Related companies often use intercompany master service agreements in order to allocate common costs of doing business among the related entities. Depending on the size and nature of the business conducted, these service agreements can be extensive and include several services that are used throughout the related companies.
Something that business owners may not consider when drafting these agreements is the possibility that sales tax may need to be collected on the services provided. To complicate matters, each state has different laws that dictate whether services provided are subject to sales tax. Therefore each state that the related companies are located in should be considered in any sales tax analysis of intercompany service fees.
Sales Tax in New York
In New York State, sales of services are generally exempt from sales tax. However, services related to tangible personal property, software, and real property can be subject to sales tax and should be reviewed carefully if such services are included in an intercompany services agreement.
For example, if a service agreement includes repair and maintenance or installation services to computers, equipment, vehicles, or other tangible property, those services are subject to sales tax. License fees for access to software applications, unless specifically customized for the purchaser, are also subject to sales tax in New York State.
Avoid Costly Errors in Classification
If services related to real and tangible personal property are included in a service agreement, it is crucial to segregate these services on the invoice to the purchaser. It’s very likely that the majority of the services performed under an agreement are nontaxable due to the fact that in general most administrative services are exempt from sales tax. However, in most states, bundling both taxable and nontaxable services under a general label of “management fee” will make the entire transaction subject to sales tax. Consequently, for companies with large management fee income, an error in classification could be very costly.
If your business utilizes intercompany service agreements and has not performed a sales tax analysis, you should discuss the possible audit risks that you may face and steps to ensure proper tax filing compliance with a professional.
Freed Maxick's SALT team can assist with analysis of your service agreement to determine taxable versus nontaxable sales and review invoices for proper segregation of services to make certain that nontaxable sales do not become subject to sales tax. Contact us to get started.