Legislature(2005 - 2006)
04/30/2005 02:15 PM L&C
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* first hearing in first committee of referral
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SB 158-MUNI TAX ON STATE CONSTRUCTION CONTRACTS 3:11:47 PM CHAIR ANDERSON announced that the final order of business would be SENATE BILL NO. 158, "An Act prohibiting the imposition of municipal sales and use taxes on state construction contracts and certain subcontracts; and providing for an effective date." SENATOR CHARLIE HUGGINS, Alaska State Legislature, sponsor, began by saying that SB 158 represents the interest of the citizens of Alaska. This legislation will maintain what most believe is already the case. He posed a situation in which there is a state airport project for $8 million. In the process, a subcontractor is subjected to a 5 percent sales tax on that subcontractor's $400,000 contract, which amounts to about $21,000. However, that wasn't the process when the subcontractor bid on the project. In discussions with folks about this, [subcontractors] didn't view the aforementioned scenario as appropriate and even inquired as to how much [money] a community wants from them. Therefore, SB 158 has been introduced. SENATOR HUGGINS informed the committee that SB 158 doesn't preclude taxation on the equipment leased in the locale. He emphasized that this legislation isn't about "rural" or "urban" areas but rather about how the state does business. In a normal year, the state has about $350-$400 million worth of construction contracts. If the state doesn't take action similar to what's encompassed in SB 158, an unstable environment will be created. He informed the committee that he has an e- mail from the Alaska Municipal League (AML) that indicates that communities using a certain law firm have a policy of collecting sales tax from subcontractors doing business in the community, regardless of the funding source. 3:15:43 PM SENATOR HUGGINS said that when talking with state agencies, it was foggy at best regarding the state's position on taxing authority. This legislation clarifies the aforementioned and provides a predictable business environment. 3:16:17 PM CHAIR ANDERSON noted that his research has determined that the impact of [such taxation practices] is de minimis, although he acknowledged that it adversely impacts the City of Nome. He asked if there is a way to grandfather in current infrastructure where there are taxes, or would that defeat the purpose of the legislation. SENATOR HUGGINS indicated that from his conversations with average Alaskans, the question is how much is enough. Senator Huggins emphasized that [allowing the current situation to continue] will drive up the cost of contracting and will cost all Alaskans. In response to Chair Anderson, Senator Huggins said, "Where we're going out to enhance that community, that to reach out and carve money out of that and drive up the price of contracting is not right." 3:17:39 PM REPRESENTATIVE CRAWFORD inquired as to what the contract was for that cost the subcontractor in the earlier example $21,000 in taxes. SENATOR HUGGINS explained that it was an electrical contract for $400,000 and the community imposed a 5 percent tax on that. Senator Huggins reiterated that such a practice isn't right. REPRESENTATIVE CRAWFORD posed a situation in which a [subcontractor] had a contract to construct a fence at an airport. If that [subcontractor] miscalculated the amount of fencing necessary and purchased the remainder of the fencing in the location of the construction, would that [subcontractor] be charged the sales tax. SENATOR HUGGINS replied yes. In the case that prompted this legislation, the electrical company spent just shy of $80,000 in the community on things from hotel rooms to rental cars and paid tax on those items. The legislation doesn't [change that]. 3:19:28 PM SENATOR HUGGINS, in response to Representative LeDoux, clarified that even under SB 158 the [subcontractor] in Representative Crawford's example would pay the tax on the fencing purchased in the location of the construction. In further response to Representative LeDoux, Senator Huggins informed the committee that at least two boroughs or cities, Sand Point and Nome, have levied the tax [on a state contract] at least once. Both those communities are advised by the same law firm. He mentioned that Unalaska may potentially be the third such community. Senator Huggins remarked that the specific communities aren't important because without something like SB 158, this business practice will spread throughout the state. He noted that in the Senate only three members didn't agree with this legislation. 3:20:46 PM REPRESENTATIVE LEDOUX related her understanding that a city or borough can't tax the state. SENATOR HUGGINS answered that it's not clear. Although the state assessor would agree that a city or borough can't tax the state, he would include a "but" clause. Therefore, SB 158 clarifies the situation. 3:21:23 PM REPRESENTATIVE LEDOUX inquired as to how this occurs now. SENATOR HUGGINS specified that the city or borough merely taxes the subcontractor. He reiterated that SB 158 is about the people of Alaska and whether the desire is to increase the price of contracting or establish a mechanism such that across the state purchases at the location of the project would be taxed. 3:22:50 PM REPRESENTATIVE LEDOUX inquired then as to how this legislation is different from the current practice. CHAIR ANDERSON clarified that Senator Huggins is delineating between tangible items [such as the purchase of nails] and providing a service [the subcontractor's work]. 