Sales and use taxes: The neglected step-child of federal income tax

For those involved in building transmission lines, taxes on revenue and cost of goods sold can together amount to more than the net income subject to federal income taxation, according to Gerard Quinlan, principal with Ryan, a North American tax services firm. 

Sales tax on equipment and electricity can be overlooked, he said at TransmissionHub’s TransForum Texas conference on April 26.

“The sales tax is the somewhat forgotten-about tax that in your business in the electricity and construction world can be on your revenue and on cost of goods sold, which are two numbers that by a very large number are much bigger than your net income for federal income tax purposes,” Quinlan said. “[S]ales and use tax is very important in your line of business because of your spend levels. Also, the sale of electricity is obviously a high revenue ticket.”

Communication between engineers, project planners, budget cost controllers and tax professionals is necessary not only to understand what items may be tax-exempt, but to be as prepared as possible in the event of a state comptroller’s audit, he said.

“It’s very important that procurement, project planning, cost control, engineers, and tax [people] talk about understanding the documentation requirements that are going to be necessary to defend that audit,” he said.

To begin with, a contract with an engineering, procurement and construction supplier should contain a paragraph stating that it is for sales and use tax purposes and specifying whether it is a lump-sum or cost-plus or “separated” contract, Quinlan said.

“In four to five years from now, the comptroller will look at the contract and try to turn the contract into a contract type that creates a tax liability position for them to assess tax,” Quinlan said, adding that indemnification clauses bring little to bear on the matter.

It is also important to keep in mind tax rates, he said. In Texas, the idiosyncrasies of local tax rates can be somewhat esoteric and difficult to navigate, he said. The state tax rate is 6.25%, but local counties and jurisdictions can levy up to 2% more on top of that. Therefore, taking into consideration where purchases are made or received could save a company 2% on all taxable materials over the life of a project, he said.

“It’s a pretty simple process to shift that tax but 6.25% versus 8.25% on ‘x’ million dollars is a meaningful number,” Quinlan said. 

Texas is also complicated around the taxation of services, Quinlan said. There are 17 services subject to tax, one of which is real property services, including tree-trimming services. However, tree-trimming services around utility poles are nontaxable because they are for non-aesthetic purposes, he said.

“It’s complex around these services and it’s important that engineering, budgeting, planning, cost and tax organizations talk so you understand what’s taxable in these 17 services,” Quinlan said. He added that understanding these services is also relevant to the type of EPC contract chosen. In a lump-sum contract scenario, if the seller of materials is the conduit for collecting tax, he will likely over-collect, in the event that he may not be able to recover losses from the purchaser in the event that he has under-collected on tax.

“So be wary … that when you’re paying tax to your suppliers you may be overpaying,” Quinlan said, adding that “there are a lot of strategies around the 17 services.”

The biggest exemption for tangible property is for manufacturing, he said. If the transmission and distribution facility is part of an integrated utility, the step-up transformer is exempt but the poles and conductor cables are taxable, for example, he said.

In the deregulated world, a transmission and distribution company has different rules and regulations around it, regarding the sale of electricity. If a T&D company is selling electricity to a customer, then the comptroller classifies it as a service, and does not grant an exemption on the step-down of current, he said. 

However, if a company is selling electricity to a retail electric provider for resale, the manufacturing exemption should apply. However, Quinlan said, “I’ve seen the comptroller flip-flop on this.”

Under contention today is whether the conductors and equipment used to transport electricity should be considered taxable, Quinlan said. Under current law, they are.

“We contend that the conductor is exempt equipment even today,” Quinlan said. He added that there is a case on the matter which will take “a couple of years” to resolve.


About Rosy Lum 525 Articles
Rosy Lum, Analyst for TransmissionHub, has been covering the U.S. energy industry since 2007. She began her career in energy journalism at SNL Financial, for which she established a New York news desk. She covered topics ranging from energy finance and renewable policies and incentives, to master limited partnerships and ETFs. Thereafter, she honed her energy and utility focus at the Financial Times' dealReporter, where she covered and broke oil and gas and utility mergers and acquisitions.