Mississippi Department of Revenue v. Hotel and Restaurant Supply
Cause No. 2014-CA-01685-SCT (March 10, 2016)
In Mississippi Department of Revenue v. Hotel and Restaurant Supply, the Mississippi Supreme Court on Thursday, March 10, 2016, upheld the reversal of a sales tax assessment levied against a vendor who failed to collect sales taxes on construction-related materials sold to a contractor who presented the vendor with a material purchase certificate (“MPC”). The Court’s decision could have broad implications for a wide range of other sellers, and likely prohibits the Department from attempting to hold a vendor liable for its customers’ unpaid sales taxes when the vendor obtained valid exemption documents such as MPCs, direct pay permits, retail sales tax numbers, and other items that statutorily shift the tax payment responsibility from a vendor to a customer. The Court also provided important clarification on the standard of review applicable to tax appeals, but left some critical questions unanswered.
The Exemption Issue
Mississippi Code Section 27-65-21 taxes commercial construction contracts over $10,000 at a special 3.5% contractor’s rate on the entire contract amount (labor, materials, and any other costs encompassed within the contract) in lieu of the regular 7% retail sales tax rate. General contractors on those jobs are required to “qualify” most of these contracts with the Department of Revenue before beginning work, and must either prepay the anticipated tax or file a bond guaranteeing payment. Once qualified, the Department issues the contractor an MPC which entitles the contractor and its subcontractors to purchase all their component materials tax-free because the cost of those materials will be included in the total contract price subject to the special 3.5% tax rate.
In Hotel and Restaurant Supply, a commercial construction contractor presented its vendor with an MPC when purchasing certain materials. In the Department’s subsequent audit of the vendor, the Department contended that the commercial construction contractor had not used the items as component materials on the underlying project and, therefore, attempted to hold the vendor – but not the contractor – liable for not having collected the 7% retail sales tax otherwise applicable to sales of non-component items. In essence, the Department argued the vendor should have known, in advance, exactly how the contractor was going to use the particular items and to have collected the tax at the correct rate.
The Department’s position, had it been upheld, would have put all sellers in a precarious position because no matter what documentation the customer provided at the time of purchase, the vendor would in effect be responsible for auditing that customer’s ultimate use of the goods to ensure they were used in a manner justifying the exemption. Under Mississippi sales tax laws, two identical items could be used in different ways on the same project, with one becoming a component material of the final structure and the other maintaining its character as tangible personal property. That determination depends on numerous factors such as precisely how the item was installed, whether it could be removed without design or structural changes, whether it could be removed without altering or destroying the item or structure, and numerous other job-specific factors which a vendor ordinarily cannot determine either in advance or after the fact. See Miss. Admin. Code 35.IV.10.01(503); ECO Resources, Inc. v. Blount, 986 So. 2d 1052 (Miss. Ct. App. 2008), cert. denied 987 So. 2d 451 (Miss. 2008). Because the ultimate use may not occur until well after the underlying transaction, that vendor could never truly know whether it had complied with the state’s tax laws and, even once audited, would never be able to adequately verify whether the Department’s contentions were even accurate due to taxpayer confidentiality limitations.
In holding that the vendor was not liable, the Court recognized that Mississippi law expressly exempts vendors from collecting sales taxes when the purchasing contractor has registered the job for the contractor’s tax and presented the vendor with an MPC. The Court noted that “the onus of complying with the statutes is placed clearly on the contractor who obtains the material purchase certificate.” Moreover, the Department “can audit the contractor – the person with the best knowledge about how purchases were used – and have the contractor pay the correct amount.” Accordingly, it was inappropriate for the Department to seek to collect sales tax from the vendor which had been presented with an MPC.
Mississippi’s sales tax laws contain other similar instances in which a vendor is statutorily excused from collecting sales tax from a customer, including when the customer provides the seller a direct pay permit, retail sales tax number, or other exemption certificate. The Department has recently become very aggressive in auditing vendors and attempting to hold them responsible for knowing whether their customers used their items in a permissible tax-exempt manner. The Court’s decision in Hotel and Restaurant Supply should give taxpayers some level of comfort that the Department’s aggressive and unsupportable positions are unlikely to be accepted on appeal.
Standard of Review
A potentially more significant sub-issue within Hotel and Restaurant Supply was whether the chancery court should give deference to (1) the Board of Tax Appeals when the Board has reversed an action or decision of the Department of Revenue and the Department has appealed the Board’s order to the courts or to (2) the Department’s original administrative decision. Although an earlier version of Mississippi’s appeals statute, Mississippi Code Section 27-77-7, stated that the court was to defer to the Department “as it does with the decisions and interpretation of any administrative agency,” case law also suggested that the court must defer to the decision of the agency whose decision is directly before it, in this case the Board of Tax Appeals.
The chancery court recognized the inherent conflict between these requirements in that it simultaneously must defer to two conflicting actions by two independent agencies. It also recognized that if it had to defer to the Department, even when that agency had lost its case before the independent Board of Tax Appeals, the latter would essentially be a meaningless and powerless agency. Instead, the chancery court gave deference to neither agency and applied the revised statutory standard enacted in 2014 which states that “the chancery court shall give no deference to the decisions of the Board of Tax Appeals, the Board of Review or to the Department of Revenue, but shall give deference to the department’s interpretation and application of the statutes as reflected in duly enacted regulations and other officially adopted publications.” Miss. Code Section 27-77-7(5) (Supp. 2015) (emphasis added).
Avoiding this subtle but important issue for now, the Court acknowledged that even under a limited “arbitrary and capricious” standard of review, the courts always review the interpretation of a statute de novo as that is an issue of law, even though “great deference” is given to “the agency” having made that interpretation. As for the level of deference to be given and to whom it should be given, however, the Court concluded that issue was “of no moment” in the present case because the Department’s interpretation in this case was “contrary to the unambiguous terms or best reading of [the] statute.” Therefore, that interpretation was not entitled to any deference no matter which version of the appeal statute governed.
This opinion might be interpreted by some as softening the Court’s prior decision in Equifax, Inc. v. Miss. Dept. of Revenue, 125 So. 3d 36 (Miss. 2013), which was widely viewed as establishing a virtually insurmountable hurdle in challenging many of the Department’s actions. During oral arguments in Hotel and Restaurant Supply, however, the Court on its own prerogative aggressively questioned the Department about the statute’s new de novo standard and deference limitations, openly asking whether those provisions were constitutional under separation of powers considerations.
Those important questions remain unresolved at this point, but taxpayers should recognize that the validity of the new appeal statute could be questioned and potentially even invalidated in some future case. Until the Court has fully vetted and resolved those issues, taxpayers should exercise caution throughout the entire administrative and judicial appeals process, especially in cases in which the taxpayer prevailed before the Board of Tax Appeals and the Department challenged that decision in the courts.