If you own a business which produces and sells tangible goods, then you are obligated to pay sales tax to the CDTFA. There are, however, a number of exemptions to this rule, some of which apply to various types of goods and others which attach to certain buyers.
It is important to understand which types of business can get a partial or full sales tax exemption and the consequences for improperly failing to pay sales or use tax. Sales tax is a complex area of law, with a huge range of exemptions that apply to various goods or types of sellers.
Penalties for failing to pay sales tax are steep, so a little knowledge now can keep you from a huge liability later.
Exemptions and Exclusions From Sales and Use Taxes
There are a number of exemptions to the obligation to remit sales and use taxes. Some of these exemptions exist in an attempt to promote certain types of industry or consumer choices. An example is the current such exemption on fresh, but not prepared, foodstuffs.
Other exemptions exist to avoid burdening certain organizations with the obligation to collect sales tax, and so many nonprofit or veterans’ organizations are wholly exempt. Other exemptions are in place so that the same item does not give rise to two sales tax charges.
Thus, items purchased for resale, or to various out-of-state entities (usually transport companies) or which are in transit to an overseas destination, are exempt.
Other examples of exempt sales include sales of certain food plants and seeds, sales to the U.S. Government and sales of prescription medicine. The list of exemptions is long and detailed, so if you are not sure if your business falls under those headings, you may wish to clarify with the CDFA.
In general, businesses which provide a service that does not result in a tangible good are exempt from sales tax, as it only applies to goods. For example a freelance writer or a tradesperson is not required to remit sales tax, although a carpenter making custom furniture is so required.
Online sellers who do not have sufficient sales nexus within California also do not have to collect sales tax, although the test for “sales nexus” is so wide that it will be considered sufficient if one of your affiliates, agents, warehouse suppliers or other place of business is located within the state. Presence at trade shows or conventions for more than 15 days in a calendar year will also establish nexus.
If you are selling to a customer who has an exempt status, you must collect a California Sales Tax Exemption certificate and keep it on file. If you are audited, you will be expected to produce this as proof that you sold an exempt item.
If you are a reseller, you may also apply for a California Resale Certificate, which allows you to buy goods within California for resale without paying sales tax on those goods.
Tax Exempt Items
There is a long and detailed list of items that are not taxable, but generally, the following are tax exempt:
- Food for human consumption
- Manufacturing machinery
- Raw materials for manufacturing
- Utilities and fuel used in manufacturing
- Medical devices and services
Looking at these broad categories, you can see the delineation between taxable and tax-exempt can be anything from the fact that the item in question is a human necessity, like food, to tax breaks provided to encourage certain industries to operate in the state. It also seems like for each exemption or exclusion there is an exception to the rule. Let us take a look.
A Closer Look at Tax Exempt Items
For a detailed list of tax-exempt items, the CDTFA puts out a Sales and Use Tax publication that shows the exemptions and exclusions to the tax, some of which have expiration dates.
The CDTFA breaks the items into broad categories:
- Necessities of life
- General public benefit
- Industry benefit
- Exclusions by definition
- Other exemptions, exclusions and credits
As you may have guessed, the top necessity of life is food. However, the exemptions can appear complicated because the CDTFA looks at a variety of items that may not seem to be food but are related in a way that allows tax exemption.
For example, most food products for human consumption are easily recognized but where and how they are sold impacts the exemption. Food that falls under the following conditions is considered taxable:
- Sold in a heated condition
- Served as meals
- Consumed on or at a seller’s facilities
- Is ordinarily sold for consumption on or near the seller’s parking facility, or
- Is sold for consumption where there is an admission charge
However, there is an exception. Hot bakery items or hot beverages such as coffee sold for a separate price are still tax exempt.
The justification for the tax exemption on food products sold through a vending machine is just as convoluted. The vending machine operator is considered the consumer of any food products retailing for 15 cents or less and food products sold through bulk vending machines for 25 cents or less.
Wait, there is more: for sales of cold food products, hot coffee, hot tea and hot chocolate through a vending machine for more than 15 cents, 67 percent of the receipts are tax exempt. The rest is fully taxed.
Other necessities of life include health-related products, services, and meals as well as some utilities like gas, water and electricity.
General Public Benefit
General public benefit tax-exemptions are conferred on alternate energy technology, museums and public art exhibits, certain aspects of non-profit, religious or educational organizations, and miscellaneous categories such as POW bracelets and pollution control facilities.
Non-profit organizations may only be tax-exempt if the profits from the items they sell go to benefit a specific group, such as AIDS/HIV patients or disabled children. Some exemptions even include language requiring the items to be made by the non-profit group.
Industry benefits in California obviously include the entertainment industry but also include transportation, petroleum, leasing, and manufactured houses and buildings, plus a raft of special classes like numismatic coins, custom computer programs and hay production.
Other exclusions and exemptions can be found in the list that includes details about sales prices and gross receipts, admission charges, and other transactions not considered to be tangible personal property. There is even an exclusion for the term “person.”
It seems there is no such thing as a simple tax. Sales and use taxes carry a plethora of legal definitions, exclusions, exemptions and exceptions within a group of exemptions. It’s enough to make a seller’s head spin. However, it is unlikely a single seller will need to be cognizant of every category.
If you are not certain whether you should collect sales or use tax, look at the CDTFA website or call a knowledgeable tax attorney to help you make certain you are doing the right thing.