Can an out-of-state contractor get a Kansas direct pay permit for its construction contracts, and how is the tax base figured?

Plain-English summary

An out-of-state contractor that subcontracts its installation and maintenance work to Kansas contractors asked for a direct pay permit, hoping it would simplify accounting for Kansas sales tax under the contractor rules of K.A.R. 92-19-66b.

A direct pay permit cannot be used for construction contracts. The Department pointed to Notice 98-02, whose subsection (f)(2) provides that "[a] holder of a direct pay permit shall not use their direct pay authority to claim exemption: . . . (3) in connection with construction contracts." Accordingly, the out-of-state contractor could not be granted a direct pay permit, and even if it held one for activities like manufacturing or interstate warehousing, it "would not be allowed to use the authority to account for its construction contracts." A direct pay permit would not solve the problem.

The Department then explained the correct tax base under K.A.R. 92-19-66b. The regulation "explains how contractors should establish the tax base for their labor services charges when they perform taxable services in Kansas," and "does not apply when [the contractor] or any other general contractor does not perform labor services in Kansas."

• When the contractor performs taxable services in Kansas: it collects tax from its Kansas customers "on the difference between the contract amount and the tax paid materials and tax paid subcontractor charges."
• When the contractor performs no taxable services in Kansas and subcontracts out all its labor: it "must pay sales tax to its Kansas subcontractors," owes "[n]o addition[al] tax" on those charges, and must "collect sales tax on the equipment and materials that [it] provides under the contract, unless [it] paid tax when it purchased the equipment and materials for the project."

Bottom line: the accounting fix the contractor wanted (a direct pay permit) is unavailable for construction contracts; the contractor must instead apply the 92-19-66b tax-base rules, which turn on whether it performs taxable labor services in Kansas.

What this means for you

A direct pay permit is not a construction workaround

Direct pay authority lets a permit holder buy without tax and self-assess later, but it is expressly off-limits "in connection with construction contracts." A contractor cannot use it to smooth over the accounting for construction jobs, even if it qualifies for direct pay on unrelated activities like manufacturing or warehousing.

The tax base depends on where the taxable labor happens

K.A.R. 92-19-66b governs a contractor's labor-service tax base only when it performs taxable services in Kansas. If a general contractor performs no labor services in Kansas and subcontracts all of it, the regulation's difference-based formula does not apply to it.

Performing taxable services in Kansas

Where the contractor does perform taxable services here, it charges tax on the contract price reduced by tax-paid materials and tax-paid subcontractor charges — not on the full contract amount billed to the customer.

Subcontracting all labor to Kansas subcontractors

Where the contractor performs no taxable Kansas services and hands all labor to Kansas subcontractors, it pays sales tax to those subcontractors (no additional tax on those charges) and collects tax on the equipment and materials it supplies, unless it already paid tax when buying them. Charges rebilled for subcontractor installation include the tax the contractor already paid to the subcontractors.

Common questions

Q: Can an out-of-state contractor get a Kansas direct pay permit?
A: Not for construction contracts. A direct pay permit may not be used to claim exemption in connection with construction contracts, so it would not help an out-of-state contractor account for that work.

Q: If a contractor performs taxable services in Kansas, what is the tax base?
A: The difference between the total contract amount and the sum of its tax-paid materials and tax-paid subcontractor charges.

Q: What if the contractor subcontracts all of its Kansas labor and performs no taxable services here?
A: It pays sales tax to its Kansas subcontractors, owes no additional tax on those charges, and collects tax on the equipment and materials it provides unless it already paid tax on them.

Q: Does having a direct pay permit for manufacturing change the construction answer?
A: No. Even a permit issued for manufacturing or interstate warehousing cannot be used to account for construction contracts.

Citations and references

• K.A.R. 92-19-66b — explains how contractors establish the tax base for their labor-service charges when they perform taxable services in Kansas; it does not apply when a general contractor performs no labor services in Kansas.
• Notice 98-02 — Department notice on direct pay permits; subsection (f)(2) provides that a direct pay permit holder may not use the authority to claim exemption in connection with construction contracts.
• K.A.R. 92-19-59 — the regulation authorizing private letter rulings; this ruling was issued under it and binds the Department only as to the requesting taxpayer.

