Focus on New Laws: Sales Tax Exemption Changes

Changes to the city/county sales tax exemption will reduce city sales tax liability and expand the exemption to instrumentalities of cities.
(Published Jun 30, 2014)

Since the Legislature extended a sales tax exemption to purchases by cities and counties in 2013, there has been confusion about the tax status of certain types of purchases, and whether purchases made by various instrumentalities of cities were also eligible for the exemption.

Instrumentalities in question included joint powers entities, economic development authorities, and housing and redevelopment authorities.

During the 2014 legislative session, the League of Minnesota Cities worked with the Department of Revenue (DOR) and key legislators to expand and clarify the scope of the local government sales tax exemption. While some of the changes go into effect on July 1, 2014, a number of changes do not go into effect until Jan. 1, 2016. Joint powers entities and instrumentalities should pay close attention to the effective date of these changes.

Taxable city purchases (the “private business” exception)
One of the most problematic provisions of the municipal sales tax exemption granted in 2013 was the exclusion of inputs to “goods and services generally provided by a private business.” The 2013 statute created many problems for cities because the list of these goods and services was not definitive, and DOR was required to interpret what types of goods and services were exempt from the sales tax and which were not. The new law is now far clearer.

Beginning on July 1, 2014, most city purchases will be exempt from the state sales tax. However, inputs to the following list of specific goods and services will be taxable when purchased by a local government:

  • Liquor stores
  • Gas and electric utilities
  • Golf courses
  • Marinas
  • Campgrounds
  • Cafes
  • Laundromats Solid waste hauling
  • Solid waste recycling
  • Landfills

Allocation of sales tax
While the new law is a significant improvement for cities, it will not eliminate all administrative hassles. For example, a municipal utility that provides water (tax-exempt) and electricity (taxable) will have to pay sales tax on purchases used to support the provision of electricity. Cities will need to develop a method for allocating between purchases used to provide exempt services and those used to provide non-exempt services. (If the municipal utility purchases office paper that is used by the utility, for example, the city will have to determine what percentage of the paper is used to provide the taxable service, and allocate a portion of the sales tax it paid for the paper.)

The DOR has given cities flexibility in allocating sales tax, stating only that a city must “use a reasonable method of allocation and keep business records that clearly identify how [it] determined the tax.” It will be important for cities to keep good records of the allocation method in the event of an audit.

Exempt entities expanded—but not until Jan. 1, 2016
The 2013 legislation granted a sales tax exemption to “cities and counties,” however, the Department of Revenue interpreted this language to exclude joint powers entities and other instrumentalities of local government.

The new law expands the sales tax exemption to instrumentalities of cities and counties, including: joint powers entities, all economic development authorities, housing and redevelopment authorities, port authorities, as well as special districts defined under Minnesota Statutes, section 6.465 and special taxing districts defined under Minnesota Statutes, section 275.066.

Unfortunately, the expanded exemption is not effective until Jan. 1, 2016. This delayed effective date was included in order to fit the omnibus tax bill's tax reductions into the overall budget target.

Sales tax proposal that did not become law
The League pursued legislation to simplify the process by which cities can secure the sales tax exemption for construction materials. Under current law, construction materials for public buildings and other construction projects are exempt from the sales tax, but cities must follow a complicated bid and administrative process that often costs cities more money than they would save with the exemption. This legislation did not pass, but the League has developed detailed guidance for cities that wish to claim the sales tax exemption on construction materials.

The League also sought an exemption from the motor vehicle sales tax for vehicles used for road and highway maintenance and construction purposes. Purchases of these vehicles by cities were not exempted under the 2013 general sales tax exemption, even though similar township purchases have been exempt for many years, and the 2014 Legislature did not extend the exemption to city vehicles.

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