Sales tax rates are not uniform across North Carolina’s 100 counties.  In some counties, the combined rate of sales tax is as high as 7.5%, while in others that rate is as low as 6.75%.  Why?  “Local option” sales taxes.

Unless state law specifies an alternative rate, the general rate of North Carolina’s state sales tax is 4.75%.  See G.S. § 105-164.4(a) (listing the majority of transactions subject to state sales tax and the rates at which such tax is levied).  But the General Assembly also has permitted North Carolina’s counties to impose certain sales taxes—referred to colloquially as “local option” sales taxes—that apply in addition to the base state rate.  See G.S. Chapter 105, Art. 39 (1 cent), Art. 40 (0.5 cents), Art. 42 (0.5 cents), Art. 43 (0.5 cents or 0.25 cents, depending on the jurisdiction),[1] and Art. 46 (0.25 cents).  Not all counties have levied the same local option sales taxes—as of October 1, 2022, every county has levied the Article 39, Article 40, and Article 42 taxes, four counties have levied Article 43 tax, and 47 counties have levied the Article 46 tax.

Because rates of sales tax can differ by county, a retailer must determine the county in which a taxable sale occurs in order to collect sales tax at the correct rate.  But how does a retailer make that determination?  For example, assume that a retailer with a brick-and-mortar store in Orange County (where the aggregate “local option” sales tax rate is 2.75%) sells a lawnmower to a resident of Chatham County (where the aggregate “local option” sales tax rate is 2.25%) and delivers it to the Chatham County resident’s home.  Which county’s rates apply?

This blog post answers that question and more generally explains how “sourcing principles” contained in North Carolina law determine the location of a taxable sale for purposes of North Carolina sales and use tax.  Because these “sourcing principles” affect the State’s allocation and distribution of some “local option” sales taxes to North Carolina’s counties and municipalities, the proper application of these principles is essential to ensuring that counties and municipalities receive the amounts of “local option” sales taxes to which they are entitled.

The Origin of North Carolina’s Sourcing Principles: The Streamlined Sales and Use Tax Agreement

The State of North Carolina has entered into the Streamlined Sales and Use Tax Agreement, as amended through December 21, 2021 (the “Streamlined Agreement”).[2]  See G.S. § 105-164.42C (authorizing the Secretary of Revenue to enter into the Streamlined Agreement); G.S. § 105-164.3(259), as revised by S.L. 2022-13, Section 3.2 (revising G.S. § 105-164.3(259) to reference the December 21, 2021 version of the Streamlined Agreement, effective as of June 29, 2022).

The Streamlined Agreement is a multi-state effort to simplify the administration of state and local sales taxes.  It does not modify North Carolina law by itself (see G.S. § 105-164.42D)—but the North Carolina General Assembly and the legislatures of other signatory states have taken steps to implement its provisions.

Among other things, the Streamlined Agreement contains a set of uniform “sourcing” principles (in Sections 309 through 315) that the North Carolina General Assembly and other signatory states have codified.  See G.S. § 105-164.4B.  These principles determine where a taxable transaction takes place for purposes of North Carolina’s state sales and use taxes and for each of North Carolina’s local option sales taxes.[3]

Basic Sourcing Principles for North Carolina Sales Taxes

The Streamlined Agreement’s sourcing rules, codified in G.S. § 105-164.4B, are “destination-based,” meaning that in most cases a taxable sale is deemed to occur where a buyer “receives” an “item” (i.e., “tangible personal property, digital property, or a service” (G.S. § 105-164.3(113)).  These sourcing rules stand in contrast to an “origin-based” regime in which a taxable sale is typically deemed to occur where the seller of an item has a physical presence or is otherwise located.

When an otherwise taxable sale occurs, the Department of Revenue deems a purchaser’s “receipt” of an item to occur when (1) for “tangible personal property,” the purchaser takes possession, (2) for a service, the purchaser makes first use, or (3) for “certain digital property,” the purchaser takes possession or makes first use.  See N.C. Dep’t of Revenue, Sales and Use Tax Bulletins (Apr. 25, 2022) (“SUTB”), § 4-1(A).[4]

G.S. § 105-164.4B(a) sets out five general rules, each detailed below, for determining where a taxable sale occurs for North Carolina sales tax purposes.  If Rules #1 and #2 do not apply to the given set of facts, proceed to Rule #3.  If Rule #3 does not apply to the given set of facts, proceed to Rule #4.  If Rule #4 does not apply to the set of facts, proceed to Rule #5.  The location of most taxable sales can be determined using Rules #1 or #2.

Readers should know that despite the existence of these general rules, alternative rules can apply to certain types of taxable sales, including sales of telecommunications services, direct mail, and certain floral products.  For more information, see SUTB, supra, §§ 4-1(B) – 4-7.

