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Unlike the vast majority of states, North Carolina does not excuse a local government from paying sales or use taxes incident to its purchases solely because it is a governmental entity.  Instead, unless state law exempts a particular type of transaction from sales or use tax, a local government that makes a taxable purchase must either pay sales tax to a retailer or use tax to the North Carolina Department of Revenue (NCDOR).  This blog post explains what North Carolina “use” tax is, when and how North Carolina’s local governments might need to report and pay use tax to NCDOR, and when most local governments can obtain a refund of use taxes.

What Is “Use” Tax?

In North Carolina, state and local sales taxes apply to the retail sale of certain “items” (defined to include tangible personal property, certain digital property, and some services).  See G.S. 105-164.4(a)(1) (state sales tax); G.S. 105-467 (Art. 39 tax); G.S. 105-483 (Art. 40 tax); G.S. 105-498 (Art. 42 tax); G.S. 105-507.2 (Art. 43 tax for Mecklenburg County); G.S. 105-509.1 (Art. 43 tax for Wake, Durham, and Orange County); G.S. 105-538 (Art. 46 tax).  In a typical non-exempt transaction, a retailer collects state and applicable local sales taxes at the point of sale and remits those taxes to NCDOR.

But what happens when a North Carolina retailer fails to collect applicable North Carolina state and local sales taxes from a local government in connection with a taxable sale?  Or what if a local government makes a purchase of property (e.g., lumber) from a retailer in another state (e.g., Virginia or South Carolina), sends its employees to obtain the item and bring it back to North Carolina, and pays applicable sales taxes to the other state?  In each of these cases, must a local government then pay sales taxes to NCDOR?

The highly technical answer to that question is “no”—but in each instance, a local government likely must pay state and local “use” taxes to NCDOR.  In North Carolina, complementary state and local “use” taxes—at rates equivalent to state and local “sales” taxes—apply to items that a purchaser uses, stores, or consumes in North Carolina.  See G.S. 105-164.6(a) (state use tax).  See also G.S. 105-468 (Art. 39 use tax); G.S. 105-483 (Art. 40 use tax); G.S. 105-498 (Art. 42 use tax); G.S. 105-507.2 (Art. 43 tax for Mecklenburg County); G.S. 105-509.1 (Art. 43 tax for Wake, Durham, and Orange County); G.S. 105-538 (Art. 46 tax) (collectively, the “Local Use Tax Statutes”).

The primary purpose of a “use” tax is to prevent a consumer from evading the payment of North Carolina state and local sales tax upon an “in-state” purchase or upon the purchase of an item in another state that is subsequently used or consumed in North Carolina.  See Matter of Assessment of Additional North Carolina and Orange County Use Taxes Against Village Publishing Corporation For the Period From April 1, 1972 Through March 31, 1978, 312 N.C. 211, 215 (1984).

Extinguishing Use Tax Liability

A retailer’s proper collection and remission of sales taxes to NCDOR extinguishes any use tax liability that a purchaser—including a local government—might have.  See G.S. 105-164.6(c)(1) (providing use tax credit for “amount of sales or use tax paid on the item to [North Carolina]”).  But where a retailer fails to collect applicable North Carolina state and local sales taxes, a local government must pay state and local use taxes—at rates equivalent to the rates of applicable sales taxes—to NCDOR.

But what if a local government properly pays sales taxes to another state in connection with its purchase of property in that state?  For example, assume that the staff of a North Carolina county makes a purchase of lumber just across the state line in Virginia, pays applicable state sales tax, and hauls it back to North Carolina. In that case, North Carolina law also entitles the purchaser—in this case, a county—to a credit for the amount of “sales or use tax due and paid for the item to another state.”  See G.S. 105-164.6(c)(2) (state use tax) and the Local Use Tax Statutes, supra.

However, if the applicable rates of sales and use tax in the other state exceed the applicable rates of state and local sales and use tax in North Carolina, that “credit” might not extinguish all of a purchaser’s use tax liability.  For example, the combined rates of state and local use taxes currently in effect in North Carolina range, depending on the jurisdiction, from 6.75% to 7.5%.  But in Virginia, the combined applicable rates of sales taxes range from 5.3% to 7.0%.  If a local government purchases lumber from a retailer’s brick and mortar location in Virginia, pays a lower rate of sales tax (e.g., 5.3%) than it would pay in the North Carolina county where the lumber will be used (e.g., 6.75%), the local government must pay North Carolina “use” tax—at a rate equal to the differential between the lower out-of-state rate and higher in-state rate—to NCDOR.

