Taxpayer’s Invoicing Methodology Leads to Alabama Sales Tax Exposure

February 26, 2019

In cases where a business is selling both taxable goods and non-taxable services, sales tax may be due on the entire charge unless the business maintains appropriate documentation showing the separate prices for each.

When determining how to invoice sales for both goods and services, there may be times that, for business reasons, a seller charges one price as opposed to separately stating the price for the goods and the price for the services.  Regardless of the methodology chosen, it is important to understand the sales tax consequences, since an invoice that charges one price for all items/services sold – in the sales tax world, this is referred to as a “bundled transaction” – can be subject to different sales tax rules than an invoice that separately states a price for each item/service. This was the issue addressed in a recent Alabama Tax Tribunal opinion ruling that the taxpayer was liable for additional sales tax.[1]

In that case, the taxpayer made retail sales of hearing aids and also provided both pre- and post-sale services to its customers related to the purchase of those hearing aids. The taxpayer did not separately state the different transactions on its invoices; rather, it charged one amount for everything. The taxpayer collected sales tax on the “price” associated with the hearing aids and pre-sale services, but it did not collect sales tax on the “price” associated with its post-sale services (i.e., adjustment, maintenance, repair, etc.). Alabama audited the taxpayer and determined it owed sales tax on the full purchase price of the products/services.

Alabama’s code states that gross proceeds of sales includes “the sale of tangible personal property [including] the cost of materials used, labor, or service costs. . . .”[2] Further, Alabama’s regulations state that “sales tax is due on labor or service charges, whether included in the total price of a product or billed a separate item, if the labor or service is incurred incidental to preparing the product for sale and is performed before the sale is closed.”[3]

The taxpayer argued that Alabama was incorrectly assessing sales tax on the post-sale, non-taxable services.  The taxpayer did not dispute the fact that it did not separately list charges for the non-taxable services on its invoices. Instead, the taxpayer’s owner testified that it computed sales tax based on the cost of the hearing aids and all pre-sale service charges plus 10 percent mark-up, and that the rest of the invoice amount constituted post-sale, non-taxable services.  Alabama argued that the post-sale services were subject to sales tax because they were not separately stated on the invoices, making the entire purchase price subject to sales tax as a bundled transaction.

The Tax Tribunal reviewed the taxpayer’s documents (i.e., invoices and other pieces of evidence that would allow the Tribunal insight as to how the taxpayer was billing its customers) and concluded that it could not determine what portion of the charges were for the non-taxable services. Interesting, the Tribunal Judge stated that she believed that the taxpayer’s owner testified honestly.  However, the law requires that a taxpayer keep books and records from which the tax liability can be correctly ascertained.  Since the documents presented in this case did not allow the Tribunal to determine that amount of the purchase price attributable to the post-sale, non-taxable service, it concluded that the assessment was correct, and that the taxpayer must remit sales tax on the entire sales price charged.

This case highlights the importance of understanding a state’s sales tax requirements when dealing with bundled transactions, in terms of both how those transactions will be taxed as well as any documentation required to support that tax treatment.  Aprio’s SALT team has the technical expertise and experience in sales tax to assist your business with understanding the potential sales tax implications of its transactions.  Our guidance will ensure that your company remains in compliance with its sales tax obligations and does not incur unexpected liabilities and penalties.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact  Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at [email protected] for more information.

This article was featured in the February 2019 SALT Newsletter.

[1] Southern Hearing Assoc. v. State of Alabama Dep’t of Revenue, Docket No. S. 16-310-CE, Alabama Tax Tribunal, Jan. 14, 2019.

[2] Ala. Code § 40-23-1(a)(6).

[3] Ala. Reg. 810-6-1-.84(2).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.