TWIST - This Week in State Tax

Missouri: Department Rules on Food Delivery Service Platforms

A food delivery service platform recently requested a letter ruling from the Missouri Department of Revenue. The platform, which has no physical presence in Missouri, enters into agreements with Missouri-based restaurants to display the restaurants’ menus, provide marketing, and facilitate the delivery of the restaurants’ food and beverages to customers. When a customer places an order with a restaurant on the platform, the customer has the option to pick up the order at the restaurant’s location, or to request delivery of the order. If the customer selects the delivery option, the customer must pay an additional delivery fee to the platform. The platform retains the delivery fee if the platform arranges delivery with a third-party contractor rather than with the restaurant. Once the platform confirms the customer’s order, the platform charges the customer’s credit card or PayPal account. The platform then remits all funds collected, including the order subtotal, the delivery fee (if the restaurant performed the delivery), and any applicable taxes to the restaurant. By contract, the restaurant agrees to remit the taxes collected to the state on its own behalf.

In the letter ruling request, the platform asked whether it was required to collect and remit sales taxes on sales made to Missouri customers from in-state restaurants. The Department responded that the platform was not required to collect and remit sales taxes, but that the platform may transfer sales taxes collected on behalf of the restaurants to the restaurants. The Department analogized the platform’s role to that of a financial institution or credit card company which does not have a requirement to collect sales taxes on payments that it facilitates. The Missouri restaurants using the platform, however, still have a requirement to charge, collect, and report sales taxes on sales facilitated by the platform.

The platform also requested a ruling on whether the delivery fees charged to customers were subject to Missouri sales and use tax. The Department responded that because customers had the option to request pickup rather than delivery of their orders, the delivery fees were optional and excluded from tax. In Missouri, delivery charges that are usual, customary, and stated separately from the sale of taxable goods are not subject to tax.

The Department’s letter ruling did not address Missouri’s marketplace law, which went into effect this year. The marketplace law requires marketplace facilitators engaged in business activities within Missouri to collect and remit use tax on taxable sales delivered to customers in the state. For questions on Letter Ruling 8244, please contact John Griesedieck. 

North Carolina: Contract Manufacturing Service Fees Sourced Using Rules for Sales of Tangible Personal Property

In a recent private letter ruling, the North Carolina Department of Revenue responded to a taxpayer’s request for guidance as to the sourcing of service fees received from a related party. The service fees reimbursed and compensated the taxpayer for contract manufacturing services provided to its foreign parent corporation. The manufacturing facilities were in North Carolina. After the manufacturing process was finished, the products (tangible goods) were distributed by the parent corporation for sale both in the U.S. and globally. In North Carolina, receipts are generally sourced to the state if the taxpayer's market for the receipts is in North Carolina.  A taxpayer’s market for service receipts is in North Carolina if and to the extent that a service is delivered to a location in the state. Under a North Carolina rule, “where a taxpayer has receipts subject to this Subchapter from transactions with a related entity customer, information that the customer has regarding the sourcing of receipts from these transactions shall be imputed to the taxpayer.” In the Department’s view, this rule applied to the situation at hand because the contract manufacturing services were provided to a related entity, and the goods at issue were sales of tangible personal property.  Next, the Department stated that the taxpayer must source its receipts in the same manner as the foreign parent- the related entity customer. As such, applying the rule for sourcing sales of tangible personal property, the Department concluded that the service fees should be sourced to North Carolina if the finished product was ultimately delivered by the related entity to a customer located in North Carolina, regardless of F.O.B. terms. If the taxpayer was not provided the ultimate destination and could not determine the locations where the products were ultimately delivered, the Department determined that the service fees should be sourced to North Carolina, the location where the taxpayer performed the contract manufacturing services. Please contact Nikki Emanuel Jarrell with questions on Corporate Private Letter Ruling 2023-02.

