This is an explanation by Holly Hoffman, Owner of Sales Tax Advisory Network, of Wisconsin Department of Revenue’s article Construction Contract Exemption- Updated
Holly’s comments added to the Department’s original article are in red font.
Lump-Sum Exemption
Some contractors sell both real property improvements (not taxable) and tangible personal property (taxable). An exemption applies for certain contracts entered into October 1, 2013, through November 30, 2017, in which the contractor sells both real property improvements and tangible personal property for one price (“lump sum contract exemption”). For information about the lump sum contract exemption, see the article titled, Septic System Installers – Taxable Items Less Than 10% of Total Contract Price.
Construction Contract Exemption
The Lump-Sum exemption has been expanded to certain construction contracts first entered into or extended, modified, or renewed on December 1, 2017 (“Construction Contract Exemption”). This article summarizes the tax treatment of the exemption changes.
The construction contract exemption applies to contracts entered into or extended, modified, or renewed on December 1, 2017, and thereafter.
Besides the name change, the expansion of the exemption provides three primary differences from the Lump-Sum exemption:
- Calculation of exemption is based on >90% of sales price of total contract related to real property construction services. NOTE: The 10% portion of products includes tangible personal property and “services” which includes both taxable and nontaxable services. No longer is the calculation based on taxable versus nontaxable items.
- The exemption applies to time and materials jobs, not just lump-sum contracts.
- The exemption can flow through a general contractor to a subcontractor (if the subcontractor is providing a contract with a mix of real and personal property work.)
Calculating the Threshold for a Construction Contract
The construction contract exemption applies if the total sales price of all “products” is less than 10 percent of the total amount of the construction contract (including change orders or additional work billed). This calculation is made without regard for any exemptions that may be provided by the customer (e.g., exempt entity, manufacturing, farming, etc.). “Products” includes tangible personal property, and items, property, and goods under sec. 77.52(1)(b), (c), and (d), Wis. Stats., and both taxable and nontaxable services. The calculation does not include real property construction activities.
Alternatively, the construction contract exemption applies if more than 90 percent of the total contract price relates to real property construction activities (including services to real property).
Important Information:
- Construction Contract Exemption tax treatment is not optional. If a construction contract meets the 90% threshold, the contractor is required to use this tax treatment.
- When determining if a contract meets the 90% threshold identify the total sales price related to real property construction activities. The customer’s manufacturing, farming, or other use-based exemptions do not affect this calculation.
- If the Construction Contract Exemption applies, a contractor will not be able to accept or apply the customer’s use exemption. Therefore, use tax will apply to purchases of equipment and materials for items customarily purchased for resale. This is out of the ordinary for contractors.
- No need to calculate the threshold for exempt entity customers. The Construction Contract Exemption has no effect on exempt entity customers. A contractor’s tax treatment is always the same with those entities. No tax on the sale to an exempt entity for which a fully completed exemption certificate claiming exempt status is obtained. Contractor may purchase materials without tax, for resale, that are physically transferred to the customer in personal property sales and services. Contractor must remit sales or use tax on materials consumed in real property unless an exemption applies (e.g., building materials exemption.)
For the “Prime Contractor”
NOTE: “Construction Contract” in sales tax law language means a contract to perform real property construction activities and to provide “products” (tangible personal property and taxable/nontaxable services).
If the total selling price of the real property construction activities of the prime contractor’s construction contract are more than 90 percent of the total contract price:
- The prime contractor’s sale to its customer is not taxable
- The prime contractor must pay sales or use tax on its purchase of products that are not consumed in real property construction activities. (Exception for exempt entity customers.)
To purchase products without tax from the subcontractor who is providing a mix of real and personal property work, the prime contractor must provide an exemption certificate to the subcontractor.
- The exemption certificate’s box for “other sales exempted by law” must be checked as the reason the purchase is exempt
- The prime contractor should write “sec. 77.54(60), Wis. Stats.” in the space provided
- If no exemption certificate is provided by the “prime contractor” to the subcontractor, the subcontractor must pay tax on its sales of taxable products and services sold to the prime contractor
- Prime contractor cannot provide an exemption certificate claiming the Construction Contract Exemption to a subcontractor that is only providing taxable services (because it is not a “construction contract.”) The prime contractor is deemed the consumer of the services of the subcontractor and must pay tax on its purchase.