3:23:31 PM SENATOR HUGGINS explained that in the example with the airport, the contract was to fix the airport to a standard the community would like. When [the subcontractor] purchases something in the community, there would be a tax on that purchase. REPRESENTATIVE LEDOUX surmised then that under SB 158 if the subcontractor was located in the community and sold his/her services to someone, not to a contractor on a state project, in the community, then there would be a sales tax. However, the subcontractor who sells his/her services to the contractor on a state project would not be taxed, even if the subcontractor is located in the community. Representative LeDoux specified: You could have a contractor come in from Anchorage, for example, but then they hire somebody from ... Nome to be the subcontractor on it. Now normally, if that subcontractor were selling to anybody else in Nome there would be a tax on that. So, how would this be different, then? SENATOR HUGGINS expressed his desire that both contractors and subcontractors for the state would be taxed [for items purchased] and not be penalized by the location of their business. 3:25:45 PM REPRESENTATIVE ROKEBERG said that he finds the concept of potential double taxation very compelling and thus he expressed his support of SB 158. However, Representative LeDoux makes a good point in regard to whether there is a definition of subcontractor in statute. Furthermore, he questioned whether there is a distinction between the service component of a subcontractor and a supplier of materials that would be taxable in the local municipality. Representative Rokeberg opined that there is the desire to avoid the double taxation, but the legislation shouldn't be used to avoid the payment of local taxes that would occur under normal circumstances for the purchase of an item. SENATOR HUGGINS agreed that there will be a tax on materials purchased in a community. REPRESENTATIVE ROKEBERG posed a situation in which the supply of materials is subcontracted out. SENATOR HUGGINS specified that materials aren't exempt. 3:27:35 PM REPRESENTATIVE ROKEBERG returned attention to the earlier hypothetical regarding the fencing project, and inquired as to the tax ramifications if the subcontractor merely supplied the material. SENATOR HUGGINS said that he didn't know. 3:29:25 PM REPRESENTATIVE GUTTENBERG related his understanding that the contractor isn't taxed, but the subcontractor is taxed for the total value, regardless of services. He then asked if all subcontractors are taxed, regardless of the location of the business. SENATOR HUGGINS reiterated that this [taxation on subcontractors] will spread throughout the state if nothing is done. However, he agreed that there should be assurances that there shouldn't be a way to circumnavigate [appropriate local taxation]. Senator Huggins said that he would obtain an answer for Representative Guttenberg. REPRESENTATIVE GUTTENBERG inquired as to whether this is a new practice or ordinance. SENATOR HUGGINS specified that this is a new practice. 3:32:00 PM DAVID LANTZ, General Manager/Owner, Dimond Electric; Board Member, National Electrical Contractors Association - Alaska Chapter (NECA), informed the committee that he bid the Nome project in August 2001 and performed the work in 2002. He noted that Dimond Electric had done work on the Nome airport over the course of the last 15 years. During those 15 years, the tax had never been an issue because by definition it's a retail sales tax. Dimond Electric purchased some $75,000 worth of services and goods in the city and paid taxes on those. The company also paid the sales tax on the gross amount of the subcontract, and therefore Dimond Electric was double taxed on the portion paid on the items and services purchased in the city. Mr. Lantz highlighted that it wasn't until 2002 that [the City of Nome] applied the sales tax to Department of Transportation & Public Facilities projects, and thus there was a change in the [city's] interpretation of how to apply the tax. 3:34:26 PM MR. LANTZ opined that Dimond Electric was caught by surprise with the change, and therefore the company paid some $20,000 in taxes as well as another $10,000 or so in attorney fees to resolve the issues. As a NECA board member, Mr. Lantz informed the committee that research discovered that there were other instances, beyond the Nome project, in which the [double] taxation occurred. Mr. Lantz expressed the need to have a known playing field with regard to what's taxed on state projects in communities across the state. 3:36:51 PM REPRESENTATIVE GUTTENBERG asked if, in a normal bid document for a state project, [the subcontractor] would receive all of the taxation policies that would apply. MR. LANTZ, drawing on his 20 years of working on state projects, that subcontractors worked under the assumption that they, as well as the general contractor, were not subject to sales tax. Therefore, it hasn't been an issue on state projects because in practice state projects have been exempt from the sales tax. 3:37:53 PM REPRESENTATIVE LEDOUX surmised that the real problem is that Mr. Lantz's company was caught between the changes made between 2001 and 2002. Therefore, if the subcontractor now knows, she inquired as to how difficult it would be to check with the communities regarding taxation just as they would check fuel and material prices. MR. LANTZ said that he didn't want to see communities changing their mind about taxation [between the time a project is bid and the work is performed]. 