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There are certain exceptions to the application or non-application of taxes on a transaction in the United States. What are these exceptions?
Retail sales of tangible personal property are generally taxable for U.S. sales and use tax purposes. However, even if a sale constitutes a retail sale, the transaction may be exempt for various reasons.
Exemptions vary from state to state and are, in some cases, based on criteria relating to the region’s economy. It is important to note that coordinating exemptions between several states can be complex due to variations in tax rules and taxation criteria.
Three situations where tax exemption is possible
Depending on the nature of the goods
In principle, there are three situations where tax is not applicable, the first being exemptions due to the nature of the goods. These transactions are not taxable per se and do not require any special documentation once it has been established that the object of the sale is a good or service that is not taxable.
For example, some states will not tax food products, while others will not tax medical products or certain types of clothing.
Depending on the buyer’s status
The second category includes exemptions linked to the buyer’s status. For example, churches, governments and certain charitable or educational organizations may be exempt from paying tax. In such cases, the seller must retain proof of its customer’s status under which the exemption applies.
It should be noted that some of these exemptions may be transferred to the exempt customer’s supplier. The rules vary from state to state.
Certain exemptions are based both on the buyer’s status and the nature of the transaction. In some cases, companies may benefit from temporary or specific exemptions for particular projects taking place in one or more States.
This could include exemptions for construction projects, temporary events or other specific activities that occur in one or more jurisdictions. For example, a company may obtain an exemption for a specific construction project or for a trade fair. Once the event is over, the exemption automatically expires.
Depending on the use of the good or service
Lastly, the third category includes various exemptions related to the buyer’s use of the property. These exemptions ensure that only the retail buyer, i.e., the consumer of the taxable good or service, will be liable to pay sales tax and that intermediaries will not have to pay additional taxes, which would result in double taxation.
For example, retailers will not pay tax on their stocks, but will pay tax on their counters and the goods used to promote them. The service provider will pay tax on its inputs, but will not have to charge tax on its services.
Most frequent exemptions
Exemption from sale for resale
By default, sales of tangible personal property are taxable. However, sales for resale are exempt in all states on the express condition that the supplier has the documentation justifying this exemption.
The resale exemption is the best-known retail sales tax exemption. Resale exemptions apply to goods acquired for resale in the same condition and may extend to goods used to become an integral part of a good to be resold. In general, if the property acquired for resale is ultimately used by the retailer, then the retailer will have to pay tax on that property.
Resale exemption certificates are used by resellers to purchase goods for resale without paying sales tax.
Some businesses are granted a direct payment permit by the State, which means that their suppliers do not have to charge them tax. These businesses will then have to pay the tax themselves when filing their tax returns for the period including when they consume or use taxable goods.
Exemption for manufacturing equipment
Manufacturing exemptions play an essential role in supporting the manufacturing sector by alleviating the tax burden associated with goods and services used in the process of manufacturing goods that will be resold.
In some cases, manufacturing exemptions may be partial rather than total. This means that specific goods or services will be taxable, but at a reduced rate. Rates and criteria may vary, adding to the complexity of the process.
Manufacturing exemptions are often linked to the specific use of goods and services in the manufacturing process. This means that in order to benefit from the exemption, the goods must be used directly in the production, processing or assembly stages. This exemption can cover both manufacturing equipment and components of the good that is produced and will be resold.
Goods that are not used directly and exclusively in the manufacturing process may not qualify for exemption. Determining when the manufacturing process begins and ends varies from state to state. These variations concern, for example, equipment used in research and development, packaging equipment, equipment used to move parts or goods during the process, and equipment linked to environmental or safety requirements.
Manufacturing exemptions can vary in terms of the parts and components used in manufacture. Sometimes, only parts and components that become an integral part of the final product benefit from the exemption, while parts used for the maintenance or repair of existing equipment are excluded.
Manufacturing exemptions often come with strict documentation requirements. Companies must be able to document that goods and services are used in accordance with the exemption criteria. This may include keeping accurate records, retaining invoices and receipts and preparing appropriate returns.
Exemptions for use in several states
Some states grant exemptions that apply to goods or services used in more than one jurisdiction. These exemptions generally apply to software in situations where, for example, an entity signs a contract with a software supplier for several licenses. The licenses are managed by the head office located in one state, but will be used by company employees in several states.
In such cases, some states allow the buyer (i.e., the head office) to provide a certificate of exemption for use in several states to its supplier so that the latter does not collect tax on the transaction; it will then be up to the buyer to pay the tax itself in the various states where the licenses will be used.
Documentation
Sellers who have an economic nexus in a state are responsible for collecting and remitting tax on its taxable supplies and, in the event of failure to do so, may have to pay the tax with penalties and interest. The burden of proof that the transaction is exempt, if applicable, therefore lies with the seller. If in doubt, sellers should generally collect the tax and buyers should request a refund from the tax authorities.
Each state has its own rules concerning exemption certificates and their renewal. Some jurisdictions require additional information when renewing, while others simply ask for confirmation that the information is still valid. It is essential to consult the local tax authorities for precise information on renewal requirements in each state, as validity periods vary from state to state.
It is important to regularly check the validity of the exemption certificates you hold. The rules are subject to change and it is possible that some states may require information to be updated or renewed. Additionally, changes in certain companies’ activities or structure may have an impact on their exemption eligibility.
Furthermore, it should be noted that some states do not allow sellers who are registered or required to be registered to simply receive a completed exemption certificate and rely on it to be relieved of their obligations if the sale is otherwise taxable. Indeed, these states will require sellers to be aware of the rules applicable in the state where they are doing business and to know whether the exemption actually applies depending on the particular goods being sold and the context. For example, some states may require sellers to pay tax on the supply of goods that are not subject to exemption, even if they have an exemption certificate duly completed and signed by the buyer.
When expanding into the US, it is important to understand the intricacies of the various exemptions and to ensure that you meet the eligibility criteria and documentation requirements. A thorough understanding of these limitations can help companies avoid costly mistakes and maximize tax benefits while maintaining full compliance with ever-changing regulations.