603(p), which is an imposition statute, is commonly referred to as the original construction exemption.

As enacted in 1970, K.S.A. 79-3603(p) offered little guidance about when tangible personal property that is attached to or installed in a building or structure was considered to become "a part of such building or structure" during its "original construction." The statute's wording would have allowed the department to exempt all of the labor services performed during the original construction of a building or structure. However, the department rejected this construction, and choose instead to construe the statute as imposing sales tax on installation services performed during the original construction of a building or structure if the tangible property being installed did not become a "part of such building or structure."

This required the department to develop a test that could be used to determine when property that is attached or affixed to a building or structure (hereinafter "attached or affixed TPP") would be treated as having become part of real property or as having remained tangible personal property. To make this distinction, the department fashioned a kind of fixtures test, which it explained in the following statement:

When this test determined that the attached or affixed TPP was installed a way that its removal would "cause material damage to the building or structure," the attached or affixed TPP was considered to be part of real property. If the installation services were performed during original construction of a building or fixture, the services were not subject to sales tax. When the test determined that the attached or affixed TPP could be removed without "material damage to the building," the installation services were taxable even when the services were performed during the original construction of a building or structure.

For existing buildings or structures, the department utilized the same fixtures test to determine whether attached or affixed TPP that was being maintained, serviced, or repaired had become a part of real property or remained tangible personal property. If the test determined that the attached or affixed TPP had become part of real property, the repair, maintenance, or servicing of the attached or affixed TPP was not taxable since K.S.A. 79-3603 did not tax services done to real property. If the test determined that the attached or affixed TPP remained tangible personal property, the repair, maintenance, or servicing of the attached or affixed TPP was taxable since services to repair, service, or maintain tangible personal property were taxed by K.S.A. 79-3603(p).

The department's fixtures test was not used to determine the taxability of labor services when attached or affixed TPP was removed and replaced with another unit or substitute property. If attached or affixed TPP was removed and replaced, the department held that the services were taxable because replacement property was being installed. This rule applied regardless of the outcome of the department's fixtures test.

To implement SB 423, the department asked taxpayers to submit questions about how the new tax on services would effect their payment and collection of sales tax. The department published the taxpayer's questions and its answers in the department's monthly Revenue Bulletins beginning in July, 1970. By the end of the year, the department had published over five hundred Q & A's to explain how K.S.A. 79-3603(p) applied to contractors, their vendors, and to property owners. The department applied its "fixtures test" when answering the questions.

A serious problem arose because many of the department's answers could not be reconciled with its answers to other similar questions. The inconsistencies in the Q & A's resulted in litigation that culminated in Kansas City Millwright Co., Inc. v. F. Kent Kalb, Director of Taxation, 221 Kan. 658, 562 P. 2d 65 (1977).

In Millwright, the Kansas Supreme Court reviewed the department's use of its fixtures test to implementK.S.A. 79-3603(p) and ruled that the statute was unconstitutionally vague. The court found that K.S.A. 79-3603(p) denied taxpayer's due process of law because it was so vague that taxpayers had to guess about how it applied to their business activities, and provided for fines and penalties if a taxpayer guessed wrong.

The Shawnee District Court that had heard the Millwright case on appeal from the Board of Tax Appeals also held that K.S.A. 79-3603(p) was void for vagueness and therefore unconstitutional. The district court explained its decision in a journal entry:
The underlined parts of the district court's discussion identify some of the inconsistencies that resulted from the department's application of it fixtures test. The Kansas Supreme Court identified more inconsistencies in the department's Q & A's and noted the difficulties that are inherent in fashioning a fixtures test to determine when attached or affixed TPP is considered a fixture (and therefore part of real property) or tangible personal property. The Supreme Court explained: Here, the Millwright court criticized the department's assumption that a fixtures test could be fashioned and applied to determine whether attached or affixed TPP was a fixture, and thus part of real property, or remained tangible personal property. The court reviewed the fixtures test that had evolved in Kansas case law and reasoned that it is impossible to consistently apply the Kansas fixtures test to determine when K.S.A. 79-3603(p) imposed sales tax on labor services done to attached or affixed TPP. This criticism clearly suggested that it would be a waste of the department's and legislature's time and resources to attempt to fashion a fixture's test that would decide the taxability of labor services based on whether attached or affixed TPP became a fixture or remained tangible personal property.

