Wisconsin Corporation Can’t Avoid Tax with Middleman Subsidiary

By Joe Forward, Legal Writer, State Bar of Wisconsin

Aug. 29, 2012 – A Wisconsin construction company that used a subsidiary “customer” to move building materials must pay $80,067 in taxes and interest under a recent decision by the state tax appeals commission, which ruled in favor the Wisconsin Department of Revenue.

Under Wis. Stat. section 77.51(2), contractors and subcontractors are considered consumers and must pay applicable sales and use taxes when purchasing building materials, unless the contractor or subcontractor sells the building materials as a supplier to “customers.”

However, many contractors are not mere suppliers. They supply the building materials and perform the work under construction contracts. If a supplier is also performing work, the contractor must pay tax on the purchased building materials under Wis. Admin Code § Tax 11.04(4).

If purchased building materials are sold directly to a tax exempt entity by a separate supplier, the sale is not taxable under § Tax 11.04(5). The tax exempt entity is not required to pay sales tax for purchasing the building materials for the construction project.

Sullivan Brothers Inc. (Sullivan Brothers) is a construction company in Madison. It purchases, supplies, and installs ceiling tiles. Sullivan Brothers formed a subsidiary, Sullivan Brothers Supply Inc. (Sullivan Supply). Both entities operate from the same location and have the same owners.

The Department of Revenue alleged that at some point, Sullivan Brothers began purchasing building materials without paying sales tax, then transferred the materials (on the books) to Sullivan Supply at cost. Sullivan Supply would sell the materials to tax exempt entities. In turn, Sullivan Brothers would use the building materials supplied by Sullivan Supply to perform construction work for those same tax exempt entities.

In 2009, the Wisconsin Department of Revenue assessed unpaid sales and use taxes for a four-year period against Sullivan Brothers, claiming it was using the building materials supplied by its subsidiary to perform work and unlawfully bypassing the tax laws related to exempt entities.

In Sullivan Brothers Inc. v. Wisconsin Department of Revenue, No. 09-S-242 (Aug. 14, 2012), the Wisconsin Tax Appeals Commission agreed with the Department of Revenue.

The commission rejected Sullivan Brothers’ argument that Sullivan Supply was considered a customer under section 77.51(2). Contractors and subcontractors are exempt from paying sales tax on building material purchases if sold to customers “for whom the contractor will not perform real property construction activities involving” the building materials.

Sullivan Brothers argued that it was not performing work for Sullivan Supply. But to avoid sales tax, section 77.51(2) requires a contractor to demonstrate “sound reason” to believe the contractor will sell materials to “customers” who don’t use the contractor for construction work to be performed with the building materials, the commission explained.

“[T]he taxpayer’s willful imposition of a wholly owned intermediary to create a ‘customer’ to avoid the sales tax is not, in our view, ‘sound reason,’” wrote Commissioner Thomas McAdams.

The commission also rejected Sullivan Brothers’ argument that it had business purposes for the transaction structure, applying the “substance and realities” test.

“We are not aware of any significant business that Supply conducted on its own unrelated to these transactions,” wrote Commissioner McAdams, noting other problems with Sullivan Supply. “In general, a taxpayer may not secure, by a series of contrived steps, different tax treatment for a transaction than if he or she had carried out the transaction directly.”