When contemplating construction services makes them taxable – Wacky Tax Wednesday
Anyone who’s ever been involved in a construction project knows how challenging they can be, even when everything goes as planned. Determining the taxability of construction services is no different. It can be a quagmire from the outset.
Consider a bill recently enacted in Washington state (House Bill 2229). Part of an effort to “remove barriers to the creation of affordable housing,” it defines “land development or management” and clarifies which activities are taxed as retail or wholesale sales, and which are taxed as services. The intent of the act is “to maintain the application of the law and not to extend retail treatment to activities not previously treated as retail activities.”
In a special notice on the subject, the Washington Department of Revenue confirms, “The amendment to the law does not affect the department’s position on how the law is applied. Rather, [it] affirms the department’s prior and current position.” The notice focuses on retail sales tax and doesn’t address the Business and Occupation (B&O) tax.
What is land development or management?
HB 2229 defines land development or management as “site identification, permitting, and other preconstruction regulatory services provided to the consumer of the constructing, building, repairing, improving, or decorating services.” It includes acting as an owner’s representative during any design or construction periods by:
- Approving invoices
- Controlling the work itself
- Monitoring the budget
- Recommending a contractor
Whether land development or management services are subject to retail sales tax depends on whether they’re included or excluded from the definition of services rendered in respect to construction.
Land development and management activities are not construction services — and are therefore not subject to retail sales tax — if the person or entity providing the services is:
- Not responsible for the building, constructing, decorating, improving, or repairing services; or
- Responsible for the building, constructing, decorating, improving, or repairing services, but the initial contract was only for land development or management services, and the person can prove that at the time of the first contract, “it was not contemplated by the parties … that the same person would be awarded both contracts.”
The first point is straightforward. A company that doesn’t provide building, construction, decorating, improvement, or repair services won’t be subject to tax on the land development or management services it does provide.
The second point is more nuanced. Taxability essentially hinges on the intent of the two parties — what they contemplated — when the contract was drawn and signed.
The Washington Department of Revenue provides several examples to help taxpayers understand. The cast of characters in all scenarios are fictional companies XYZ Development and Land Inc.
In the first scenario, XYZ Development hires Land Inc. to conduct preconstruction land development services (e.g., budget estimate, engineering, permits, and site feasibility).
Land Inc. is not responsible for the actual construction project, so the land development services it provides “are not considered services rendered in respect to construction” and are not subject to retail sales tax.
In the second scenario, XYZ Development hires Land Inc. to conduct preconstruction land development services. At the time, neither XYZ Development nor Land Inc. contemplate having Land Inc. handle the actual development.
Later, after a bidding process, XYZ Development hires Land Inc. to manage all building and construction activities. Retail sales tax does not apply to the initial agreement because “it was not contemplated by either party that the same person would be awarded both contracts.” However, the separate construction contract is subject to sales tax.
In the third scenario, XYZ Development hires Land Inc. to provide preconstruction services and to complete the construction project if site approval goes through.
If Land Inc. is awarded the construction project, both the preconstruction land development services and the construction services are subject to sales tax because, “at that point,” land development becomes “services rendered in respect to construction.”
In the fourth and final scenario, XYZ Development hires Land Inc. to provide preconstruction services and to complete the construction project if site approval goes through, as in the third scenario.
However, the site is not approved for development and the construction project can’t move forward. Thus, the preconstruction land development services that were performed are not subject to sales tax.
When sales tax relies on intent
What I find wacky about this is that taxability relies, in part at least, on intention. This raises questions.
What counts as contemplation?
What if, in the first scenario, Land Inc. really wants to be awarded the construction project but conceals that fact from XYZ Development. Or if, in the second scenario, one of the two parties contemplated what it would be like to have Land Inc. manage construction. Should the land management services be taxable because Land Inc. contemplates taking on the construction project?
What would happen in the third scenario if XYZ Development decided to go with a different construction company at the last minute, or Land. Inc. backed out for some reason? Would the land management services remain taxable because the intention was for Land Inc. to oversee the construction project (i.e., both parties contemplated that)? Or would the land management services be exempt because Land Inc. didn’t end up providing the construction services?
It’s complicated. But it involves both construction and sales tax, so that’s to be expected. That’s also why businesses in the construction industry can benefit from automating sales tax management.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
Stay up to date
Sign up for our free newsletter and stay up to date with the latest tax news.