The Millwright court's comments about fixture tests were not new observations. In 1897, a Kansas Court of Appeals reviewed the law on fixtures and cautioned that there is no single rule of law that can be called upon to establish whether something is or is not a fixture:
The Kansas legislature quickly responded to the Supreme Court's holding in Millwright by amending K.S.A. 79-3603(p) to define the terms "building," "structure," and "original construction." 1977 Kan. Sess. Laws ch. 337, Sec. 2; 1977 Senate Bill 49. SB 49 contained separate subsections that imposed tax on the services of "repairing, servicing, altering or maintaining tangible personal property," (K.S.A. 79-3603(q)) and on service and maintenance contracts for such property. K.S.A. 79-3603(r). The enactment became law on April 12, 1977, which was only five weeks after the Millwright case was handed down.

The Constitutionality of the new imposition on labor services was upheld in In re Black, 9 Kan. App. 2d 666, 684 P.2d 1036 (1984). In Black, the taxpayer challenged the revised statute by raising the same constitutional due process arguments that had succeeded in Millwright. The court considered and rejected the challenge and upheld the constitutionality of K.S.A. 79-3603(p), K.S.A. 79-3603(q), and K.S.A. 79-3603(r), which among other things taxed installation and application services to both tangible personal property and real property, except when done in connection with the original construction of a building or facility. The terms "building" and "facility" were defined in SB 49.

The criticism of the use of the fixtures test in Millwright serves as the court's rejection your argument that since Venetian blinds are fixtures according to some fixtures laws, Kansas sales tax law is required to treat the decorating center as a contractor that is improving real property when it installs Venetian blinds. Millwright and Cook teach that, at least in Kansas, the law of fixtures cannot be relied on to determine how Kansas sales tax applies to the acquisition, installation, and repair of fixtures like Venetian blinds and built-in appliances.

1998 Senate Bill 493's expansion of K.S.A. 79-3603(p) to exempt residential repair and remodel work.

The remedial provisions in K.S.A. 79-3603(p), K.S.A. 79-3603(q), and K.S.A. 79-3603(r) that took effect five weeks after Millwright was handed down remained in place from 1977 until 1998, when the Kansas legislature enacted Senate Bill No. 493. SB 493 provided a new exception (i.e. exemption) for installation or application services performed in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence." "Residence" was defined to mean "only those enclosures within which individuals customarily live.

Under SB 493, K.S.A. 79-3603(p) continued to exempt the original construction of a commercial building or facility, while K.S.A. 79-3603(q) continued to exempt:

SB 493 exempted the services that were identified in K.S.A. 79-3603(p) and K.S.A. 79-3603(q) when preformed in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement" of a residence. The services taxed under these two subsections were: (1) "the service of installing or applying tangible personal property" regardless of whether the tangible personal "remains tangible personal property or becomes a part of real estate"; and (2) "the services of repairing, servicing, altering or maintaining an item of tangible personal property" whether or not that property "has been and is fastened to, connected with or built into real property."

SB 493's exemption of labor services performed in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence" contained the same conceptual problems for its application as the ones that resulted in the 1970 statute being declared unconstitutional. While subsection (q) taxed repairs done to tangible personal property, including tangible personal property that is "built into real property," subsection (p) exempted "repairs" that are done to a "residence." Therefore, it could be assumed that subsection (p) was intended to exempt repairs done to residential fixtures. However, when installation and repair services were done to attached or affixed TPP that did not become a residential fixture, it could be assumed that the services were taxable under both K.S.A. 79-3603(p) and K.S.A. 79-3603(q) because the attached or affixed TPP had not become a residential fixture, and remained tangible personal property.

These conflicting provisions raised the Millwrightesque dilemma of trying to apply sales tax to residential services based on whether the attached or affixed TPP being serviced had become a residential fixture or remained tangible personal property. As has been discussed, under SB 493, services done to a residence (including residential fixtures) were exempt while services done to tangible personal property (including attached or affixed TPP that had not become a part of a residence) were taxable.

Similarly, it was difficult to determine when services are done in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement" of a residence. Did the repair of a single residential fixture repair qualify as repair services that were being performed in connection with the "reconstruction, restoration, remodeling, renovation, [or] repair" of the residence? Was the installation of a single replacement fixture considered to be installation services that were being performed in connection with "reconstruction, restoration, remodeling, renovation, [or] repair" of the residence? Were the words "restoration, remodeling, renovation" intended to have different meanings?

