The North Carolina Department Of Revenue Issues New Directive Outlining When Service Contracts Will Be Subject to North Carolina Sales and Use Tax.
Beginning January 2014, sales of “service contracts” will now be subject to North Carolina sales and use tax. The term “service contract” is defined as a “warranty agreement, a maintenance agreement, a repair contract or a similar agreement or contract by which the seller agrees to maintain or repair tangible personal property.” N.C.G.S. 105-164.3(38b). On December 23, 2013, the NCDOR issued Directive No. SD-13-5 providing long awaited clarification as to how the NCDOR will apply these new rules.
First, the Directive clarifies that a “one off” single repair transaction, which is not completed pursuant to a “service contract,” does not constitute a “service contract” subject to sales tax. For example, where an automobile repair shop sells and installs an alternator for a motor vehicle, this transaction would not be subject to the new service contract rules as long as the transaction is not completed as part of a service contract. Instead, sales tax would be due on the retail sales price of the alternator, but not the installation charges, as long as the installation charges are separately stated on the retailer’s invoice.
Next, the Directive clarifies that the new service contract rules do not apply where a retailer agrees to maintain or repair real property. The Directive also states that the new service contract rules do not apply where the retailer agrees to maintain an item of tangible personal property that is permanently attached to real property, as long as the service contract is sold to a purchaser after the item of tangible personal property is permanently attached to the real property. So, it appears that sales tax would be due on the sale of a service contract that is sold to a purchaser before or simultaneously with the sale of an item of tangible personal property that is or will be permanently attached to the real property.
The Directive provides an example where a purchaser buys a house that has garage doors on the garage. Later, the home-owner purchases an annual garage door service agreement that covers all repairs. In that event, the garage door service contract is not subject to sales tax, since the contract provides for the maintenance of personal property that is already permanently attached to real property. However, the garage door company would continue to be responsible for charging sales tax on sales of tangible personal property used to fulfil the contract. So, if the garage door service company makes a separate retail sale of a part to a homeowner that is not covered by the garage door sales contract, then the sales tax is assessed on the sales price of the part.
Another example in the Directive involves a warranty contract for the liner of an in-ground pool. The warranty agreement is purchased after January 2014, but the liner was purchased from the retailer and installed before the warranty agreement was sold. In this example, since the pool liner was already attached to real property at the time of the sale of the warranty agreement, the subsequent warranty agreement would not be subject to sales tax.
Likewise, in another example provided by the Department of Revenue, the sale of a HVAC service contract would not be subject to sales tax since the HVAC system is already attached to real property at the time of the sale of the service contract. Instead, the HVAC service provider will continue to be subject to the sales tax on repair parts and supplies used in providing the service contract to the customer. This example suggests that if an HVAC company sold both the HVAC and the service contract to a new customer at the same time, or as part of the same transaction, then the service contract would be subject to the sales tax.
These examples suggest that taxpayers who routinely sell items of personal property that become permanently affixed to real property may want to consider the timing of when they sell service contracts to provide maintenance and service to those items. Based on the examples provided by the Directive, it seems that such taxpayers may wish to wait until after the sale of the personal property to enter into a service contract with the customer in order to avoid application of sales tax to the service contract.