Reporting and Paying Use Tax

If a local government determines that it must pay use tax in connection with a particular purchase, it can do that by reporting the use tax on the sales and use tax return (Form E-500) that it files with NCDOR to report its taxable sales (e.g., at a local government concession stand).  Under state law, sales and use taxes are payable when a return is due—either on a monthly or quarterly basis, depending on a local government’s typical monthly liability for sales and use tax.  See G.S. 105-164.16(a).

Use Tax Liability for Indirect Purchases of Tangible Personal Property

Broadly speaking, North Carolina’s local governments make two types of purchases—“direct” and “indirect.”  The former type of transaction encompasses items that a local government purchases directly from a retailer (e.g., a purchase of lumber described in the sections above), while the latter type of transaction encompasses items a local government’s contractor purchases from a retailer and then integrates into real property that a local government owns or leases.  This “indirect” purchase can in some cases result in use tax liability for a local government.

For example, assume that a construction contractor to a North Carolina county is under contract to build several wooden picnic shelters in the county’s parks.  Further assume that the contractor purchases building materials in Virginia, uses its truck to pick up that lumber in Virginia, pays applicable Virginia sales tax at a rate of 5.3%, and takes the lumber back to the North Carolina county (where the combined rate of state and local sales and use tax is 6.75%) to build the picnic shelters. Must the contractor pay North Carolina use tax to NCDOR when it integrates that lumber into the structure that the North Carolina county owns?

Yes, because the combined rate of sales and use tax in effect in the county exceeds 5.3%Why?  the contractor is using and consuming tangible personal property—lumber—in North Carolina when it integrates the materials into the county’s picnic shelters.  Therefore, North Carolina law subjects the contractor’s consumption of that property—for which it did not pay sales tax in North Carolina—to use tax.[1]  See G.S. 105-164.6(a)(1).  Although North Carolina law would entitle the contractor to a credit for the amount of “sales or use tax due and paid for the item to another state”—in this case, the Commonwealth of Virginia—that credit would not cover all of the contractor’s use tax liability.  See G.S. 105-164.6(c)(2) (state use tax) and the Local Use Tax Statutes, supra.  But if the contractor must pay use tax, why is this a potential problem for the county?

North Carolina law makes the contractor and the owner or lessee of the improved real property—in this case, the county—jointly and severally liable for use tax due upon items integrated into that real property.  See G.S. 105-164.6(b).  If a contractor fails to pay the proper amount of use tax to NCDOR upon items integrated into a county’s structure, the county also can be liable.

Can a Local Government Extinguish Use Tax Liability for “Indirect” Purchases?

Even though a local government has potential liability for “use” tax on its “indirect” purchases, a local government can easily extinguish that liability on “indirect” purchases by taking one simple step: obtaining an affidavit from a construction contractor certifying that applicable North Carolina sales and use taxes have been paid.  See G.S. 105-164.6(b).

In most cases, though, most of North Carolina’s local governments take this step because state law entitles the unit to obtain a refund of North Carolina sales or use taxes properly paid upon “direct” and “indirect” purchases.

Refunds of Sales and Use Tax

North Carolina law entitles most local governments to an annual refund of North Carolina sales and use taxes paid upon their direct and indirect purchases.  See G.S. 105-164.14(c) (entitling counties, incorporated municipalities, and twenty-two other types of local governments to such refunds); N.C. Department of Revenue, Sales and Use Tax Bulletins § 74-4 (Jan. 1, 2023) (“SUTB”).[2]  A local government can apply to NCDOR on an annual basis—using NCDOR Form E-585 and Form E-536R—to receive a refund of these sales and use taxes.

NCDOR will not refund sales taxes paid to another state.  For example, if a North Carolina county’s staff travels to Virginia to purchase lumber, properly pays Virginia sales tax, and returns the lumber to North Carolina to use, it could only receive a refund of North Carolina use taxes paid.  Similarly, even if the picnic shelter contractor in the previous example purchased lumber in Virginia, properly paid Virginia sales tax, integrated the lumber into the county’s property, and paid applicable North Carolina use taxes (after application of the credit for Virginia tax paid)—the local government would only receive a refund of the North Carolina use taxes—not Virginia sales taxes.

