When a Kansas customer orders a custom-fabricated article billed in progress payments, when and on what amount does Kansas sales tax apply?

Plain-English summary

A company contracted with a third party to fabricate a piece of taxable equipment and ship it to Kansas, paying in progress installments (engineering drawings, ordering materials, receiving materials, completing manufacturing, and shipment). It asked when Kansas sales tax applies.

The Department explained that a business that produces a custom article to a customer's special order is a retailer, and the retail sale occurs when the finished article is delivered to and accepted by the customer. At that point the fabricator must charge Kansas state and local sales tax on the full "sales or selling price" — the total amount charged, including all fabrication, material, design, insurance, profit, travel, and other overhead costs, plus any shipping or delivery charges. None of those costs may be deducted or broken out as a separate untaxed line item (K.S.A. 2004 Supp. 79-3602(ll)). Local tax is sourced to where the buyer takes delivery.

Crucially, the progress billings are not taxable as they are billed. Because the retail sale of a fabricated article does not happen until the completed article is shipped and accepted, none of the interim progress payments are taxed; the entire amount is taxed only when the article ships. The Department contrasted this with construction services, where progress billings are taxable at the time they are billed (K.A.R. 92-19-3a(f)(2); Kansas Revenue Ruling No. 19-2010-05). The fabrication rule commonly applies to photographers, sign makers, tailors, sheet metal fabricators, and taxidermists (Kansas guideline EDU-27).

What this means for you

Fabricators and custom manufacturers

Treat yourself as a retailer. Charge sales tax on the entire price of the finished article when the customer takes delivery — you cannot deduct your material, labor, design, or overhead costs, and shipping charges you bill are part of the taxable base. Do not collect tax on progress payments; the taxable event is delivery and acceptance of the completed article.

Buyers of custom-fabricated goods

Expect sales or use tax on the full delivered price of the article, including shipping, when it is delivered and accepted in Kansas — not spread across your progress payments.

Construction contractors (contrast)

The fabrication rule is the opposite of the construction rule: taxable construction-service progress billings are due when billed, not deferred to project completion.

Tax professionals

Watch the line between fabricating tangible personal property (taxed as a TPP sale at delivery) and performing taxable services on real property (taxed as billed). The "no deductions from selling price" rule of K.S.A. 79-3602(ll) means the entire charge is the tax base.

Common questions

Q: When does Kansas sales tax apply to a custom-fabricated article?
A: When the finished article is delivered to and accepted by the buyer, on the full selling price — not as progress payments are billed.

Q: Can a fabricator deduct material or labor costs from the taxable amount?
A: No. K.S.A. 79-3602(ll) prohibits deducting any costs or expenses, and shipping charges are also taxable.

Q: Are the progress payments taxed as I pay them?
A: No, for a fabricated article — the whole amount is taxed when the completed article ships. Construction-service progress billings, by contrast, are taxable when billed.

Q: Does this opinion bind the Department?
A: An Opinion Letter is general guidance without the force of law; another taxpayer with different facts should not assume the same result.

Citations and references

• K.S.A. 2004 Supp. 79-3602(ll) — definition of "sales or selling price" (no deduction for costs or expenses)
• K.A.R. 92-19-3a(f)(2) — accrual reporting of taxable construction services (progress billings taxable when billed)
• Kansas EDU-27, Sales Tax Guidelines for Fabricators
• Kansas Revenue Ruling No. 19-2010-05 (cited on construction progress billing)

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: O-2014-001

Original ruling text

Opinion Letter

Body:

Office of Policy & Research

April 22, 2014

XXXXX
XXXXX
XXXXX

RE: Your e-mail received on April 16, 2014

Dear XXXX:

Your company has contracted with a third party to fabricate a piece of taxable equipment and ship it to Kansas for use here. Your company will bill the customer for fabricated article according to the following progress-billing agreement:

15% - Engineering drawings are completed
20% -Ordering of major materials
35% -Receipt of major materials
20% -Completion of manufacturing
10% - Shipment

Taxation of businesses that fabricate articles for third parties is discussed in EDU-27, Sales Tax Guidelines for Fabricators. It instructs:

A business that produces an article of tangible personal property to the special order of a customer is a retailer. When a business fabricates an article for a customer, a retail sale takes place when the fabricated article is delivered to and accepted by the customer. When the article is delivered to a buyer in Kansas, the fabricator is required to collect state and local Kansas sales or use tax on the "sales or selling price" of the fabricated article. This is the total amount charged to the buyer by the fabricator, including any shipping or delivery charges. Local tax is sitused to the location of delivery.

The statutory definition of "sales or selling price" prohibits a fabricator from deducting any costs or expenses from the tax base of its retail sales. K.S.A. 2004 Supp. 79-3602(ll). Nondeductible costs and expenses include the fabricator's production and fabrication costs, material costs, design costs, insurance, licenses, profit, travel expenses, meal expenses, mileage, and all other overhead expenses. These expenses may not be: (A) deducted from the selling price; (B) stated as a separate, untaxed line-item charge on the customer billing; or (C) contracted for separately with the buyer when the expenses are an integral part of the article's design, fabrication, and sale. This means that sales tax applies to the total amount charged for a fabricated article, including shipping or delivery charges. Taxable retail sales include those where the custom-made article is fabricated from materials furnished by the customer. (Underlining added).

This rule is most commonly applied to businesses such as photographers, sign makers, tailors and seamstresses, sheet metal fabricators, and taxidermists. See EDU-27, Sales Tax Guidelines for Fabricators; see also 68 Am.Jur.2d 130, Sales and Use Taxes, Sec. 85. Services rendered by or to printers, publishers, photographers, and artists. (1973). This approach for taxing fabricated goods simplifies sourcing for the fabricator, since the customer charges are taxed and sourced as the sale of tangible personal property. In general, sales of the fabricated article are sourced to the place where the buyer takes delivery of the article.

This treatment also shows the sale of a article that the buyer contracts to be fabricated is subject to Kansas sales or use tax only after fabrication of the article is complete and the buyer has accepted delivery. According, none of the charges you list as agreed upon progress billings are taxable until the fabricates article is shipped to the buyer. At that time, the buyer should be billed Kansas sales tax on the entire amount that you bill, including any shipping charges that you bill to the buyer. This approach is reasonable from a taxing perspective since the fabricated article is not even in existence until after 70% of the progress-billing payments have been made.

Please note that progress billing for construction projects are taxable at the time they are billed. If a contractor reports sales tax on the accrual basis, it must report the taxable services it performed during the period covered by a progress-billing statement on the return it files for the sales tax reporting period in which it recognizes the charges on its progress-billing statement in its books and records as earned. K.A.R. 92-19-3a(f)(2); see also Kansas Department of Revenue, Revenue Ruling No. 19-2010-05, September 9, 2010.

Progress payments for construction services are treated as charges and payments for services rendered. This is not the case when fabricated articles are sold at retail, since these sales do not occur until the buyer accepts deliver of the fabricated article.

Sincerely,

Thomas E. Hatten

Date Composed: 04/22/2014 Date Modified: 04/22/2014

Table 1

| Letter Number: | O-2014-001 |

Table 2

| Tax Type: | Kansas Retailers' Sales Tax |
| Brief Description: | Sales taxation of businesses that fabricate articles for third parties. |
| Keywords: | |
| Approval Date: | 04/22/2014 |