NC Department of Revenue Issues Guidance on RMI and Capital Improvements

The NC Department of Revenue (NCDOR) has issued a formal written notice to further explain major changes to the applicability of sales & use tax to transactions involving repairs, maintenance and installation services (RMI services) and for those transactions that would likely be treated as capital improvements.

The notice contains a list of over 200 specific and detailed transaction examples that are divided into several general categories placed in alpha order to facilitate reading. The notice states whether each transaction qualifies as: 1) a capital improvement with the gross receipts exempt from sales & use tax, or 2) an RMI service subject to tax, or 3) an RMI service exempt from tax by statute. The notice was prepared with input from legislative leaders and their staff in addition to a number of practitioners, including DHG, who were specifically invited by the Department to provide feedback in a recent meeting. It should be a benefit to taxpayers to aid in understanding the changes.

While the publication does provide clarity for a large number of transactions, it is particularly important to note that the taxability of a transaction may change depending upon the specific facts pertinent to that transaction. As a result, the NCDOR notice contains a disclaimer of which appears on every page indicating that the notice is not to be considered “specific tax advice.” The notice was made available on the NCDOR website on Monday, March 20, 2017.

Prior to March 1, 2016, the RMI services were not subject to the North Carolina sales tax. Effective on that date, the retail sale of RMI services became subject to the state and applicable local tax rate if the service provider was deemed to be “engaged in a retail trade.” The statutory test for making that determination was whether a majority (more than 50%) of the RMI provider’s revenues were derived from retail sales of tangible personal property, digital property, or taxable services. RMI services from providers who only provided such services and were not otherwise engaged in a retail trade were exempt from sales tax, while those services provided by retailers were taxable. Thus, the taxability of RMI services differed depending on the classification of the provider. The application of the test was deemed by many taxpayers and the NCDOR as inequitable and difficult to apply in practice, resulting in taxpayer confusion despite the issuance of several detailed directives by NCDOR to clarify the operation of the statute.

In response to taxpayer concerns, the General Assembly enacted additional changes to the taxation of RMI services and other sales tax statutes which became effective January 1, 2017. In response to the new statutory changes, the NCDOR issued a series of additional supplementary directives in late 2016 to interpret the new changes and explain their application in view of the prior statutes and directives. As a result, RMI service providers have been required to determine their potential sales tax liability under three separate statutory regimes: Pre-3/1/16, 3/1/16 through 12/31/16 and 1/1/17 forward. For some taxpayers, their sales tax liability could possibly be different under each scenario, especially where their transactions are impacted by the changes to taxation of RMI services.

As of January 1, 2017, the statutory definition of “retail trade” was repealed and all persons who sell taxable RMI services that are sourced to North Carolina are considered retailers even if their only business activity is providing RMI services. Those businesses are required to register for sales tax purposes and collect and remit sales tax on those sales unless a specific exemption applies. RMI services provided in the performance of a “real property contract” are exempt. A real property contract is defined as a contract to perform construction, reconstruction or remodeling with regard to a “capital improvement.” A capital improvement is defined by statute as “an addition or alteration to real property that is new construction, reconstruction, or remodeling of a building, structure, or fixture on land that becomes part of the real property or is permanently installed or applied to the real property so that removal would cause material damage to the property or article itself. A capital improvement does not include a single RMI service, but does include the replacement or installation of a heating, ventilation, and air conditioning unit or system as well as plumbing, electrical, commercial refrigeration, irrigation, sprinkler, or other similar systems.”

If a transaction meets the definition of a capital improvement, it is taxed as a real property contract and the RMI services are exempt from sales tax. If a transaction does not qualify as a capital improvement, then it may be taxable as an RMI service to real property or as a service contract for real property unless a statutory exemption applies. For capital improvements, Form E589CI should be issued to substantiate that a contract, or a portion of work performed to fulfill a contract, should be taxed as a real property contract.