Arizona’s transactions privilege tax (“TPT”) system changed drastically in 2015, a product of legislation enacted over the last several years. This legislation was intended to reform and simplify the TPT system, but the results have been mixed.
The new TPT system affects the construction industry in particular. The following discussion sets forth the principal changes to the TPT system.
Delayed Administrative Simplification
The goal of TPT reform was to make the Arizona Department of Revenue (“ADOR”) the central point for licensing, collection, and administration of the TPT system, utilizing an “online portal.” This goal, however, has yet to be met because of technical problems with the online portal. ADOR recently announced that the online portal would not be ready for tax year 2016.
Consequently, businesses should continue preparing and filing separate municipal tax returns and remitting TPT directly to municipalities. Businesses should also renew their state TPT license with ADOR and their municipal TPT licenses with the appropriate city.
All Projects Are Not Taxed Equally
Before 2015, virtually all construction activity was taxed as prime contracting, with contractors paying TPT on 65% of their gross receipts and purchasing materials free of retail TPT. Now, the law excludes a class of projects known as “service contracting” from prime contracting TPT. Contractors must instead pay an amount equal to retail TPT on materials used in service contracting projects.
A project qualifies for the service contracting exclusion if (1) the construction contract is between the owner (or a lessee or management agent) and the contractor and (2) the project is for the maintenance, repair, replacement, or alteration of existing property. “Maintenance” is “the upkeep of property or equipment,” such as restaining a wood deck. A “repair” activity “returns real property to a usable state from a partial or total state of inoperability or nonfunctionality,” such as clearing a blocked pipe or readjusting a satellite dish. A “replacement” activity is the “removal from service of one component or system of existing property . . . and the installation of a new component or system . . . that provides the same, similar or upgraded design or functionality.”
An “alteration” is an “activity or action that causes a direct physical change to existing property” and falls within certain thresholds. For residential property, a project is an alteration if the contract price is 25% or less of the property’s full cash value, as computed by the county assessor. For commercial property, a project is an alteration if (1) the contract price is $750,000 or less, (2) the scope of work directly relates to 40% or less of existing square footage, and (3) the scope of work expands the existing square footage that is 10% or less of the pre-existing square footage.
New Rules For Exemption Forms
Before 2015, businesses purchased materials free of retail TPT for incorporation into construction projects by presenting ADOR Form 5000 to their suppliers. General contractors also issued ADOR Form 5005 to their subcontractors to establish the general contractor’s responsibility for remitting prime contracting TPT.
Now, businesses may continue to purchase materials free of retail TPT if they (1) hold a current TPT license and (2) submit a current Form 5000, whether or not the project is classified as prime contracting or service contracting. General contractors must continue to issue Form 5005 to TPT-licensed subcontractors that perform work on prime contracting projects. For service contracting projects, general contractors may, but need not, issue Form 5005 to their TPT-licensed subcontractors. Doing so makes the general contractor responsible for remitting retail TPT on materials purchased by its subcontractors, but gives the general contractor additional rights in the event of an audit.
ADOR issued new templates for Forms 5000 and 5005 in 2015. Going forward, businesses should issue updated exemption forms using these new templates.
ADOR also created new forms for use in specific circumstances. Certain health care entities must use new Form 5000HC to establish that they are exempt from prime contracting TPT and retail TPT. Contractors who seek to purchase materials free of retail TPT for certain service contracting projects must use new Form 5000M. Finally, if a contractor on a prime contracting project retains a subcontractor that does not hold a TPT license, the unlicensed subcontractor may not purchase materials free of retail TPT unless ADOR has issued a Form 5009-L exemption certificate for that particular project.
What Does the Future Hold?
The law governing the new TPT system will certainly continue to evolve, whether as a product of new legislation or new guidance issued by ADOR. And as with any tax law, the new TPT system includes many special rules and traps for the unwary. Please contact us if you have specific questions about how the new TPT system affects you or your business.
DISCLAIMER: The information in this article is of a general nature only and does not constitute legal advice. You should contact an attorney or tax professional to obtain advice with respect to any particular issue or problem.