The devil is in the definition: the sales-and-use tax now covers services, but which ones?

• Author: Fred Parker
• Position: Law Journal 2014

The General Assembly regularly strikes fear into service providers by threatening to make them sales-tax collectors. State expenses increase every year, and revenue never catches up, so the deficit widens and fair-minded individuals vehemently disagree over solutions. Instead of raising rates, it seems easier for the state legislature to expand the scope of what is taxed. Regardless of your perspective on whether the changes reflect good policy, everyone must consider the enacted changes.

Last summer, the legislature negotiated, drafted and established a tax law--An Act to Simplify the North Carolina Tax Structure and to Reduce Individual and Business Tax Rates. Most folks learned of the Tax Act because of its amendments impacting their income taxes, corporate taxes or the unfortunate death of the much-loved tax-free shopping weekend. However, its reach has other less-publicized impacts. For example, the sales-and-use tax now applies to certain service contracts sold by retailers. Services were not previously subject to sales tax; now some of them will be. As is often the case, the difficulty is in the definitions.

The Tax Act amended the N.C. General Statutes to levy the general state (currently 4.75%) and applicable local and transit sales-and-use tax rates on the sales price of a service contract sold by a retailer. The service contracts affected are 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."

By authority granted to it under the General Statutes, the N.C. Department of Revenue issued a precedential directive on Dec. 23, 2013, (later revised on Jan. 17). The directive includes a summary that explains the applicable terms (such as retailer, tangible personal property, engaged in business, etc.), exemptions, sourcing principles and offers examples of applying the tax. Most of the examples address standard situations that would trigger the Service Contract Tax, including sales of an extended automobile warranty and an all-terrain vehicle maintenance agreement. It also includes one that wouldn't--an HVAC service contract, which is exempt because HVAC systems attach to real property.

However, a seemingly innocuous example, combined with the statutory terms, potentially extends sales tax to unsuspecting businesses. An individual purchases a $500 repair contract for a laptop from a computer-repair...