- Change in Tax Law May Save Nonprofit Developers Money
- December 14, 2009 | Author: Bridget A. Hust
- Law Firm: Faegre & Benson LLP - Minneapolis Office
The omnibus tax bill, signed May 29, 2008, by Gov. Tim Pawlenty, contains a small tax law change—Minn. Stat. § 297A.71, subd. 23—that could save nonprofit developers of low-income housing projects thousands of dollars.
Previously, purchases of construction materials or equipment incorporated into the construction, improvement or expansion of qualified low-income housing projects were exempt from the sales tax, but only if the owner of the qualified low-income project was a nonprofit corporation qualifying under Section 501(c)(3) or 501(c)(4) of the Internal Revenue Code, or a limited partnership in which the sole general partner was a public housing agency or authority.
Because most low-income housing projects financed with tax credits are owned by limited partnerships, the statute had little applicability, except for senior projects financed by Section 202 loans or developed by certain counties that have the authority to form limited partnerships under their Housing and Redevelopment Authorities. The statute did not exempt sales taxes for projects owned by limited partnerships in which the general partner was a nonprofit entity.
The new law expands the sales tax exemption to limited partnerships in which the sole or managing general partner is a nonprofit. The exemption applies regardless of whether the purchases are made by the owner of the facility or its contractor.
To apply for the exemption, the project must be a "qualified low-income housing project," which includes any qualified low-income housing project meeting all of the requirements of the low-income housing tax credit under Section 42 of the Internal Revenue Code, regardless of whether the project actually applies for or receives the low-income housing credit.
Other exemptions are available for bond projects. For mixed-use projects or housing projects in which some of the housing units are market rate, the sales tax exemption applies only for the portion that qualifies as low-income housing units.
Process for Obtaining the Tax Exemption
To obtain a tax refund for low-income housing projects, owners must comply with the following procedures.
- The owner or its contractor must pay the sales tax at the time the materials and equipment are purchased from the supplier. Typically, the owner's general contractor will pay the taxes and include the cost of those taxes with each application for payment. In certain rare circumstances, an owner may elect to purchase the materials and equipment directly from the supplier.
- Upon completion of the project, the owner or the contractor (depending upon who ultimately paid the tax) must prepare and submit Form ST11P—Special Purchase Refund Claims, available from the Minnesota Department of Revenue. The form requires the owner to list the time period covered by the refund claim, the type of project in which the tax exempt materials were used or consumed in, and the total amount of the refund claimed.
- In addition to submitting Form ST11P, the owner must also submit separate statements from each of the contractors, subcontractors, or other purchasers of the materials. The separate statements must include the refund amount requested, the project name, the amount of the sales or use tax paid during the construction of the project, and the cost of each of the items purchased. If use tax was paid, the contractor, subcontractor, or other purchaser must also provide their Minnesota identification numbers. The contractor must also sign and certify that the amounts listed in the statement have been paid on the project or the portion of the project that directly relates to the qualifying low-income housing and do not include any amounts paid for equipment and machinery purchased or leased by the contractor for the contractor's general operations.
- The owner must provide the Department of Revenue with copies of the parties' entire construction contract, including all exhibits and documents incorporated into the construction contract. The owner must also submit a statement confirming that the owner and the project qualify for the low-income housing project exemption.
- The owner must submit all required information to the Minnesota Department of Revenue's Duluth office. The owner must apply for the refund within 3½ years from the due date of the tax return in which the sales taxes were incurred. An owner is limited to filing two tax refund claims per year.
Revisions to Construction Contract
In light of the detailed requirements necessary to obtain the tax exemption, owners should consider revising their construction contracts to ensure compliance with Department of Revenue refund procedures.
First, an owner should include a provision requiring the contractor and its subcontractors to accurately account for all sales and use taxes paid on the project and to abide by all applicable refund requirements promulgated by the Minnesota Department of Revenue. The owner should also mandate that the contractor and its subcontractors prepare the certifications and statements necessary to obtain the refund, including the statement setting forth the amount of sales and use tax paid by the contractor for the qualifying items. The owner should attach the appropriate form for the contractor's statement as an exhibit to the parties' contract.
The owner should also consider including a provision requiring the contractor to reimburse the owner for any tax refunds that were not obtained due to the negligence or failure of the contractor to comply by the parties' contract or the Department of Revenue's refund requirements.
Effective Date of the Revised Law
The new law applies to sales and purchases made after June 30, 2009. This effective date will not be a problem for projects that must meet the 10 percent carryover requirement under Section 42 of the IRS Code in the spring of 2009. The Housing and Economic Recovery Act enacted by Congress and signed by President Bush on July 31, 2008, permits states to extend the time period in which a project must meet its carryover from six months to 12 months.
Since most carryover agreements are signed in December, the timing of the carryover could have been problematic under prior law. Because the Minnesota Housing Finance Agency (MHFA) has chosen to extend the 10 percent carryover deadline from 6 months to 12 months, it may be prudent to delay the purchase of materials until after June 30, 2009, in order to obtain the refund if developers need to purchase materials to meet the carryover requirements.
Materials and Equipment Exemption for Nonprofit Owners
In addition to the tax exemption available under Minn. Stat. § 297A.71, subd. 23, some project owners may qualify for a tax exemption under Minn. Stat. § 297A.70, subd. 4. This tax exemption applies to materials and equipment purchased by nonprofit groups where the project is predominantly used for nonprofit purposes.
