When a direct-sales or multi-level-marketing company gives away free prizes or awards at a home party, who owes the tax -- the company or the person who receives the prize?

Subject

Direct Sales Organization/Multi — Level Marketing Company — Prizes/Awards/Gifts Given To Hostesses/Home Distributors Hosting Home Parties — Guidelines For Taxability And Refunds

Plain-English summary

An independent distributor for a direct-sales/multi-level-marketing company asked about the tax treatment of free prizes or awards given away at home parties. The company had been collecting tax from the person who received the prize.

The Comptroller's Tax Policy Division said that approach was backwards. It is the company giving away the prize that owes the tax, not the recipient:

• The company holds the prize items in tax-free resale inventory (purchased for resale, so no tax was paid on them).
• Taking an item out of that resale inventory to hand it out as a free prize or award is a divergent use of the property -- it's no longer being resold, so tax becomes due, and it is the party awarding the prize who owes tax on the item's cost.
• Tax that was instead collected from the recipient of the prize was collected in error.

Amounts collected in error from recipients cannot be used to offset the company's own tax liability on the divergent use. Under Tax Code § 111.016(a), anyone who collects a tax (or money represented to be a tax) from another person holds it in trust for the state and is liable for the full amount plus penalty and interest. So the tax wrongly collected from prize recipients has to either be returned to those recipients or remitted to the state -- it can't just be kept or netted against what the company owes.

The letter notes the opinion is based on the facts presented and could change if the facts are different.

What this means for you

Direct-sales and multi-level-marketing companies

If your company gives away merchandise as prizes or awards at home parties (or through hostesses/distributors), you -- not the prize recipient -- owe use tax on the item's cost when it comes out of resale inventory. Don't collect tax from the person who wins or receives the prize.

Independent distributors and hostesses

If you've been charged tax on a prize or award you received at a home party, that tax was collected in error. It's the company's responsibility to pay tax on the item's cost, not yours to pay tax on receiving it as a gift.

Accountants and tax professionals

Watch for this "divergent use" pattern any time inventory purchased tax-free for resale is instead given away, used internally, or otherwise diverted from resale. The party diverting the item owes tax on its cost. Separately, if tax was ever collected in error from a customer or recipient, § 111.016(a) requires that amount be returned to that person or remitted to the state -- it cannot be used to offset other tax liabilities.

Common questions

Q: Who owes the tax when a company gives away a free prize at a home party?
A: The company (or whoever awards the prize) owes tax on the item's cost, because taking it out of tax-free resale inventory to give away is a divergent use.

Q: Can the company charge tax to the person who receives the prize?
A: No. Tax collected from the recipient is collected in error.

Q: What happens to tax that was already collected from prize recipients in error?
A: It must be returned to the recipient or remitted to the state. It cannot be used to offset the company's own tax liability on the divergent use.

Q: What's the legal basis for returning or remitting tax collected in error?
A: Tax Code § 111.016(a): anyone who collects a tax, or money represented to be a tax, from another person holds it in trust for the state and is liable for the full amount collected plus accrued penalty and interest.

Citations and references

• Tex. Tax Code § 111.016(a) (tax collected from another held in trust for the state)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9608L1426A07

Original ruling text

August 26, 1996

Attn: Sales Tax Department

Dear Sir/Madam:

The question has been raised by one of your independent distributors about
the taxability of free prizes or awards given at a home party. The tax has
been collected from the recipient of the prize or award.

It is our understanding that your company is giving away the prizes or
awards. The persons that awards the prize is responsible for the tax on
its cost. Taking the prize out of a tax free inventory [items purchased
for resale] is a divergent use of the property and tax is due by the
purchaser.

The tax was collected in error from the recipient of the prize. The
amounts collected in error cannot be used to offset your company's liability.

The tax collected from the recipient for the value of the prize has to be
returned to the payor or remitted to the state. Texas Tax Code 111.016 (a)
states: "Any person who receives or collects a tax or any money represented
to be a tax from another person holds the amount so collected in trust for
the benefit of the state and is liable to the state for the full amount
collected plus any accrued penalties and interest on the amount collected."

This opinion is based upon the facts presented. If there are additional or
different facts, the opinion may change.

You may call me toll free at 1-800-531-5441 extension 50892. The direct line
is 512/475-0892. You may also write to Tax Policy Division, Comptroller of
Public Accounts.

Sincerely,

John J. Fitzgibbons, CPA
Tax Policy Division