- The prime contractor must pay sales or use tax on its purchase of materials and supplies relating to the real property improvements.
REMINDER: The prime contractor cannot provide resale exemption certificates to subcontractors or vendors if its contract meets the Construction Contract Exemption. The Construction Contract Exemption deems the prime contractor as the consumer of all materials and services and therefore, cannot purchase any items for resale.
For the “Subcontractor”
For the Construction Contract Exemption to apply to a subcontractor’s contract, the subcontractor’s contract must be a mixed contract containing both real and personal property sales (refer to the definition of “construction contract.”) The construction contract exemption applies if either of the following applies:
- The prime contractor provides the subcontractor with an exemption certificate claiming the exemption under sec. 77.54(60), Wis. Stats., OR
- The total selling price of the real property construction activities of the subcontractor’s construction contract (includes time and materials jobs) are more than 90 percent of the subcontractor’s total contract price.
If the construction contract exemption applies to the subcontractor’s contract:
- The subcontractor’s sale to the prime contractor is not taxable.
- The subcontractor must pay sales or use tax on its purchase of products not consumed in real property construction activities. (If end customer is exempt entity, Construction Contract Exemption does not apply. See above explanation of tax treatment.)
- The subcontractor must pay sales or use tax on its purchase of materials and supplies relating to the real property improvements.
The subcontractor is going to follow the same guidance as the Prime Contractor.
Tax Treatment if Subsequent Contract Changes Affect Applicability of Exemption
The prime contractor must decide at the start of the contract whether he/she will be claiming a resale exemption or construction contract exemption, but not both.
The resale and construction contract exemption have opposing tax treatment, so you must make a business decision at the start of a contract based on knowledge of your business and projects as to which treatment fits best.
You will use the appropriate treatment the duration of the project, until and unless such time that the threshold calculation changes. Below is an explanation of what actions may or may not be required to be taken should the threshold be crossed.
Keep in mind, for a contract (in the traditional sense of the word) change orders and subsequent iterations of the contract count as that one contract. Your total real property activities include the change orders and additions to the total contract. For a time and materials job or a maintenance contract, the entirety of the project may be the contract period, total job, an agreed upon scope, etc. and may include multiple invoices and extend over a period to include a year or more.
This is for the purpose of calculating the >90% real property threshold. Always keep a record of how you calculated your exemption and be as consistent as possible with your approach. Document so you can explain it and remember what you did.
The liability for tax depends, in part, on whether the prime contractor gives an exemption certificate for its purchases.
- If the prime contractor gives an exemption certificate claiming resale, and the contract qualifies for exemption under sec. 77.54(60), Wis. Stats., the prime contractor is liable for tax on its purchase price of the products and services purchased from the subcontractor
When a Prime Contractor originally claimed Resale:
- The change in sales price of the personal property portion of the contract goes from taxable to nontaxable.
- Prime Contractor is deemed the consumer of personal property resold as personal property sales and services under the Construction Contract Exemption. Use tax is owed on Prime Contractor’s purchases of materials and services sold as personal property (trade fixtures, personal property work, landscaping, etc.)
- Prime Contractor cannot force Subcontractors to correct subcontracts already billed or contracts already agreed to.
- If the prime contractor gives an exemption certificate claiming the exemption under sec. 77.54(60), Wis. Stats., and the contract does not qualify for the exemption, the prime contractor must collect/remit tax on the sales price of the taxable products and services sold to the customer
When a Prime Contractor claims the Construction Contract Exemption:
- Eliminates the use of resale on materials used in personal property.
- Eliminates benefits of use-based exemptions like manufacturing, farming, etc. because contractor is unable to purchase equipment and materials without tax, for resale.
- Eliminates sales tax on labor and pushes sales tax down to original purchase of materials (if exemption works out right.)
