Tennessee Court Addresses Distinction between Retail and Wholesale Sales for Security Equipment Provider

February 2, 2017

The classification of sales as retail or wholesale can sometimes impact taxes paid, as illustrated by Tennessee’s Business Tax.

By Tina Chunn, SALT senior manager

Reviewing a transaction to determine if it should be classified for tax purposes as a retail or wholesale sale is not always simple. While this analysis most often arises in the context of state sales and use taxes, there are other taxes for which this distinction can be significant. For example, the Tennessee Business Tax is essentially a gross receipts tax levied on the privilege of engaging in business in the state, similar to other states’ occupation or license taxes. [1] However, the rate of tax paid under the Business Tax is higher for businesses engaged in making retail sales versus those making wholesale sales. A recent Tennessee Court of Appeals decision addresses whether sales of security equipment to licensed alarm contractors should be treated as retail sales or wholesale sales for Business Tax purposes. [2]

In this case, the taxpayer, Security Equipment Supply, Inc. (“SES”), sells security-related electronic equipment such as burglar alarms, fire alarm systems, closed-circuit televisions cameras, access control systems and electrical wiring. Licensed alarm contractors purchase this equipment from SES and install it in homes and businesses. The contractors will then provide monitoring services for these systems after installation. SES reported its sales as wholesale sale and paid tax at a rate of three eightieths of one percent (3/80 of 1%). During an audit, the state disagreed and re-characterized the sales as retail sales subject to tax a rate of one tenth of one percent (1/10 of 1%). SES appealed an adverse decision received in a lower court.

At issue for this case is whether SES sales are properly treated as retail or wholesale sales under the Business Tax. A business is classified as a retailer or wholesaler based on its dominant business activity which provides the major and principal source of taxable gross sales of the business, and the classification determines the applicable tax rate. [3] Although the statutory definitions of “wholesale sale” and “retail sale” were amended in 2009 during the audit period (2007-2011), they remained similar. The definition of wholesale sale was changed to “any sale to a retailer for resale.” [4] The definition of “retail sale” was changed to mean “any sale other than a wholesale sale.” [5] Despite the amendments, the court noted that the distinction between retail and wholesale sales consistently remained whether or not the sales are “sales for resale,” and it looked to the regulations for further guidance as to when a sale is a “sale for resale.” [6]

In reviewing the provisions of the regulation, the Department had classified SES’s dominant business activity as retail sales based on subsection 5 which clarifies that sales made to a contractor who in the course of performing his contract installs property or uses services in a structure, as a component part thereof, are retail sales to a user or consumer and are taxable at the appropriate retail rate. However, SES argued that subsection 5 did not apply because its equipment is removable from the real property on which it is installed. SES further argues that its sales should be considered wholesale sales because it sells equipment to dealers who further process the equipment as a component part of the comprehensive product they sell to the end user as set forth in the definition of a sale for resale provided in subsection 1 of the regulation.

The court noted that subsection 4 of the regulation provides that the controlling factor for determining whether a sale is one for resale is “what the vendee does with the purchase.” SES’s customers are contractors that install the SES equipment into homes and businesses. Although subsection 5 requires the equipment be a component part of the structure upon which it is installed, it does not require that the property be permanently affixed to the realty for the sale to be classified as a retail sale. As such, the court ruled that subsection 5 was applicable and affirmed the decision of the lower court that the Department had properly classified SES’s sales as retail sales taxable at the retail rate under the Business Tax.

As each state provides varying definitions in determining whether a sale is classified as retail or wholesale sales, it is important to review the differences and how they would apply to your particular business transactions, particularly as in this case, the tax rate imposed was different for each type of sale. In the context of sales and use taxes, this distinction would determine whether or not a vendor should charge and collect tax (i.e., a retail sale) or whether he should not charge tax and collect a resale certificate (i.e., a wholesale sale).

The Aprio SALT group is experienced with sales transactions in the various states to determine if they are treated as retail or wholesale sales. We are here to assist you with any concerns you may have regarding the proper tax treatment for your specific scenario. We constantly strive to keep our clients advised of important issues and developments in state and local taxes in order to help them address their specific tax situations. We will continue to monitor these and other significant tax developments, and we will include any updates in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the January 2017 SALT Newsletter. To view the entire newsletter, click here.

[1] Tenn. Code Ann. §§ 67-4-701 to -730.

[2] Security Equipment Supply, Inc. v. Richard H. Roberts, Commissioner of Revenue, State of Tennessee, No. M2016-00423-COA-R3-CV, Tenn. Ct. Appeals, Nov. 28, 2016.

[3] Tenn. Code Ann. § 67-4-702(a)(5).

[4] Tenn. Code Ann. § 67-4-702(a)(23)(A) (current through Aug. 10, 2010). Subsequent amendments to the Business Tax did not change these definitions but did renumber the subsections such that the definition of wholesale sale is now found at Tenn. Code Ann. § 67-4-702(a)(25)(A).

[5] Tenn. Code Ann. § 67-4-702(a)(15) (current through Aug. 10, 2010). Subsequent amendments to the Business Tax did not change these definitions but did renumber the subsections such that the definition of retail sale is now found at Tenn. Code Ann. § 67-4-702(a)(16).

[6] Tenn. Comp. R. & Regs. 1320-04-05-.47.

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 this matter.

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About the Author

Tina Chunn

Tina is a senior manager with Aprio’s State & Local Tax group. She has over 24 years of experience assisting companies and their owners to minimize their tax liability and maximize their profitability. Some of the industries Tina serves include professional services, manufacturing, warehousing and distribution, telecommunications, real estate, retailers and wholesalers. Tina has extensive experience dealing with corporate tax issues, including state and local tax returns; state and federal tax credits; state and local sales; and use, income, escheat, business licenses and property tax issues.