Construction companies and contractors generally understand that the purchase and utilization of materials in construction contracts have sales tax implications. Those implications can vary from state to state and can create unexpected liabilities if not properly handled. In Indiana, the appropriate sales tax treatment depends in part upon whether the contract is a time and materials contract or a lump sum contract.
For Indiana sales tax purposes, a time and materials contract is one in which the cost of construction material and the cost of labor or other charges are stated separately. A contractor under a time and materials contract is considered a retail merchant for sales tax purposes, as he or she is deemed to be selling the materials to the customer. IC § 6-2.5-4-9. Under this structure, the contractor does not pay sales tax when purchasing construction materials that are going to be incorporated into the real property improvements or otherwise “re-sold” to the client. Therefore, the contractor should provide a “sale for resale” sales tax exemption certificate when purchasing such materials.
However, as the retail merchant, when the contractor then “sells” the materials to the customer under the time and materials contract, the contractor must collect sales tax on the cost of the materials to the customer and remit such amounts to the Indiana Department of Revenue. In other words, the sales tax is imposed on the retail price of the materials (the price to the customer), not the wholesale price paid by the contractor. If the contractor does not fulfill this role, he or she can be held liable for the tax the customer should have paid.
In contrast, a lump sum contract is a contract in which all elements of cost are included in the total contract price. The contractor under the lump sum contract is considered the “end user” and not a retail merchant reselling those materials. IC § 6-2.5-4-9; 45 IAC 2.2-4-26. Therefore, the contractor is liable for the sales tax on the construction materials at the price paid by the contractor, and the contractor must pay the sales tax at the time the materials are purchased or remit use tax at the time the construction material is converted into real property. Therefore, the form of contract has real implications from a sales tax perspective, as it impacts the amount subject to tax and who is liable to collect and remit tax. The Department of Revenue issued Information Bulletin #60, which describes the Department’s interpretation of the law regarding construction contracts.
Real life, of course, is not so straightforward. The complicating factor is that the terms of many construction contracts do not always fall neatly into the “time and materials contract” or “lump sum contract” definitions, but rather are a hybrid of the two concepts. For example, a contract may specifically contemplate the purchase of certain materials and identify those materials and the price of those materials, but also include an overall price for the entire contract. Similarly, a contract may specify time and materials but then include a “not to exceed” cap. An underlying principal is that the contractor bears the risk of loss (and opportunity for gain) with a lump sum contract, whereas that risk and opportunity shift to the customer under a time and materials contract. But contracts can be creatively drafted to allow for a sharing of that loss and benefit, thereby making the sales tax implications less clear.
The Indiana Code and guidance from the Indiana Department of Revenue do not dictate how to handle these situations. Understanding these uncertainties and drafting contracts with these issues in mind helps to minimize potential Indiana sales and use tax exposure that may arise in an audit after the project has been completed. There may also be opportunities to obtain a ruling or less formal advice from the Department of Revenue to minimize these risks.
An additional consideration is when the ultimate beneficiary of the construction contract is exempt from Indiana sales tax. Whether the customer is a governmental entity, tax-exempt organization, or is otherwise exempt from Indiana sales tax, if the customer can produce a valid sales tax exemption certificate, this impacts the application of sales tax on the construction contracts. If such an exemption certificate is provided, for both time and materials contracts and lump sum contracts, the contractor does not need to pay sales tax when purchasing the construction materials or collect the tax from the customer so long as the proper processes are followed by the contractor to utilize the sales tax exemption. 45 IAC 2.2-4-22(b). However, even if there is a valid sales tax exemption for the project, the exemption only covers the materials and equipment that are incorporated into the project. The Department of Revenue has specifically provided that tools and equipment a contractor purchases and uses on the project, but are not incorporated into the project, do not qualify for sales tax exemption. 45 IAC 2.2-4-26.
This is an area of the law that trips up many taxpayers. For construction projects in Indiana, or construction materials purchased in Indiana, it is critical to understand these distinctions in Indiana sales tax treatment in drafting contracts, purchasing materials, and invoicing clients. The devil is in the details.
Mark Richards and Matthew Ehinger are attorneys with Ice Miller LLP. Richards has practiced federal and state tax law for over 30 years, and has experience in resolving tax controversies; Ehinger concentrates his practice on state and local tax planning, compliance and controversy.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.