Maryland sales and use tax laws are often unfamiliar territory for small business owners. The first audit by the Comptroller’s office is often a learning lesson. In order to avoid the audit from being a costly one, the following are three areas that are often unknown or confusing to Maryland businesses.
Many commercial cleaning companies are unaware that they are required to charge sales tax at the six percent tax rate on the performance of their cleaning services performed at industrial and commercial buildings. The sales tax applies regardless of whether the company charges the customer based on the job or by the hour. The following are specific examples of taxable cleaning services:
- janitorial services
- floor, carpet, wall, window, ceiling and exterior cleaning
- Common Area Maintenance (CAM)
- HVAC cleaning in an industrial building
The only cleaning services that are exempt are residential cleaning services which include cleaning of an owner occupied apartment, condominium, or home. A cleaning service is considered to be commercial when the service is performed in between occupancy of residents at an apartment or rental condominium. However, charges for cleaning of new homes prior to sale to a resident are non-taxable, unless the structure is being used as a model home or sales center prior to being sold to the homeowner.
Commercial cleaning performed for a government agency is exempt. However, commercial cleaning performed for a contractor for a government agency is not.
A significant number of sales and use tax field audits result in an assessment for failure to accrue use tax on commercial cleaning services. All businesses should check whether their cleaning vendor is charging sales tax on their invoices. If not, the business should request that vendor begin doing so and open a sales tax account. If they refuse to do so, the business should contact the Comptroller’s Office about the issue and may wish to switch vendors.
Businesses may be under the impression that all transactions with government or government-related agencies are tax-exempt. However, the taxability of contracts depends on the nature of the relationship with the agency and products or services being provided to the agencies.
Under a procurement contract, a contractor should not charge sales tax on sales of tangible personal property (“TPP”) provided directly to the governmental agency. The contractor must have a valid Maryland sales and use tax license and may then purchase TPP tax-free by providing the vendor with a resale certificate for items that are being purchased solely for resale to the government agency. However, if the contractor uses the TPP in any way prior to or after title transfers to the government agency, the contractor may not claim the resale exclusion, and would owe sales and use tax on its purchase of the TPP.
A contractor who is performing a service for the government agency need not charge the agency sales tax regardless of whether the service is considered taxable or non-taxable under Maryland law. However, purchases of TPP used in performing the contract are subject to sales and use tax even if title to the TPP is transferred to the government agency either before or after use by the contractor. Contractors who are constructing real property under a contract with a government agency are also required to pay sales and use tax on the purchase of materials incorporated into the real property, as well as all tools and equipment used to perform the contract.
In contracts involving a mix of sales and services, Contractors should request that the government agency separately state the charges or contract price and allocate the charges between the TPP that is solely for resale to the agency and charges for services. If the government agency is unwilling to do so, the contractor is tasked with differentiating the TPP purchased for the mixed contract and retaining documentation substantiating the TPP’s transfer to the agency. If the records do not clearly support that a resale of TPP exists, the contractor will be liable for sales tax on all purchases made under the contract.
Software and Software Maintenance Agreements
The application of sales and use tax to purchases of software depends on whether the software qualifies as custom computer software services or is canned software. Custom computer software services are exempt from sales and use tax. If the software is canned software, the taxability depends on the method of delivery from the vendor to the customer. Under Maryland law, the purchase of software in a tangible form such as a CD-ROM is subject to sales and use tax. However, sales and use tax does not apply if the software is electronically transferred or downloaded from the vendor’s website. Due to software purchases being treated differently depending on the method of delivery, document retention for software purchases, especially for large purchases, is critical for audit purposes. Businesses should retain invoices, confirmation e-mails, and any other materials that clearly state the method of delivery to the purchaser by the vendor.
The taxability of software maintenance is dependent on several factors. If the software maintenance is required as a condition of sale of the software, the maintenance agreement is subject to tax if the software itself is taxable. In addition, if the maintenance agreement is optional or if the underlying software is exempt, the maintenance agreement is subject to tax if the buyer has a right under the terms of the agreement to receive at no additional cost software products that are separately priced and marketed by the vendor. It is important to note that the taxability of software maintenance hinges on whether the buyer has the right to receive these updates in tangible form, and not on whether the buyer actually receives any tangible item during the course of the period covered by the agreement. It is possible that no update becomes available during the period, or that the buyer may elect to download the update rather than receive it in tangible form. These factors do not affect the taxability of the agreement if the right to receive tangible updates exists.
Andrew J. Maschas is a hearing officer with the Comptroller of Maryland’s Hearings & Appeals section.