South Carolina: Home Improvement Retailer’s Construction Contracts Held to be Retail Sale of Materials

The South Carolina Administrative Law Court recently held that a taxpayer, a home improvement retailer, was properly assessed retail sales tax on purchases of items that it subsequently installed in customer’s homes. Under South Carolina law, contractors are the retail purchasers of materials used in the performance of construction contracts. Contractors do not purchase materials used in construction contracts for resale, and construction services are not taxable services. The taxpayer at issue purchased building materials and appliances at wholesale (using a resale certificate) and sold them at retail to customers. Some customers wished the taxpayer to install the materials/items. In these cases, after a customer selected  materials for a project, or items to install (e.g., a new appliance), the taxpayer engaged a third-party subcontractor to provide a quote for the installation services, prepared a contract that separately identified the labor and material costs, and executed the contract with the homeowner. The contract included all materials and items, such as appliances to be installed, at the retail price regularly charged in the store, and the customer paid the entire contract price upon execution. No sales tax was included in the payment as it was treated as an installation contract. The taxpayer then remitted use tax on the materials/items identified in the contract based on its wholesale cost. On audit, the Department disagreed with this position, and the matter eventually came before the court.

Originally, the Department of Revenue took the position that the taxpayer was not a “true contractor” in its installation contracts and that the transactions constituted the retail sale of materials/items, with ancillary installation services performed by a third-party contractor. However, at trial, the Department ultimately argued that (1) the withdrawal or use of the materials by the taxpayer during the installation was a “deemed sale” by the taxpayer to itself; (2) as the final user of the materials, the taxpayer should be required to pay sales tax on the materials at the time it withdrew, used, or consumed them; and (3) the gross proceeds of the deemed retail sales should be based on the fair market value of the materials as measured by the price paid by installation contract customers, not the taxpayer’s purchase price. Accordingly, the Department assessed the taxpayer for sales tax based on marking the materials/goods up by 40 percent from the taxpayer’s purchase price. In the Department’s view, this represented the taxpayer’s retail margin had it sold the materials directly to customers outside of an installation contract.

The court acknowledged that by contracting with customers to install home improvements, including repairs and additions to real property, the taxpayer qualified as a contractor. However, the court noted that the taxpayer was also a retailer and purchased materials for the installation contracts with a resale certificate, not as a retail consumer. in the court’s view, this made the customer, not the taxpayer, the final purchaser of the materials. The court rejected the taxpayer’s argument that because customers left the store after executing the contract without the materials themselves or title to the materials, the transaction was not a retail sale. The court noted that the same situation could arise if the taxpayer purchased an item in a traditional sale that was then ordered specially. The taxpayer provided installation services only when the materials/goods were purchased at its store, and stand-alone installation services were never provided. As such, the court concluded that the overarching purpose of the installation contracts was to facilitate sales to retail customers and the installation service was merely incidental and secondary in nature. While the court noted that the Department relied on an incorrect argument that the taxable retail sale was the taxpayer’s withdrawal, use, or consumption, rather than the customer’s purchase of the materials, the assessment based on a 40 percent markup was affirmed as the correct amount of tax due. It is worth noting that the Department had also assessed a negligence penalty because the taxpayer had been assessed on the same issue in a prior audit and informed of the proper treatment of the transactions. The court declined to assess the penalty, noting that with the Department’s moving position on the issue and the complexity of the area, it was hard-pressed to consider the penalty appropriate. Please contact Nicole Umpleby at 714-335-5586 for more information on Lowe’s Home Center, LLC v. South Carolina Department of Revenue.