Could a separate purchasing entity use a Kansas direct-pay permit and then accept a resale certificate from the related operating entity that consumed the property?

Plain-English summary

An adviser proposed creating a separate purchasing entity to make centralized purchases for an operating entity. The purchasing entity would hold a direct-pay permit, while the operating entity would give it a resale certificate even though the operating entity used the property.

The Department said the structure had basic flaws. Direct-pay permits allowed taxpayers to defer tax on their own business-use purchases when the proper destination or treatment was difficult to determine — for example, railroad materials stored in Kansas before their installation state was known.

The permit was not intended for a purchasing entity's sales to another legal entity. The operating entity could not issue a resale certificate for property it bought to use or consume.

The adviser also wanted to buy unspecified services under the permit and account for tax later. Centralized compliance could be a valid reason to request a permit, but the Secretary had broad discretion and needed complete facts because permits increased audit burdens. The Department specifically said direct-pay permits could not exempt real-property contractor billings, where the permit holder could not account for tax on both labor and the contractor's own material purchases.

A separate purchasing division inside the operating company might avoid the improper two-entity resale arrangement, but the Department still needed details about the services and the problem the permit would solve.

The letter was not a Private Letter Ruling because the taxpayer was not identified and the facts were incomplete.

What this means for you

Centralized purchasing groups

Do not pair a direct-pay permit held by one entity with a resale certificate from a related entity that consumes the property.

Operating companies

A division within the same legal entity may be structurally different, but permit approval still requires a full factual explanation.

Tax professionals

Identify the taxpayer, purchases, services, sourcing uncertainty, and accounting difficulty. General efficiency claims alone did not support a determination.

Common questions

Q: Can an operating entity claim resale for property it uses?
A: No. The Department called that resale claim improper.

Q: What is a proper direct-pay use?
A: The letter's example involved a taxpayer's own materials whose ultimate taxable destination was not known when purchased.

Q: Can a direct-pay permit cover real-property contractor invoices?
A: No under the opinion because the holder could not properly account for labor tax and the contractor's material tax.

Q: Did the Department issue a binding Private Letter Ruling?
A: No. The taxpayer and operative facts were insufficiently identified.

Citations and references

• Kansas temporary-storage rule — discussed through the railroad example; no section number cited
• Notice 98-03 — cited for situations where a direct-pay permit may not benefit the operating company

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: O-2002-001

Original ruling text

Opinion Letter

Body:

Office of Policy & Research

January 8, 2002

XXXX
XXXX
XXXX

RE: Your inquiry about direct pay permits

Dear XXXX:

I have been asked to answer your letter that we received late last year. You request a private letter ruling. A private letter ruling is issued only when the taxpayer is identified and when the operative facts are sufficiently complete to allow an opinion to be formed and a determination made. You do not identify the taxpayer nor do you set forth facts that describe its business operates. Accordingly, my letter to you is not a private letter ruling. However, I believe that I can provide you and your client guidance about the questions that you raise.

Your letter discusses whether or not a direct pay permit can be issued to a company (Purchasing Entity) that is created by a client (Operating Entity) to make centralized purchases for the client (Operating Entity). You believe that the Operating Entity can then issue a resale exemption certificate to the Purchasing Entity for the items the Operating Entity uses.

This scheme contains a number of basic flaws as it related to Kansas sales tax. A direct pay permit is issued to taxpayers to exempt purchases of items that they use in their business operations and have difficulty accounting for. For example, a railroad in Kansas may purchase and store rails and ties from an out-of-state vendor for eventual use in several different states. Kansas has a temporary storage rule. Accordingly, the railroad cannot know which state should receive the use tax until the rails or ties are removed from inventory in Kansas and shipped to the site where they are installed. A direct pay permit allows the railroad to pay tax at the time the destination of the rails and ties is fixed. The rails and ties are something that railroads purchase for their own use.

Under your proposal, a direct pay permit would be used as part of an accounting scheme where one entity holds the direct pay permit and sells exempt under a resale exemption certificate to another entity that uses the property. This would be inappropriate because a direct pay permit should not be used only to exempt items that a business, such as the Purchasing Entity, sells and a business, such as the Operating Entity, cannot claim a resale exemption certificate on things that it buys to use or consume.

You also state that the Purchasing Entity intends to use the permit to buy services exempt from sales tax and account for the tax later. You assert that this would enable your client "to simplify and centralize its sales/use tax reporting, review and compliance process." While these are valid reasons for requesting a direct pay permit, you do not explain what the services are. The Secretary of Revenue has broad discretion when issuing direct pay permits, since permits place additional burdens on our audit staff to assure that the permit holder is properly accounting for the taxes owed. Without a full disclosure of the problems that a taxpayer hopes the direct permit will remedy, a direct pay permit should not be issued. Because your letter does not explain what the services are, I can only guess at whether a direct pay permit may be used to benefit the Operating Company. For example, direct pay permits cannot be used to claim exemption on billings from real property contractors since the direct permit holder has no way to account for the tax due on labor services and the tax due on the contractor's purchases. As Notice 98-03 indicates, there may be other situations where a direct pay permit would not benefit the Operating Company.

Please note that reorganization might work if the Operating Company creates a separate division within it to account for the purchases made under a direct pay permit. This would avoid the problems of having two separate legal entities involved with one making and the other honoring improper resale exemption claims. Even if this organizational approach is workable for your client, you still have not identified what services are involved. Without such facts, I can only guess whether a direct pay permit would be appropriate for the Operating Company. While I appreciate your apparent confidentiality concerns, you must provide me with additional information before I can begin to provide you with a meaningful discussion about you client's business plans.

If you and your client choose to provide me with the additional information, I will be happy to review what you send.

Sincerely,

Thomas E. Hatten
Attorney/Policy & Research

Date Composed: 01/09/2002 Date Modified: 01/10/2002

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