Last Friday, the Alabama Court of Civil Appeals handed the Department of Revenue (Department) a significant loss in their continued attempt to tax non-enumerated services and tangible property provided in conjunction with those services under the sales tax. See State Dep’t of Revenue v. Omni Studio, LLC, No. 2140889 (Ala. Civ. App. Apr. 29, 2016). Specifically, the appellate court affirmed the taxpayer’s motion for summary judgment granted by the trial court, which set aside the Department’s assessment on the basis that photographs provided by a photography studio are merely incidental to the nontaxable photography services provided by the studio. While the prospective effect of the holding in the photography context is unclear due to recent amendments to the photography regulation (effective January 4, 2016), the case is significant in that it strengthens the “incidental to service” (or “true object”) precedent in Alabama and should be seen as a rebuke to the Department for ignoring judicial precedent in favor of their own administrative practices and guidance.
This decision is important in analyzing the taxability of mixed/bundled sales to Alabamans (i.e., where services and some degree of tangible personal property are provided as part of the same transaction). As with any decision, taxpayers should consider potential refund claims.
Facts
Omni Studio, LLC (Omni) is a photography studio in Birmingham, Alabama that provides photography services to a variety of customers ranging from advertising and marketing firms to wedding parties. During the audit period, Omni had not remitted any sales tax on the photographs and services provided as part of its business and charged clients based on the time and resources spent to provide the services offered (as opposed to the number, size or type of photo produced). In June 2013, the Department audited Omni for a six-year period from 2007-2013. At the conclusion of the audit, the Department determined that Omni owed sales tax for “headshots, flat-rate photography sessions, digital studio photography, portraits, weddings and reception events” and issued a final assessment to the tune of over $27,000—which included interest and penalties. Omni appealed the final assessment to the Jefferson County Circuit Court and the parties each filed motions for summary judgment. The trial court denied the Department’s motion and granted Omni’s—setting aside the Department’s final assessment. The Department appealed.
Taxpayer’s Argument
Omni cited a number of Alabama cases standing for the notion that some transfers of tangible personal property are merely incidental to the nontaxable sale of services and, therefore, are not themselves taxable under a true object analysis. For example, they highlighted an Alabama Supreme Court decision finding that the transfer of dentures and other prosthetic devices from a dentist to patient is not a sale, but a mere incident to the professional treatment rendered by dentists. See Haden v. McCarty, 275 Ala. 76, 78, 152 So.2d 141, 142 (1963). Omni noted that the court has expanded this notion beyond the “learned professional” context and directed the court to two decisions finding catalogues and brochures provided by an advertising agency and portraits provided by an artist to be merely incidental to the sale of the services provided. See State v. Harrison, 386 So.2d 460, 461 (Ala. Civ. App. 1980) (public relations services); see also State v. Kennington, 679 So.2d 1059 (Ala. Civ. App. 1995) (artistic services). Omni argued that there is no meaningful distinction between the services and personal property Harrison and Kennington provided to their clients and the services and property Omni provides.
While the taxpayer initially argued at the trial court level that the license to use the images it provides is not a transfer of ownership (and not a sale), it backed away from this argument during the appellate court proceedings and the issue was not addressed.
Department’s Argument
The Department asserted that Alabama has long rejected the argument that a photographer renders a nontaxable professional service and took the position that the sale of photographs are taxable retail sales under Alabama law. In making this argument, they did not point to any decisions of the Court of Civil Appeals or Alabama Supreme Court, but instead relied on three administrative law division decisions.
Holding
The appellate court affirmed the trial court decision granting Omni’s motion for summary judgment, agreeing with Omni that there is no meaningful distinction between the photos provided by Omni and the various items of tangible personal property provided in Harrison and Kennington. The court pointed out that at least one of the administrative law division decisions relies on the administrative decision in Kennington, which has since been abrogated. The court found that although the interpretation of the statute by an administrative agency charged with its enforcement is persuasive, that interpretation is not binding on the court. Citing stare decisis, the court concluded that they were not asked to revisit their various holdings finding transfers of tangible personal property to be merely incidental to nontaxable services, and refused to overrule the controlling precedent cited by the taxpayer.
Practice Note
This decision transcends the photography context and may provide a basis for refund claims for providers of other services that collect on the tangible personal property they provide in Alabama. Photography businesses should be careful not to overlook the Department’s amended photography regulation. However, this regulation is not applicable to other service-based taxpayers and photographers doing business in Alabama before this year. At a minimum, this case provides a reminder of the binding “incidental to service” test and the persuasive effect of any Department guidance to the contrary.
It should be noted that this Department loss comes just a month after the Department made an unsuccessful push to legislatively expand the definition of tangible personal property to include “digital goods.” See our prior coverage on the rejection of this proposal by the Alabama Legislature. The competing exemption bill on the topic (House Bill 349) has yet to advance in the Senate after being passed in the House on April 12, 2016. Last week, Commissioner Julie Magee circulated a letter to state legislators opposing the bill and restating the position of the Department that there is no difference between digital and non-digital transactions. Similar to the Department’s position on photography services in Omni, the basis for this position is tied to administrative decisions and practices—which the Court of Appeals emphasized is not binding. In light of the lack of a legislative solution this year, the Commissioner’s letter indicated that the Department will not initiate any new audits on the issue and will hold in suspense any preliminary assessments of taxpayers interpreting digital transactions as nontaxable.
The Commissioner’s letter and Omni signify additional ammunition in the ongoing battle over the taxation of digital goods and services in Alabama—a battle that is likely to continue into 2017 with a legislative solution looking unlikely this year.
