The Tennessee Court of Appeals released its opinion in the Auto Glass Company of Memphis Inc. vs. Gerregano today.
In this case, the taxpayer corporation disputed the Tennessee Department of Revenue’s reclassification for purposes of the Tennessee Business Tax Act of the taxpayer corporation as a seller of services from its longstanding classification that applied to persons making sales of glass.
The taxpayer corporation was in the business of selling and installing automotive glass and making repairs to damaged automotive glass.
Although the taxpayer corporation does on occasion just sell automotive glass to a customer without selling any other related products or services, it typically installs the glass that it sells.
The taxpayer corporation was registered with the Tennessee Department of Revenue and filed its business tax returns under Classification 1(B), which includes persons making sales of glass. The Department of Revenue audited the taxpayer corporation for years 2003-2005, but did not change the taxpayer’s corporation classification. However, when the Department of Revenue later audited the taxpayer corporation again for the years 2011-2014, the Department of Revenue reclassified the taxpayer corporation to Classification 3(C) as a seller of services.
This reclassification resulted in an increased tax liability for the taxpayer corporation.
After going through the required administrative steps, the taxpayer corporation filed suit, seeking a refund of business taxes and objecting to the reclassification.
The Tennessee Court of Appeals held for the taxpayer corporation, agreeing that the proper classification of its business was under Classification 1(B), as a person making sales of glass.
The Court noted that a taxpayer is classified according to its “dominant business activity,” which means “the business activity that is the major and principal source of taxable gross sales of the business.”
It was essentially undisputed that the majority of the gross sales of the taxpayer corporation are attributable to sales of glass. However, the Department of Revenue sought to rely on the Department of Revenue’s so-called “Revenue Rule 43.” This rule is located at Tenn. Comp. R. & Regs. 1320-04-05-.43
Revenue Rule 43 essentially provides in relevant part that “[t]he total charges made by those engaged in the business of repairing tangible personal property, including parts, labor, and any other charges, shall be deemed to be service charges and taxable at either the wholesale rate or retail rate, whichever is applicable.”
In other words, Revenue Rule 43 purports to make charges for the sale of glass into charges for providing services. As the Court said, “According to the Commissioner, because Jack Morris Auto Glass’s dealings with most customers involve both charges for purchased glass as well as labor charges for installing the glass, all such charges should be treated as “service charges” under “Revenue Rule 43.”
The Court would have none of the Department of Revenue’s argument in this regard. It noted that the statutory language from which “Revenue Rule 43” is derived clearly provides that “services” “does not include sales of tangible personal property.”
The Court then went on to say that “the Commissioner cannot enlarge the scope of a taxing statute by regulation, and rules contrary to the express directives of a taxing statute are void.”
It would appear that Revenue Rule 43 is on shaky ground if not outright void based on the Court’s holding in this case.
The Auto Glass Company case should remind taxpayers not simply to accept a reclassification from the Department of Revenue without consulting with counsel. In this case, if one were to read Revenue Rule 43 on its face, one might have concluded that the Department of Revenue was right. But, the Department of Revenue cannot issue rules and regulations that are inconsistent with the underlying statute. And in this case, that was exactly what happened.
Congratulations to the taxpayer corporation in this case and to their legal counsel for a job well done.