- Therefore, if tax treatment switches to resale, contractor can submit a Buyer’s Claim for Refund for sales tax it paid on materials/services that now qualify for resale. (Refund claim can only be made by individual who paid the tax, a Prime Contractor cannot claim a refund for tax paid by a Subcontractor.)
- A Prime Contractor is not required to share with its Subcontractors that tax treatment changed from Construction Contract Exemption to Resale. If the Prime Contractor corrects its tax treatment.
- A Prime Contractor may provide Resale certificate to Subcontractors; however, a Subcontractor is not required to refund tax it paid on its purchases to its Prime Contractor.
- Prime Contractor must provide additional supporting documentation to Subcontractor to prove its contract no longer meets the Construction Contract Exemption criteria. This documentation would involve sales invoices/contract information upon which the calculation was completed for the Subcontractor to be able to keep in its records for audit purposes as to the tax treatment change.
- If the subcontractor receives an exemption certificate from the prime contractor claiming resale, and the prime contractor’s contract qualifies for exemption under sec. 77.54(60), Wis. Stats., the subcontractor is not liable for tax on the purchase price of the materials sold as products and services to the prime contractor as a part of the construction contract (the liability rests with the prime contractor). The subcontractor is still liable for tax on its purchase of materials used in real property construction activities.
Exemption Certificate
When a fully completed exemption certificate claiming resale is obtained within 90 days of original sale, the seller is relieved of liability under Wisconsin law. As long as the seller maintains the exemption certificate that is signed and dated or seller can show it was received electronically – then signature is not required.
If a seller receives an exemption certificate claiming resale after 90 days of the original sale, the seller must apply good faith. This means the certificate must be fully completed (as explained above) and must also include the purchaser’s business purpose and type of items being purchased under the exemption claimed. The Department’s forms do not provide space for this information, but auditors will be very aggressive in using this to assess tax.
- If the subcontractor receives an exemption certificate from the prime contractor claiming the exemption under sec. 77.54(60), Wis. Stats., and the contract does not qualify for the exemption, the subcontractor may claim a refund on any tax paid on the purchase of materials sold as products and services to the prime contractor as a part of the construction contract. The claim for refund must substantiate that the prime contractor’s contract did not qualify for the construction contract exemption, and that the prime contractor’s purchases qualified for the resale exemption. Note: The subcontractor may not claim a refund on its purchase of materials used in real property construction activities.
Subcontractor receives a Resale Certificate from Prime Contractor:
- The Subcontractor is not required to provide a refund to the Prime Contractor, the Prime Contractor did not directly pay the tax on the materials and therefore is not entitled to a refund.
- Regarding substantiation required to file Claim for Refund, contact Holly Hoffman at holly@salestaxlady.com to discuss further if you are a Subcontractor and this situation has occurred.
“Construction contract” means a contract to perform real property construction activities and to provide products. (Note: Includes lump-sum and time and materials contracts.)
“Prime contractor” means a contractor who enters into a construction contract with an owner or lessee of real property, except for leased property under sec. 77.52(1)(c), Wis. Stats., to perform real property construction activities on the real property.
“Product” includes tangible personal property, and items, property, and goods under sec. 77.52(1)(b), (c), and (d), Wis. Stats., and services. (Note: Services includes both taxable and nontaxable services.)
“Subcontractor” means a contractor who enters into a construction contract with a prime contractor or another subcontractor. (Note: Defined for the purpose of this exemption only and “subcontractor” is limited to a subcontractor providing a mix of real and personal property work for another contractor.)
Exception for contracts entered into with entities that are exempt from tax under sec. 77.54(9a), Wis. Stats.: Taxable products and services sold by a contractor as a part of a construction contract with an exempt entity, that are not consumed in a real property construction activity may be purchased by the contractor or subcontractor without tax, for resale. However, materials and supplies that are consumed in a real property construction activity under a construction contract with any customer, including an exempt entity, may not be purchased by the contractor or subcontractor without tax unless an exemption applies (e.g., building materials exemption for contracts with exempt entities).
For more information, contact Holly Hoffman at holly@salestaxlady.com