A Taxability of Mixed Transactions in Colorado

• Publication year: 2004
• Pages: 79

33 Colo.Law. 79 Colorado Lawyer 2004.

2004, March, Pg. 79. A Taxability of Mixed Transactions in Colorado

---

79

Vol. 33, No. 3, Pg. 79

The Colorado Lawyer
March 2004
Vol. 33, No. 3 [Page 79]

Specialty Law Columns
Tax Tips
A Taxability of Mixed Transactions in Colorado
by Norman H. Wright, Andrew W. Swain
C 2004 Norman H. Wright and Andrew W. Swain

This column is sponsored by the CBA Taxation Law Section

Column Editors

Larry Nemirow, Denver, of Davis, Graham & Stubbs LLP (303) 892-7443, larry.nemirow@dgslaw.com; and John Warnick, Denver, of Holme Roberts & Owen llp - (303) 861-7000, warnicj@hro.com

Norman H. Wright Andrew W. Swain

About The Authors:

This month's article was written by Norman H. Wright, Denver, Of Counsel with Downey & Knickrehm PC - (303) 813-1111, nwright@downknick.com; and Andrew W. Swain, Denver, an assistant attorney general in the Office of the Attorney General - (303) 638-6324, andrew.swain@ state.co.us.
The opinions and views expressed in this article are solely those of the authors, have not been reviewed by any Colorado governmental entity, and do not represent any tax opinion or position accepted or taken by any governmental entity. This article was written before Swain joined the Attorney General's Office and while he worked as a state and local tax consultant for KPMG LLP.

Complex sales transactions, which are comprised of taxable tangible property and non-taxable services, give rise to troublesome sales and use tax problems. This article discusses those issues and describes how two recent Colorado Supreme Court decisions begin to resolve them.

Colorado imposes its sales and use tax on the sale or purchase of tangible property and enumerated services.1 Enumerated services are those listed as taxable in Colorado's tax code, especially CRS § 39-26-104, rather than in tax regulations promulgated by the Colorado Department of Revenue ("CDOR") or its policy statements.2 However, the state statutorily enumerates only a few services as taxable.3

A problem arises in Colorado, as it does in most taxing jurisdictions that impose transactional excise taxes, when a sales agreement or purchase invoice includes a combination of taxable property and non-taxable services. These combined or "mixed transactions" give rise to troublesome taxing issues that stem from the difficulty in: (1) characterizing a mixed transaction as either a sale of taxable tangible property or a non-taxable service; (2) separating the transaction's taxable property component from its non-taxable service component and assigning each a price; and (3) determining if the primary purpose of the transaction was the acquisition of a service, tangible property, or both.

This article discusses mixed transactions and the tax problems associated with them. It also examines how two recent decisions by the Colorado Supreme Court begin to resolve issues involving mixed transactions. In both cases, as this article addresses, the Court restricts the power to tax services merely because they are connected to a transfer of tangible personal property.

Categories of Mixed Transactions

Mixed transactions fall into three categories: (1) non-separable mixed transactions; (2) separable mixed transactions; and (3) incidental property mixed transactions. Following are explanations of these kinds of mixed transactions.

Non-Separable Mixed
Transactions

Non-separable mixed transactions involve a sale or purchase of property, the creation of which required the performance of inseparable services or labor that, if performed alone, would constitute non-taxable services. An example of this type of transaction is the sale of a rebuilt automobile engine. Colorado imposes its sales or use tax on the transaction's entire mixed purchase price.4

Separable Mixed
Transactions

Separable mixed transactions involve distinct tangible property and service components that are readily separable and subject to individual pricing. An example is a sale of clothing along with the sale of separately-stated alteration services. Colorado generally imposes its sales or use tax only on the purchase price attributable to the tangible property portion of the mixed transaction.5 However, the key issue that frequently arises in such cases is whether a transaction is characterized as separable by the taxing authority.

