Technocom Business Systems Inc. v. North Carolina Dep’t of Revenue; No. COA11-655 (NCAPP 2/21/2012). Taxpayer sold and leased equipment. It also serviced the equipment sold and leased and charged customers for the maintenance service. It also bought property to use in performing its service agreements. It did not pay use tax on the purchases of that property. A final determination was made that taxpayer owed use tax on its purchases of such property. Taxpayer also erroneously collected sales tax on the charges for its maintenance agreements, which were services and not taxable sales of property. A final determination was made that such maintenance agreement charges were not subject to sales tax.
The issue in the case was whether the taxpayer was precluded from crediting the sales tax erroneously collected against the use tax liability by NCGS 105-164.11, which then stated: “When tax is collected for any period on exempt or nontaxable sales the tax erroneously collected shall be remitted to the Secretary and no refund shall be made to a taxpayer unless the purchaser has received credit for or has been refunded the amount of tax erroneously charged.”
The court held that this limiting rule did not apply because the tax erroneously collect was not collected on a nontaxable sale but rather on a use. This is such an astounding holding that it is worthwhile to quote the pertinent portion of the opinion:
In its February 2010 Final Agency Decision, the Department concluded that the optional maintenance agreements at issue constituted a taxable use of tangible personal property within the meaning of N.C.G.S. § 105-164.3(49) and not a sale. Accordingly, the Department held that the agreements were subject to use taxes and not sales taxes. Therefore, N.C.G.S. § 105-164.11 does not apply. We hold that the general provision in N.C.G.S. § 105-164.41 governs the outcome, entitling Technocom to a credit against the sales tax paid to the Department during the audit period.
Presumably what the court meant to say was that the taxpayer charged its customer for a service, which was not a “sale” as that term was then defined to exclude services from sale taxation. It was not that the service was a use so far as the customer was concerned, but that it was not a “nontaxable sale” because it was not a sale at all.
The ruling is, of course a great result for the taxpayer. The taxpayer was allowed to credit against its own tax liability erroneous collections from unsuspecting customers who are now out the “sales taxes” that they paid on transactions that were not taxable sales, indeed they were “nontaxable sales”; and yet the statute that would have required this taxpayer to refund the taxes to customers did not apply.
That leaves the question what is a “nontaxable sale” if it is not an exempt sale (which it is not, because exempt sales were separately referenced in the statute). Fortunately, the issue is of less significance going forward because the General Assembly amended GS 105-164.11 in 2011 to provide:
If the Secretary determines that a seller who overcollected sales tax on a transaction is instead liable for a use tax on a related transaction, the Secretary may allow the seller to offset the use tax liability with the overcollected sales tax. The Secretary shall not allow an offset if the seller has elected to receive a refund of the overcollected tax under subdivision (1) of this subsection. The decision by a seller to receive an offset of tax liability rather than a refund of the overcollected tax does not affect the liability of the seller to the purchaser for the overcollected tax.
This means that in a case like the Technocom case in the future the vendor can use taxes paid by others to pay its own use tax rather than having to refund those erroneous collections to its customers and pay its own use tax. The new statute does preserve to customers some rights to sue the vendor for the erroneously collected tax, but subject to significant limitations. Of course the most significant limitation in a case like Technocom’s is that no individual customer would have enough at state to pursue the refund.
This is the second time the DOR has recently lost an attempt to enforce the rule that had been thought to require that a vendor making erroneous sales tax collections must refund the tax to the customers before obtaining a refund or credit. See Cape Hatteras Elec. Mbrshp. Corp. v. Lay, 708 S.E.2d 399 (NC App. 2011).