  • Refunds for Direct Purchases

If a retailer fails to collect applicable North Carolina state and local sales taxes on a sale made to a local government, the unit must pay state and local use taxes—at rates equivalent to the rates of applicable sales taxes—to NCDOR.  A unit also might need to pay use tax to NCDOR if it properly paid a lower rate of sales tax upon an item purchased and obtained in another state and uses that property in a North Carolina county with a higher rate of tax.  In each case, an eligible unit of local government can obtain a refund of these types of use taxes paid to NCDOR on “direct” purchases.

  • Refunds for Indirect Purchases

An eligible unit of local government also can obtain a refund of use taxes that a contractor pays in connection with “indirect” purchases.  Typically, a contractor pays North Carolina sales or use taxes in purchasing building materials that will be integrated into real property that a North Carolina local government owns or leases, accounts for those costs in pricing its construction contract, and passes those costs along to the unit.  A local government can then apply to NCDOR to receive a refund of these expenses paid to a contractor.

    • Retention of “Certified Statements”

To satisfy NCDOR’s administrative requirements for obtaining a refund of North Carolina sales and use taxes on “indirect” purchases, an eligible local government must obtain a “certified statement” from a contractor that details: (1) the date the property was purchased, (2) the type of property purchased, (3) the name of the retailer from whom the purchase was made and the invoice number, (4) the purchase price of the property and the amount of sales and use tax paid, (5) the project for which the property was used, (6) if the property was purchased in North Carolina, a copy of the sales receipt reflecting the county in which it was delivered, and (7) if the property was not purchased in North Carolina, the county in North Carolina in which the property was used.  See SUTB, § 74-4(D).

Typically, a local government construction contract will require a contractor to provide such a certified statement in connection with each pay application that it submits to a local government or its approving third party.  At that stage, a local government can determine whether a contractor failed to pay applicable North Carolina sales or use tax upon building materials that it integrates into local government property.

    • “Belt and Suspenders” Recommendation: Make the Certified Statement an Affidavit

Although the certified statement must be signed by someone authorized to sign on the contractor’s behalf, NCDOR does not require that it be notarized.  However, local governments can simultaneously extinguish their potential use tax liability and satisfy NCDOR’s recordkeeping requirements for a refund by ensuring that these certified statements are (1) notarized, and (2) include a specific statement stating that all applicable North Carolina sales and use taxes have been paid upon materials integrated into a local government’s property.  That way, a local government can extinguish any liability for the payment of use tax in the event that the contractor’s statement is incorrect and preserve its eligibility for a refund of North Carolina sales and use tax that the contractor properly paid.

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[1] Assume that the contractor purchased lumber from a Virginia lumberyard and required that the supplier deliver the lumber directly to the North Carolina county’s construction site.  Even if that lumberyard does not have a physical location in North Carolina, it likely is a “remote seller” and required to collect North Carolina sales tax upon the sale.  See generally G.S. 105-164.8; N.C. Department of Revenue, Remote Sales Frequently Asked Questions.  In that case, the supplier should charge and collect North Carolina state and local sales taxes that apply in the place of delivery (i.e., the North Carolina county) and remit the proceeds to NCDOR.
[2] North Carolina law has entitled counties and municipalities to an annual refund of sales and use taxes on “direct” and “indirect” purchases since 1961.  See N.C. Pub. Laws 1961, c. 826, § 2(9).  Over time, the legislature has expanded the types of local governmental entities eligible for an annual refund.  At present, local school administrative authorities (i.e., boards of education) are eligible for refunds of local sales taxes, but not state sales taxes.  Compare G.S. 105-164.14(c) (state sales tax refunds to governmental entities) with G.S. 105-467(b) (Art. 39 tax); G.S. 105-483 (Art. 40 tax); G.S. 105-498 (Art. 42 tax); G.S. 105-507.2 (Art. 43 tax for Mecklenburg County); G.S. 105-509.1 (Art. 43 tax for Wake, Durham, and Orange County); G.S. 105-538 (Art. 46 tax).  See also SUTB 74-4(B).

This blog post is published and posted online by the School of Government for educational purposes. For more information, visit the School’s website at www.sog.unc.edu.

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