Rule #1 (“Over-the-Counter” Sales):  If the purchaser takes possession of tangible personal property or makes first use of a service at the seller’s business location, the sale is deemed to occur at the seller’s business location.  In its current formulation, Rule #1 also provides that if a purchaser takes possession of certain digital property or makes first use of certain digital property at a seller’s business location, the sale is deemed to occur at the seller’s business location.  But determining a “seller’s business location” for the sale of certain digital property can be challenging, if not impossible.  For example, is a “seller’s business location” in the physical place where its servers containing the digital property are located?  And, if so, does a purchaser “make first use” or “take possession” where those physical servers are located or instead where the purchaser is located?  Because the statutes do not clarify these issues, Rule #3 or Rule #4 more commonly apply to sales of digital property.

Hypothetical #1

Q:        Jack lives in County A.  Jack purchases a lawnmower from retailer’s brick-and-mortar store in County B and uses his own truck to haul it from the store in County B to his residence in County A.  Which county’s sales and use tax rates apply?

A:        County B.  A lawnmower is “tangible personal property.”  Because Jack took possession of the tangible personal property at the seller’s business location in County B, the sales and use tax rates of County B apply.

Rule #2 (“Delivered” Retail Sales):  If the purchaser, or the person for whom the purchaser is purchasing (i.e., the purchaser’s donee), takes possession of tangible personal property or makes first use of a service at a location specified by the purchaser or the person for whom the purchaser is purchasing, the sale is deemed to occur at the specified location.

Hypothetical #2A

Q:        Jill lives in County A.  Jill places an order for a lawnmower with a retailer’s brick-and-mortar store located in County B, but at Jill’s direction, the retailer ships the lawnmower to Jill’s residence in County A.  Which county’s sales and use tax rates apply?

A:        County A.  A lawnmower is “tangible personal property.”  Unlike Hypothetical #1, Jill did not take possession of tangible personal property at the seller’s business location in County B.  The shipper’s possession in County A does not constitute the Jill’s “receipt” of the item. Jill took possession of the tangible personal property at her residence in County A and the sales and use tax rates of County A apply.

Hypothetical #2B

Q:        A North Carolina business (Widget, Inc.) with a brick-and-mortar location in County A installs invisible fences for animals at residential properties in Counties A, B, C, and D.  Which county’s sales and use tax rates apply to the taxation of the installation services?

A:        The purchaser of the installation service makes first use of the services in the county in which Widget, Inc. performs the services.  Therefore, County’s A rates apply to the installation of invisible fences in County A, County B’s rates apply to the installation of invisible fences in County B, County C’s rates apply to the installation of invisible fences in County C, and County D’s rates apply to the installation of invisible fences in County D.  Widget, Inc.’s business location in County A does not govern the sourcing of these transactions.

In most cases, the location of a taxable sale can be determined using Rule #1 or Rule #2.  But if Rule #1 or Rule #2 do not apply, G.S. § 105-164.4B(a)(3), (4), and (5) provide three additional governing rules, each detailed below.

Rule #3 (Address of Receipt for Particular Transaction Unknown, But Seller Has Other Business Records Indicating Seller’s Address):  If Rule #1 or Rule #2 cannot determine the location of a sale, the sale will be deemed to occur at an address maintained in the seller’s business records.

Hypothetical #3

Q:        A North Carolina business (Well Heeled, Inc.) is headquartered in County A, but has locations in four other North Carolina counties.  Well Heeled, Inc.’s IT director purchases prewritten computer software from a seller in a taxable transaction.  When finalizing the purchase, the IT director, does not make clear for which locations she is purchasing the software—but the Seller has the address of Well Heeled, Inc.’s headquarters from prior sales to Well Heeled.  Which county’s sales and use tax rates apply?

A:        County A.  Because the Seller does not have sufficient information to precisely source the sale, it can determine the location of the sale as County A because it has other business records indicating Well Heeled’s address is in County A.

Rule #4 (Address of Receipt for Particular Transaction Unknown, But Seller Received Purchaser’s Address Information When Finalizing Sale):  If Rules #1 through #3 cannot determine the location of a sale, the sale will be deemed to occur at an address for the purchaser obtained during the consummation of the sale, including the address on a purchaser’s payment instrument (e.g., linked to a credit card).

Hypothetical #4

Q:        A North Carolina business (Widget, Inc.) with headquarters in County A, but locations in four other counties (including County B), purchases prewritten computer software from a Seller in a taxable transaction.  Widget has not entered into any previous transactions with the Seller.  When finalizing the purchase, Widget’s IT director does not make clear for which business locations the company is purchasing the software, but when paying, the IT director provides a physical address located in County B with its credit card information.  Which county’s sales and use tax rates apply?

A:        County B.  The Seller does not have sufficient information to precisely source the sale because it and has no business records indicating that Widget’s address is in County A.  However, because Widget’s IT director provided an address with its credit card payment indicating the location in County B, County B’s rates apply.