As was the case with 1970 SB 423, the ability to determine whether attached or affixed TPP had become a residential fixture (i.e. residential real property and therefore part of the residence) appeared to be an essential requirement for implementing 1998 SB 493. Under SB 493, it appeared that services to install or affix tangible personal property at a residence would be taxable if it was determined that the attached or affixed property did not become a fixture. Services performed in a residence to repair, service, alter, or maintain the attached or affixed TPP would also be taxable if the attached or affixed TPP had not become a fixture. Such services would not be taxable if the attached or affixed TPP had become a fixture, which would be considered part of the residential real property.

Some of practical day-to-day questions about SB 493's application when services are performed in a residence are:

SB 493 appeared to require the department to establish a test that can be consistently applied to determine whether installed or affixed TPP became a residential fixture or was considered to have remained tangible personal property. This was the same thing that the department attempted to do when it implemented K.S.A. 1970 Supp. 79-3703(p) by use of its unconstitutional fixtures test. In 1970, the fixtures test was used to determine the taxability of repair, service, and maintenance services, and the taxability of installation services performed during original construction. Under SB 493, it appeared that some kind of a modified fixtures test was needed to determine when residential services would be treated as having been preformed in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement" of a residence.

To sidestep the Millwright-type problems created by SB 493, the department created a presumption that all appliances were considered to be part of a residence, regardless of how they were attached to a residence or hooked up to its utilities. It also implemented SB 493 as exempting all service work done to residential property, regardless of how much other work was being done at the residence, or whether the property being serviced was considered a fixture. Notice 98-02 provided:

Adopting the presumption that appliances are part of a residence meant that repairmen who serviced an appliance were not required to determine whether the appliance was sufficiently affixed to real property to be considered a residential fixture, or whether an appliance remained tangible personal property. Any services done to residential appliances were not subject to sales tax. Similarly, repair and replacement parts were taxed based on the amount that the repairman had paid for the parts rather than the marked-up amount charged to the owner of the residence.

This approach drastically reduced revenues that the State of Kansas received from HVAC and appliance repairmen, and from other service providers. Rather than charging sales tax on the marked-up price of a replacement furnace and the services performed to install it, a business that installed a furnace was only required to remit sales tax on the amount it paid for the furnace. See K.S.A. 79-3603(l). Similarly, if a repairman billed a homeowner for service repairs, sales tax was no longer remitted on the total amount billed to the homeowner for repair services and replacement or repair part. Instead, the repairman was only required to remit sales tax on the amount it paid for the repair and replacement parts. This approach resolved the conflicts in SB 493 while achieving the goal of the Kansas legislature, which was to reduce the amount of sales taxes paid by homeowners. Nevertheless, legislative employees who had helped draft the residential exemption in SB 493 expressed surprise at how broadly the department had implemented the new residential exemption.

New definition of "sales or selling price" enacted in 2003 House Bill 2005.

In 2003, the Kansas legislature enacted House Bill 2005. 2003 Kan. Sess. Law Ch. 147, Sec. 5. Among other things, HB 2005 provided new definitions that were needed to bring Kansas into compliance with the requirements of the Streamlined Sales Tax Project (Project). The Project is a joint effort by states and the business community to simplify sales taxes by making state sales tax laws more uniform. One of the Project's goals is the passage of a federal law that allows states to required remote vendors to collect their sales or use taxes. Currently, court-developed nexus standards prohibit states from taxing these vendors unless a vendor has made certain business contacts with the state.

Among other things, HB 2005 redefined the term "sales or selling price." Under the new definition, installation services were, for the first time in Kansas, taxed as part of a retail sale. In addition to the new definition that made installation services part of the tax base for a retail sale, K.S.A. 79-3603(p) continued to impose sales tax on installation services. As amended by HB 2005, the definition of "sales or selling price" provides, in parts relevant here:
As mentioned, K.S.A. 2008 Supp. 79-3603(p) continued to tax charges for installation services. Subsection (p) taxes:

The underlined language in K.S.A. 2008 Supp. 79-3602(ll)(1)(E) and K.S.A. 2008 Supp. 79-3603(p) shows that, after July 1, 2003, the Kansas sales tax act taxed installation services either as part of a retail sale, or as labor services that may or may not be part of a retail sale. Contractor perform labor services that are not part of a retail sale when they buy materials and install them for a property owner. When K.S.A. 79-3603(p) applied, charges for installation services continued to be exempt when the services were performed "in connection with the original construction of a building or facility," or in connection with "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence."