Incidental Property
Mixed Transactions

This category includes mixed transactions that primarily involve an otherwise non-taxable service along with a small, but inseparable, incidental component of taxable tangible property. An example is the sale of information preparation services in which the information has been recorded on microfilm.6 If the service (not the microfilm) is the true object of the purchase, Colorado does not impose any sales or use tax on the purchase price.7 Typically, the service provider already would have purchased and paid a sales tax on the blank microfilm (or other medium) used to convey the information.8

Non-Separable Versus Separable Mixed
Transactions

Colorado imposes its sales and use tax on the full purchase price paid for non-separable mixed transactions. The CDOR bases this taxability position on CRS § 39-26-102(12), which provides in pertinent part that:

. . . [S]ales tax is imposed on the full purchase price of articles sold after manufacture or after having been made to order and includes the full purchase price for material used and the service performed in connection therewith. . . . [T]he sales price is the gross value of all materials, labor, and service, and the profit thereon, included in the price charged to the user or consumer. (Emphasis added.)

However, the CDOR often takes this statutory interpretation a step further and uses it to tax the entire purchase price paid for property bought in an otherwise separable mixed transaction (involving taxable property readily separable from non-taxable services). For example, an appliance retailer may have a separate fee for home delivery. The CDOR would tax the entire purchase cost, including the delivery fee.9

The CDOR interprets the phrase "service performed in connection therewith" to mean any services performed in connection with the sale of a completed product, instead of just the services performed to create, produce, or manufacture a finished product for sale.10 Based on this interpretation, the CDOR argues that these services (such as delivery charges) are services inherently associated with making the final product available to the consumer,

because they are performed before the purchaser takes title to or possession of the finished product. As such, they become subject to Colorado's sales and use tax, even though they are not expressly enumerated as taxable in the state's tax statutes.11

Thus, according to the CDOR, a non-enumerated service, such as an alteration or delivery service, is taxable. Its taxability is based on the fact that: (1) it was purchased and performed contemporaneously with the taxpayer's purchase of tangible personal property; and (2) the charge for the service, even if stated separately from the charge for the property, appears on the invoice evidencing the purchase.

In 2001, in the case of A.D. Store Co. v. Executive Director ("A.D. Store"),12 the Colorado Supreme Court rejected the CDOR's interpretation of the phrase "service performed in connection therewith" in a matter involving alteration services. In rejecting the CDOR's use of this phrase to impose sales and use tax on non-taxable, non-enumerated services, the Court announced a means by which to distinguish a separable mixed transaction from a non-separable mixed transaction.13 The CDOR currently takes the position that A.D. Store has limited application; therefore, the CDOR still frequently seeks to apply sales taxes to separable mixed transactions.

The A.D. Store Case

A.D. Store14 involved a taxpayer, A.D. Store Company, Inc., which conducted business as Auer's. Auer's made retail sales of fully manufactured women's clothing that was not custom-tailored.15 Auer's offered non-complimentary alteration services to customers buying its clothing. If Auer's sold a garment and performed alterations on it, the store's invoice stated separately the garment's price and its charge for alteration services. Auer's calculated sales tax based on the clothing's price, but not on the charge for alterations.16

The CDOR assessed sales tax on the alteration service charges when a customer purchased the service in conjunction with a clothing purchase. It argued that the amount paid for alteration services constituted a part of the total taxable consideration given in exchange for the clothing. The CDOR premised this argument on the same passage-of-title interpretation of "service performed in connection therewith" provided in CRS § 39-26-102(12).

The Colorado Court of Appeals agreed with the CDOR's argument that the services were inherently related to the creation of the article and upheld the assessment.17 However, in a four-to-three decision, the Colorado Supreme Court disagreed, reversing the lower court's decision and thereby invalidating the assessment.18 The Court concluded that, for the purpose of interpreting the phrase "service performed in connection therewith," there exist two relevant categories of services.19

1. Services as Non-Separable Mixed Transactions (Taxable) Certain services (labor) are performed prior to the point at which an item is offered for sale in a finished state. Those services go into the creation, production, construction, or manufacture of the finished product. The A.D. Store Court cited the example of furniture bought by an...