Cities need to take certain steps to get the sales tax exemption for construction materials the city’s contractor purchases on behalf of the city.
(Published Nov 25, 2013)
Last session, for the first time since 1992, the Legislature made sales to cities generally exempt from paying sales and use tax (2013 Minnesota Laws, chapter 143, article 8, section 29). Cities are now wondering whether purchases of materials made by a city’s contractor for use by the city would be eligible for the sales tax exemption. The exemption takes effect Jan. 1, 2014.
The short answer is that materials purchased by a city’s contractor are not tax-exempt unless the city takes particular steps before the city even determines the contractor.
Separate labor and materials contracts
The first thing a city must do for its contractor to purchase city materials or equipment tax-free is to solicit bids on materials and labor separately—regardless of the estimated value of the contract. The tax exemption is not available to a city if its contractor purchases materials under a combined, lump-sum labor and materials contract. Therefore, even if the labor and materials combined costs $100,000 or less, and competitive bidding is not required by the Uniform Municipal Contracting Law (Minnesota Statutes, section 471.345), the city must advertise for separate bids on labor and materials if the goal is for the contractor to purchase materials tax-free.
Contractors might respond with bids for both contracts, but the city must have the ability to accept one bid without accepting both bids. The city must ultimately award two separate contracts. And if the city wants any subcontractors’ materials/equipment purchases to similarly be tax exempt, the Department of Revenue requires contracts between contractors and subcontractors to be similarly divided.
Designate a purchasing agent
The second requirement for a city’s contractor to purchase materials and equipment for a city is to formally designate the contractor providing the materials as the city’s purchasing agent. It’s crucial that cities follow requirements provided by the Department of Revenue in designing its purchasing agent agreement or the city risks paying the sales tax later.
The requirements for the purchasing agent agreement include specifying the city has made the designation of purchasing agent, has retained the risk of loss and defects in the materials, and takes ownership of the materials at the time of sale. There are additional requirements for the agreement if a subcontractor will be purchasing supplies or equipment without paying sales tax. The agreement or a document to its effect must be supplied to materials or equipment vendors along with a completed Certificate of Tax Exemption form supplied by the state.
New LMC memo
For more information and a sample purchasing agent agreement, please see the League’s memo, City Sales Tax Exemptions in Construction Contracts. Although this memo focuses on construction contracts, the most common situation where a city’s contractor could supply both materials and labor, cities are encouraged to keep these requirements in mind for situations outside the context of construction.
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Contact Edward Cadman
Staff Attorney/Special Counsel
(651) 281-1229 or (800) 925-1122