The statute defines "nonprofit" group to mean any corporation, society, association, foundation, or other institution organized and operated exclusively for charitable, religious, or educational purposes. The Department of Revenue has applied this tax exemption to limited liability companies where the sole member of the limited liability company is a nonprofit group.
One significant advantage to this tax exemption is that an owner need not seek a refund of the taxes upon the completion of the project. Instead, an owner purchases the materials and equipment without ever paying the taxes. This may allow an owner to earn interest on the tax savings and improve the owner's cash flow during the construction of the project.
Materials and Labor Exemption Requirements
Owners must consider a number of complex contracting requirements before proceeding with this tax exemption. Nonprofit owners, for instance, are precluded from using a lump-sum construction contract or similar type of contract with a guaranteed maximum price covering both materials and labor.
The Department of Revenue mandates that nonprofit owners only include the labor costs in their construction contracts for tax-exempt projects. To account for the material costs, a nonprofit owner must appoint the contractor as its purchasing agent. As the purchasing agent, the contractor will purchase the tax-exempt materials on behalf of the owner and will then incorporate the materials into the project. The owner will either reimburse the contractor for purchasing the materials or will pay the vendor directly upon receipt of the vendor's invoices.
To comply with Department of Revenue requirements, nonprofit owners should include the following language immediately after the Contract Sum or Guaranteed Maximum Price:
The Owner hereby appoints and designates the Contractor as the Owner's purchasing agent for the purchase of the materials, supplies, and equipment used in the performance of this Agreement as set forth in the attached exhibit (the "Purchasing Agent Exhibit") and incorporated herein by reference. Items purchased by the Contractor acting as the Owner's Purchasing Agent pursuant to the Purchasing Agent Exhibit are not included in the Contract Price. The Contract Price, however, includes all services performed by the Contractor acting as the Owner's Purchasing Agent, including the receiving, unloading, inspecting, safely storing, maintaining, protecting, and installing of the tax-exempt materials purchased pursuant to the Purchasing Agent Exhibit.
Other Contract Revisions
Additional revisions to the payment procedures of the contract should be made, including a statement providing that the tax-exempt items purchased by the contractor acting as the owner's purchasing agent should not be included in the contractor's applications for payment. These items should instead be paid for separately by the owner.
A nonprofit owner must also make sure to carefully define the "Work" performed by the contractor. The contractor's "Work" should not include the costs of the materials purchased by the contractor as the owner's purchasing agent, but it should include the labor and services associated with purchasing, delivering and installing the materials:
Contractor shall complete all Work as specified or indicated in the Contract Documents. The Work includes all things reasonably inferable from the Contract Documents. The Work does not include the equipment, materials, and supplies purchased by the Contractor acting as the Owner's Purchasing Agent pursuant to the Purchasing Agent Exhibit. The Work, however, includes the labor and services performed by the Contractor acting as the Owner's Purchasing Agent, which includes the receiving, unloading, inspecting, safely storing, maintaining, protecting, and installing of the tax exempt materials.
Additional revisions addressing the risk of loss and ownership of the tax-exempt materials should be made. These revisions must clearly show that (1) the owner takes title to all materials and supplies at the point of delivery; (2) the owner assumes the risk of loss for all materials and supplies; and (3) the owner, not the purchasing agent, has responsibility for all defective materials and supplies incorporated into the project.
The owner should also ensure that the construction contract states that the contractor will notify all vendors and suppliers of the purchasing agency relationship and will require its subcontractors to comply with all applicable tax-exempt procedures. The contractor and owner must also execute a separate purchasing agency agreement to establish the liabilities and procedures of the purchasing agent relationship.
Separate Labor and Materials Contracts
It is important to note that the purchasing agency relationship does not protect the owner from price increases of the tax-exempt materials. While most contractors provide the owner with estimates of the material costs prior to the commencement of construction, the owner will ultimately be responsible for any increases in the actual price of the materials at the time the contractor purchases them for the project.
To avoid these increased costs, some owners have sought to enter into a lump-sum labor contract and a separate lump-sum material contract. By entering into separate lump-sum contracts, the owner will be entitled to hold the contractor to the price of the materials and will avoid any unexpected price increases that may occur under the purchasing agency relationship. The Department of Revenue rules, however, do not specifically allow for such an arrangement. Nevertheless, some tax-exempt organizations have sought and received written authorization from the Department of Revenue to proceed in this fashion for particular projects.
If the Department of Revenue allows the owner to execute two separate contracts—one for labor and one for material—then the owner will need to revise each contract to accurately reflect the parties' arrangement. The owner, for instance, must ensure that the contractor's work is accurately defined to clearly reflect that one contract applies to labor while the other applies to materials.
The Contract Sum or Guaranteed Maximum Price, as well as the payment provisions, will also need to reflect the exact costs included in each lump-sum contract. It is also important that the bids or proposals for the labor and materials portions stand on their own and that the owner is permitted to accept either one without accepting the other.
When considering exemption options, low-income housing developers should be aware of these complex contracting requirements. Before preparing bids and construction contracts for projects in which a tax exemption may apply, it is advisable to seek appropriate legal counsel.