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: P-1998-222

Original ruling text

Private Letter Ruling

Body:

Office of Policy & Research

December 18, 1998

XXXXXX
XXXXXX
XXXXXX

RE: Your letter dated November 23, 1998

Dear XXXX:

I have been asked to respond to your letter that we received late last month. In it, you request direct pay authority for your company. You describe XXXX as “an out of state contractor” that subcontracts its installation and maintenance contracts to Kansas contractors. You indicate that K.A.R. 92-19-66b makes it difficult for XXXX’s automated billing system to properly account for Kansas sales tax and ask for direct pay authority in hopes that this authority will overcome your accounting difficulties.

I have enclosed a copy of Notice 98-02 for your review. Subsection (f)(2) states: “A holder of a direct pay permit shall not use their direct pay authority to claim exemption: . . . (3) in connection with construction contracts.” Accordingly, XXXX cannot be granted a direct pay permit since it is “an out of state contractor.” Even if XXXX were granted such authority to cover activities such as manufacturing or interstate warehousing, it would not be allowed to use the authority to account for its construction contracts. Therefore, granting XXXX direct pay authority would not solve your problem.

In reviewing your letter, it appears that XXXX may be misconstruing Kansas law and thereby making its collection and reporting duties more difficult than necessary. K.A.R. 92-19-66b explains how contractors should establish the tax base for their labor services charges when they perform taxable services in Kansas. This regulation does not apply when XXXX or any other general contractor does not perform labor services in Kansas.

When the regulation applies because XXXX performs services here, XXXX is required to collect sales tax from its Kansas customers on the difference between the contract amount and the tax paid materials and tax paid subcontractor charges. This sales tax amount should then be remitted to the state. This means that when XXXX engages in a taxable contracts, XXXX should not charge its Kansas customers sales tax on the total amount that XXXX bills to them. As noted, the correct tax base for such contracts is the difference between the total contract amount and the sum of the subcontractor payments and payments for materials, both of which should include payment of tax.

If XXXX does not perform taxable services in Kansas on a contract but subcontracts out all of its labor services, XXXX should not follow K.A.R. 92-19-66b to determine the amount to charge to customers. On such jobs, XXXX must pay sales tax to its Kansas subcontractors. No addition tax would be due on these charges. XXXX would be required to collect sales tax on the equipment and materials that is provides under the contract, unless XXXX paid tax when it purchased the equipment and materials for the project. XXXX collection of tax on these jobs would be similar to the way it collects tax in states that do not charge tax on labor services. The one exception would be that charges that are rebilled for installation by subcontractors would include sales tax that XXXX paid to the subcontractors.

The following table sets forth the appropriate tax base for XXXX’s billings.

WHEN XXXX DOES NOT PERFORM TAXABLE SERVICES IN KANSAS

· If XXXX pays Kansas taxes on its materials and supplies and pays sales tax to its Kansas subcontractors, the appropriate taxes have been paid. Customers should not be charged additional sales tax.
· If XXXX (1) buys materials and supplies tax exempt or manufactures its own materials and supplies and (2) pays sales tax to its Kansas subcontractors, the appropriate tax base is the amount charged to the customer for the materials and supplies. XXXX should charge tax to its customers on this amount and remit it to the state of Kansas.

WHEN XXXX PERFORMS TAXABLE SERVICES IN KANSAS

· If XXXX pays Kansas taxes on its materials and supplies and pays sales tax to its Kansas subcontractors, the appropriate tax base to charge tax on is the difference between the total contract price and the total amount paid for materials and subcontractors, including sales tax.
· If XXXX buys materials and supplies tax exempt or manufactures its own materials and supplies and pays sales tax to its Kansas subcontractors, the appropriate tax base is the difference between the total contract price and the total amount paid for materials and subcontractors, including sales tax.

I hope that his assists you in understanding your Kansas sales tax duties and in simplifying your accounting.

Sincerely,

Thomas E. Hatten
Attorney/Policy & Research

Enclosure

Date Composed: 03/03/1999 Date Modified: 10/10/2001

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