The original construction and residential exemptions did not change the definitions of "sales and selling price" and its inclusion of installation services as part of the sales or selling price of tangible personal property. This meant that installation services that were billed as part of a retail sale were not necessarily exempt because the goods being sold were installed in connection with either the original construction of a building or facility or "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence."

HB 2005 allowed the department, which the new administrators in charge of it, to reconsider Notice 98-02 and how the residential exemption was being applied. The new definition of "sales or selling price" meant that installation services done within a residence did not have to be exempted when the owner contracted to buy goods and have them delivered and installed in the residence.

In 2005, the department issued a series of information guides that discussed how contractors and contractor-retailer were required to pay or accrue tax on their purchases of materials and how they were required to collect sales tax on their charges for taxable labor services and retail sales. The information guides identified goods that were considered to be sold at retail with installation. It also identified the type of "installation charges" that were taxable as part of a retail sale. These installation services were referred to as "set-up services."

The department explained set up services that were taxable as installation services that were part of the "sales or selling price" as follows:

Charges for retail sales and set-up services were fully taxable if the sale of the goods were taxable. Charges for set-up services would not be allowed to be backed out of the tax base, even when the goods were installed in a residence or during original construction.

Installation services performed in a residence that went beyond set-up services would be exempt if they were separately stated on the bill given to the property owner. EDU-28 explained:

In addition to these discussions, the Information Guides contained specific instructions that applied to many businesses that are often seen as installing or repairing residential fixtures. EDU-27 provides:
EDU-28 provides:

EDU-26, Sales Tax Guidelines for Contractors and Contractor-Retailers, provides:

This discussion of Venetian blinds informs the decorating center how it is required to collect sales tax when it delivers and installs Venetian blinds in Kansas.

The decorating center that you represent cannot elect to treat itself as a contractor or contractor-retailer that is improving real property when it installs Venetian blinds. Such treatment would give the decorating center a selling advantage over its competitors since it would charge and remit less Kansas sales tax than its competitors who were accounting for sales tax on Venetian blind installation in accordance with the directive in "(22) Venetian Blinds," which is from EDU-26 and is quoted above.

These guidelines were intended to provide Kansas businesses with directives that provide a bright-line that distinguishes contracts for the retail sale and installation of fixtures from contracts that call for improvements to real property that incidentally require materials or fixtures to be transferred and installed or affixed to a building, structure, or other part of real property. They were written to overcome the Millwright-type problems that were reintroduced into the Kansas retailers' sales tax act by SB 493, and its exemption for services done "in connection with . . . the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence."

Statutory duties and responsibilities of the department.

The secretary of revenue is charged the duty of administering and enforcing the Kansas Retailers' Sales Tax Act. K.S.A. 2007 Supp. 75-5155; K.S.A. 79-3618. These duties include implementing and administering the amendments to the Act that Kansas legislators enact and the governor signs into law. Webster's Ninth New Collegiate Dictionary defines "implement" as: "to give practical effect to and ensure of actual fulfillment by concrete measures." Black's Law Dictionary, Sixth Ed. contains the following explanation of the word "administer": "To 'administer' a decree is to execute it, to enforce the provisions, to resolve conflicts as to its meaning, to construe and to interpret its language. U.S. v Hennen, D.C. Nev., 300 F. Supp. 256, 263."

These duties mean that when the Kansas legislature amends the Act, the department is responsible for:
The department performs these duties by: (1) publishing notices, revenue rulings, information guides, and similar material that explain why the new statutory provision was enacted, how it changes the prior law, and how the department will implement it; (2) revising and publishing tax returns and instructions, if needed, to conform to the new provision; (3) deleting material from the Policy Information Library and revoking any earlier rulings that conflicts with the new provision; (4) conducting seminars for taxpayers, where the statutory changes are discussed and explained; (5) conducting educational seminars for department associates, where statutory changes are discussed and explained; and (6) adopting new regulations, if needed.

1998 HB 493 contained a number of conflicting provisions concerning the installation and repair of residential fixtures and the exemption for "the original construction, reconstruction, restoration, remodeling, renovation, repair or replacement of a residence." 2003 HB 2005 contained conflicting provisions since it included installation services in the tax base for the sale of goods, while taxing installation services unless they were performed in connection with original or residential construction. The department attempted to resolve these conflicts in the information guides that it published. This includes that provision that businesses should treat the sale and installation of Venetian blinds as a retail sale rather than as the transfer of tangible personal property under a construction contract.


Date Composed: 04/01/2010 Date Modified: 04/01/2010