Tennessee: Federal Income Tax Classification Affects Manufacturer Status

The Tennessee Department of Revenue recently addressed how a taxpayer’s federal income tax status affects its classification as a manufacturer. The taxpayer at issue was a SMLLC that was formed by its contractor company Parent to fabricate goods at a plant currently owned and operated by the Parent. The Parent intended to transfer all plant machinery and equipment to the taxpayer and the taxpayer planned to enter into a new lease for the space at the plant housing the fabrication operations. The fabricated goods were to be sold to the contractor Parent and unrelated entities. Tennessee’s sales and use tax industrial machinery exemption is granted to entities whose principal business is the fabrication or processing of tangible personal property for resale and consumption off the premises. An activity is a taxpayer’s principal business if more than fifty percent of its revenues at a given location are derived from fabricating or processing tangible personal property for resale, i.e., the “51 percent test.” The taxpayer requested guidance as to whether it would qualify for the industrial machinery sales and use tax exemption and reduced rates for water and energy, as well as whether it would be a manufacturer for Tennessee Business Tax purposes. Rulings were also requested as to whether the Parent would qualify as a manufacturer if the taxpayer elected to be treated as a disregarded entity of the Parent.

Under Tennessee law, if a SMLLC has made a valid election to be taxable as a corporation, then it will be treated as a separate entity for Tennessee state and local tax purposes. If a SMLLC does not make an election or elects to be treated as a disregarded entity on Form 8832, then it will be disregarded as an entity separate from its owner for Tennessee state and local tax purposes, unless an applicable statute requires otherwise. The Department concluded that if the taxpayer elected to be treated as a corporation for federal income tax purposes, its sales of fabricated goods would be included in the principal business test, and it would qualify as a manufacturer for purposes of the sales tax exemption and lower rates on water and fuel. The taxpayer would also qualify as a manufacturer eligible for the manufacturing exemption to the business tax if it elected to be treated as a corporation for federal tax purposes.

In contrast, if the taxpayer was treated as an entity disregarded as separate from its parent, the taxpayer would be treated as a division of the Parent, and the sales to the Parent would essentially not exist and would not count in determining if the 51 percent test was met. To qualify for the industrial machinery exemption, Parent would need to sell fabricated goods to third parties and have more than 50 percent of its revenues from such sales of fabricated items. If the Parent did not meet the 51 percent test, it would not be permitted to obtain the benefit of any exemptions or reduced tax rates available to manufacturers. Please contact Justin Stringfield with questions on Letter Ruling #23-08.

Washington State: Taxpayer Selling Personalized Pet Products was Engaged in Manufacturing

A Tax Hearing Officer for the Washington State Administrative Review and Hearings Division recently addressed whether a taxpayer was subject to manufacturing B&O with respect to sales of personalized pet products. The taxpayer was an online seller of pet products, such as collars or tags, some of which were personalized with a pet’s information, or were otherwise customized. The taxpayer had a physical location in Washington State where its machinery was located. Following an audit, the Department reclassified the taxpayer’s income from retailing B&O tax to manufacturing B&O tax. The taxpayer protested on the basis that it was not engaged in manufacturing when it personalized pet products.

The statutory definition of manufacturing in Washington State encompasses a variety of processes that result in a “new, different, or useful substance or article.” State courts have broadly construed this to include processes that make significant changes to a product. The have further identified several factors to be considered in determining whether the end-product is a new, different, or useful product; they include, but are not limited to, changes in form, quality, properties, enhancement in value, the extent and the kind of processing involved, and differences in demand. The taxpayer argued that its personalization process did not change the quality of the products or the chemical, physical or functional properties of the items. Rather than enhancing the value of the products, the taxpayer argued that the personalization process actually reduced the value of the products, as the item was thereafter only useful to the one customer whose product was personalized. The Hearing Officer disagreed, holding that the taxpayer was changing the physical property of the tags or collars by physically stamping or embroidering them. This, in turn, changed the functionality of the tags and collars dramatically. The tags and collars transformed from merely decorative items into a powerful method of identifying the owner of a lost pet and created a way for the owner to reunite with their lost pet, which the taxpayer agreed was the number one reason for purchase of a personalized pet product. The Hearing Officer also rejected the taxpayer’s position that it was not a “manufacturer” as that term is commonly understood and that the process of stamping or embroidering was too “simple” to be considered manufacturing. In the Hearing Officer’s view, the taxpayer’s personalization process created a marketable product and increased the value of the tags and collars. Please contact Michele Baisler with questions on Det. No. 18-0191, 42 WTD 005 (2023).