3:39:13 PM REPRESENTATIVE ROKEBERG asked whether the general contractor paid a tax as well as Mr. Lantz. MR. LANTZ explained that the general contractor didn't pay a tax on its contract, although he did pay taxes on the local services purchased in the community. Several subcontractors received bills from the city. 3:39:54 PM REPRESENTATIVE CRAWFORD asked whether a private contractor in the City of Nome would be charged sales tax on the total amount of a non-state contract. MR. LANTZ related his belief that tax-exempt status has only been applied to state contracts and thus contractors pay local taxes on private work in the City of Nome. 3:40:48 PM DENISE MICHELS, Mayor, City of Nome, noted that the committee should have a copy of her three-page letter in opposition to SB 158. This legislation, she opined, unfairly restricts the city's ability to raise revenues for services. She informed the committee that most of the revenue received by the City of Nome is through property and sales taxes. However, 40 percent of the property in Nome is exempt, yet those [residents] use the city's services like everyone else. When contractors work in the community, they too use the city's services. Therefore, collecting a sales tax on the subcontractors helps pay for the use of those services. Mayor Michels pointed out that whether or not to charge the sales is an option. She indicated that larger communities don't apply the sales tax in this way because they have a larger tax base. MAYOR MICHELS highlighted that the rules of engagement differ in each community, and in fact the state request for proposals recommends contacting the local government regarding possible fees. She then turned attention to the recent lack of municipal revenue sharing, which she indicated was a [contributing factor] for the City of Nome in 2004 to raise its sales tax from 4 percent to 5 percent in order to help offset the rising operating costs for the community. Mayor Michels said that taking away this taxation option would hurt the City of Nome. She informed the committee that the contractor is exempt from the sales tax [on state projects] and obtains a building permit that provides tax-exempt status on purchases in the town. The subcontractor can also apply for a building permit. 3:44:12 PM REPRESENTATIVE ROKEBERG inquired as to whether the tax exemption for a general contractor is in the City of Nome's local ordinance. MAYOR MICHELS indicated that it's state law. DEBORAH GRUNDMAN, Staff to Senator Huggins, Alaska State Legislature, pointed out that due to the state's sovereign immunity, the state is immune from taxation except when it has expressly been waived by the state. Nothing in statute waives the state from taxation, she said. Therefore, the problem is: "there's a contract and a subcontractor is tied right to that, defined as an entity to whom the contractor sublets part of the contract." Practices such as in Nome raise the price of construction projects. 3:45:30 PM REPRESENTATIVE ROKEBERG returned to the earlier mention that a subcontractor could apply for a building permit in order to receive an exemption from the sales and use tax. MAYOR MICHELS clarified that the holder of the building permit would not have to pay tax on the supplies purchased in town. She noted that most contractors and subcontractors ship in their materials to Nome. 3:46:10 PM REPRESENTATIVE ROKEBERG surmised then that Mayor Michels believes that the issue of double taxation could've been avoided if the subcontractors had applied for a building permit. He inquired as to the fee for a permit on a $400,000 contract. MAYOR MICHELS answered that the fee is based on a percentage of the project. 3:46:41 PM KATHIE WASSERMAN, Alaska Municipal League (AML), related that AML is opposed to SB 158, which is outlined in a letter that should be in the committee packet. Ms. Wasserman said that AML's main concern is that the legislature and the administration, through various actions, have made it clear that municipalities will have to survive on their taxing ability. She related that AML believes that taxing decisions should be left to those at the local level. REPRESENTATIVE CRAWFORD inquired as to how Ms. Wasserman felt about the same construction dollars being taxed twice. 3:49:01 PM MS. WASSERMAN, recalling her experience as a contractor, said that when she wasn't [working] on a state project, she paid sales tax on her contract as well as the services she incurred while in the community. Ms. Wasserman highlighted that in many communities there are state buildings that aren't taxed at all, while the state receives the same services as all the property taxpayers in the community. 3:49:52 PM SENATOR HUGGINS characterized this practice [of taxing subcontractors on state projects] as being viewed as revenue sharing by those communities using it. However, he indicated that doing so drives up the price of contracting. Therefore, Senator Huggins opined that it's a simple question. Senator Huggins suggested that people could be charged for the use of the local services, but "don't go after the contractor" [because either way they pay for the services used]. He reminded the committee that SB 158 would create a stable environment and contain the price of contracting. 3:52:32 PM REPRESENTATIVE KOTT announced that he has a conflict in voting because SB 158 could potentially impact his business environment. CHAIR ANDERSON said that Representative Kott would be required to vote. 3:53:02 PM REPRESENTATIVE GUTTENBERG said that he's torn between both sides of this issue. CHAIR ANDERSON said that although he, too, is torn, the legislation should move forward. He also recognized the dilemma that municipalities face with budgeting. 3:54:28 PM REPRESENTATIVE CRAWFORD opined that there are two questions here. One is whether there should be municipal assistance and revenue sharing and the other is whether state projects should be taxed by a municipality. He noted that he believes in municipal assistance and revenue sharing, but that's not what SB 158 is about. He recalled testimony that the local community benefits when the state spends state dollars in a community, and therefore he opined that those dollars shouldn't be taxed. Representative Crawford concluded by announcing that he would advance SB 158. 3:55:11 PM REPRESENTATIVE LEDOUX said that she wouldn't hold up the legislation. However, she reiterated that she has some serious problems with it because she didn't see any difference between the state having a contractor and the municipality taxing the subcontractor or a private individual. REPRESENTATIVE LYNN moved to report SB 158 out of committee with individual recommendations and the accompanying zero fiscal note. There being no objection, it was so ordered.