Rule #5 (Catch-All “Origin Based” Rule): If Rules #1 through #4 cannot determine the location of a sale, a catch-all “origin-based” rule applies.  The sale is deemed to occur at one of the following: (1) the address from which the tangible personal property was shipped; (2) the address from which the digital good or computer software delivered electronically was first available for transmission by the seller, or (3) the address from which the service was provided.

Sourcing Principles Matter for North Carolina Counties and Municipalities

You may ask whether these sourcing principles ultimately matter for North Carolina’s counties and municipalities.  The answer is yes!  Why?

The net proceeds of Article 39, 42, 43, and 46 taxes are, with the exception for Article 39 and 42 taxes levied on food,[5] allocated and distributed to the county in which the taxable sale of an item is deemed to occur.  See G.S. § 105-472(a) (Art. 39); G.S. § 105-501(a) (Art. 42); G.S. § 105-507.3, G.S. § 105-508.2(a), G.S. § 105-511.4(a) (Art. 43), (G.S. § 105-538 (Art. 46). Therefore, if a retailer fails to correctly determine the location of a taxable sale under G.S. § 105-164.4B, it might fail to collect and report the correct amount of “local option” sales taxes due to each taxing jurisdiction.  As a result, a taxing county will not receive the proceeds of the Article 39, 42, 43, or 46 taxes to which it is properly entitled.  Municipalities within counties that have levied the Article 39 and 42 taxes, as well as municipalities operating public transportation systems within counties that levy Article 43 taxes, also receive some portion of each respective tax.  Therefore, if a retailer makes an improper determination, these municipalities might not receive the proceeds of Article 39, 42, and 43 taxes to which they are entitled.

Can Counties Do Anything to Improve Compliance?

Even though North Carolina’s counties levy local option sales taxes, the North Carolina Department of Revenue—not counties—administers and collects these sales taxes.  But can counties take any actions to ensure that retailers or citizens are paying the proper rates of sales taxes?

At present, a county’s actions are limited largely to educational efforts or referrals to the North Carolina Department of Revenue.  At least one county (Chatham) has brought these sourcing principles to the attention of local residents and retailers by creating a website and offering to answer questions on the topic.  Located adjacent to counties with higher rates of local sales taxes (e.g., Orange and Wake), Chatham County has noted that “paying correct sales tax can save residents money and increase revenues for county services.”  If other counties have attempted to educate residents and retailers on these issues, I would be interested to hear of these efforts.

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[1] Because the proceeds of Article 43 taxes can only be used to finance public transportation, the North Carolina Department of Revenue often refers to the Article 43 tax as a “transit” tax.  See, e.g., N.C. Dep’t of Revenue, Sales and Use Tax Bulletins § 1-3(B) (Apr. 25, 2022) (using the term “transit” tax to refer to Article 43 tax).  The Article 43 tax (at a rate of 0.5 cents) is currently in effect only in the counties of Wake, Durham, Orange, and Mecklenburg.  A rate of 0.25 cents may be imposed in counties other than Wake, Durham, Orange, Forsyth, Guilford, and Mecklenburg.

[2] The Streamlined Agreement was subsequently amended on May 25, 2022, but as of October 20, 2022, the General Assembly has not yet authorized the Secretary of the Department of Revenue to enter into the latest version of the Streamlined Agreement.

[3] See Art. 39, G.S. § 105-467(c) (“The sourcing principles in Article 5 of Subchapter I of this Chapter apply in determining whether the local sales tax applies to a transaction.”); Art. 40 (G.S. § 105-483), Art. 42, (G.S. § 105-498), Art. 43, (G.S. § 105-507.2, G.S. § 105-509.1, G.S. § 105-510.1, and G.S. § 105-511.3), Art. 46 (G.S. § 105-538) (noting, respectively, that the collection and administration of Article 40, 42, 43, and 46 taxes are based upon Art. 39, therefore incorporating the sourcing principles prescribed by G.S. § 105-467(c)).

[4] “Certain digital property” is a statutorily defined term (see G.S. § 105-164.3(33)), but includes, among other items, digital books and digital audio works (e.g., songs).

[5] 50% of the proceeds of Article 39 taxes on food are allocated on a “per capita” basis (see G.S. § 105-469(a)(1)), meaning that these proceeds are allocated based on each county’s relative population—not actual relative collections of Article 39 taxes.  The remaining 50% of Article 39 taxes on food are allocated based upon the relative amount of Article 39 taxes collected by each county on food in the 1997-1998 fiscal year (see G.S. § 105-469(a)(2)). Article 42 taxes on food are allocated based on a “per capita” basis.  See G.S. § 105-469(a)(1); G.S. § 105-498 (Art. 42).  Where allocation and distribution of a tax is based only on relative population or a prior year’s collection, improper sourcing will not have a direct effect on distribution.