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Wisconsin Doesn’t Allow Companies to “Go for Two”

In early 2014 I wrote an article that explores a way in which many state and local tax “SALT” professionals advise their clients to save on state and local tax. The issue is a common one for real property improvement contractors. Specifically companies that sell real property improvements to governments or other tax exempt entities, there is a real incentive to save on high sales tax rates. What if instead of selling a real property improvement, the company separated itself into two separate legal entities. Company 1 could sell tangible personal property, tax free, to the tax exempt entity/governmental entity. Company 2 could install the tangible personal property tax free because they are only providing a service. Assuming both companies had separate contracts, the entire transaction would escape sales and use tax in most states. Conversely, if a single company purchased materials and used them in a real property improvement, then it would owe tax on all of its purchases. This savings is often substantial.

As stated above, in most states the sale of tangible personal property “TPP” is taxable while real property improvement contractors are considered the end user of tangible personal property. Therefore, they are required to pay a use tax on their material costs. In turn, they do not charge customers tax on their sales. If, however, they are installing items of TPP, then suddenly the sale of TPP plus any labor charges may become subject to sales tax in many states. More commonly, the real property contractor incorrectly does not pay tax on its materials and then attempts to exempt the sale by accepting an exemption certificate from its tax-exempt customer. Unfortunately, in most states, an exemption certificate only works to exempt the sale of tangible personal property, not real property. Therefore, if the real property improvement contractor did not pay tax on its materials and did not charge tax, it could get slammed with a hefty sales tax bill.

In 2014, Wisconsin took a different approach to the tax planning technique described above. In Sullivan Brothers Inc. v. Wisconsin DOR, No 2013-AP-818 (Wis. Ct. App. 2014), the taxpayer set up two companies for the purpose of saving on the sales and use tax. Sullivan essentially split into two companies, Sullivan the installer, and Supply the suppler of TPP. Many tax exempt entities would enter into a contract with Supply for the TPP and Sullivan to do the installation of TPP. Supply did not have to pay tax on its purchases because they were for resale. Likewise it did not have to charge tax because it received an exemption certificate. Sullivan did not charge tax because it was merely providing an installation service and it was not providing any TPP. Wisconsin took issue with this structure and hit them with an assessment. Sullivan challenged the assessment in court.

In an interesting opinion, Wisconsin ignored the form over substance assumption in sales tax law. The court skirts around the form over substance argument because Wisconsin has a “substance and reality” test derived from prior case law. Under its interpretation a court can unwind the form of a transaction and look to the substance of the transaction to tax it. Here, the court determined both entities had the same ownership and engaged in mere accounting transferring entries between one another to escape tax. Therefore, the substance of the transaction was the same as if one company existed.

The substance over form transaction is problematic for sales tax transactions. If I go Macy’s and buy a $70 shirt on sale for $10, is the substance of the transaction a $70 dollar shirt and I should pay tax on $70? For a host of reasons, the substance over form agreement that works for federal tax purposes is incredibly problematic for sales tax. For that reason, most states do not take the approach Wisconsin does and allows for clever tax planners to avoid sales tax in many occasions. Before attempting a clever transaction, this case illustrates that it is critical to know the SALT rules for your state.

About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone at 954-642-9390..

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