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The Minnesota Department of Revenue has reversed its longtime stance of not taxing optional maintenance contracts for personal property, but continued to allow optional warranty contracts to remain not taxable.

Minnesota Businesses Offering Optional Maintenance Contracts Must Pay Tax Under New Rule

  • 12/28/2012

Minnesota Businesses Offering Optional Maintenance Contracts Must Pay Tax Under New Rule

The Minnesota Department of Revenue (DOR) recently reversed its longtime stance of not taxing optional maintenance contracts for personal property in Revenue Notice 12-12, but continued to allow optional warranty contracts to remain not taxable.

The new rule will most likely result in a significant increase of audits, warns Mike Herold, state and local tax partner with CliftonLarsonAllen.

 “When the DOR issues a revenue notice, we typically see more audit activity approximately one year after the notice was released. That means there may be more audits of companies offering maintenance agreements by the end of 2013,” he says.

De minimis rule

Minnesota and several other states consider transactions that include a range of different products or services as one single transaction for tax purposes. For the most part, if the transactions are mainly tax-exempt products or services, the entire transaction is exempt from sales and use tax. Conversely, if they consist of mostly taxable products, the entire transaction is taxable.

Previously, Minnesota felt the parts and supplies were a “de minimis,” or a minor portion, of an entire maintenance contract, and the non-taxable service was an overwhelming majority of the cost. The DOR is now saying the parts and supplies make up a larger portion of this cost, and therefore, the entire transaction is taxable as a bundled transaction.

Optional maintenance agreements for computer software are not affected by this new interpretation, since these agreements fall under a separate rule.

“While the DOR needs to address many questions, the notice appears to state that if the equipment is exempt — such as manufacturing or agricultural equipment — then the maintenance agreement should also be exempt. It also seems to state that the new rule does not apply to real property maintenance agreements, since it specifically states the new taxation is effective ‘on equipment’,” says Herold.

Cost of parts

The example cited by the DOR relates to copy machine maintenance contracts. In these cases, often the toner, drum, and developer are replaced at no cost, and the service is also not taxable. Any sales tax on the toner, drum, and developer is paid by the maintenance service provider.

Under the new rules, the DOR stated that the cost is more than de minimis, because of the expense of these parts. Therefore, these transactions are now fully taxable, which means the entire contract is taxed as it is invoiced. If a customer is invoiced monthly for the maintenance agreement, the tax must be clearly shown and paid. Maintenance providers will no longer have to pay use tax on these parts and supplies, since they are being resold under the maintenance contract.

Effect on nonprofits

According to Herold, the rule does not clarify whether a tax-exempt nonprofit organization must pay tax on these maintenance contracts.

“The nonprofit exemption generally only covers purchases of tangible personal property. It appears the DOR is viewing these maintenance contracts as the sale of products and not a service. Therefore, a nonprofit with a valid Minnesota sales tax exemption ruling will most likely not have to pay tax on optional maintenance agreements,” he says.

In addition, Minnesota businesses need to make sure they are being charged the correct amount of tax when using out of state maintenance providers. If tax does not appear on the invoice, the taxpayer needs to accrue and remit use tax.

Warranty contracts

The DOR found that warranty contracts are different than maintenance contracts, and should remain non-taxable.

Warranty contracts are considered an insurance policy, the DOR stated, and there is an uncertainty whether repair or service work will ever be performed.

How we can help

Contact your tax advisor with any questions on how the new DOR rule affects your organization.


Mike Herold, State and Local Tax Partner
mike.herold@cliftonlarsonallen.com or 612-376-4548