By Joe Haberzetle, JD, LLM
Note: the information in this article had additional updates on February 19, 2018. View the updated article here.
In our May 2014 article, we discussed the difficulties commercial and residential landlords encounter in determining the extent to which amounts received from tenants are subject to Washington B&O tax. While rental income is generally exempt from B&O tax, receipts from ancillary fees and services provided to tenants may not be exempt. A recently published Department of Revenue administrative appeal determination provides new insight on this thorny issue.
The question presented in the determination was whether promotional dues received by mall owners from their tenants were subject to B&O tax. The promotional dues at issue went to fund professional advertising and promotional services that were expected to benefit all tenants of the malls.
The mall owners were not in the business of providing advertising; they merely spent the promotional funds on behalf of the tenants and the malls as a whole. In evaluating whether the dues were includible in rents, the Department of Revenue considered three factors: (1) whether the fees were part of the normal and customary landlord-tenant relationship; (2) whether payment of the fees entitled the tenants to anything beyond the right to occupy their rented premises; and (3) whether failure to pay the fees was considered a breach of the lease agreement, linked to default and potential eviction. The determination provided the following analysis of the three factors:
- Proving whether an amount paid by the tenant is customary in the industry can be difficult. The mall owners supported their position by showing that the relevant clause in the lease agreement was common in contracts between mall owners and tenants. It also cited language from the Internal Revenue Code recognizing promotional services provided to tenants as customary. Thus, the first factor was satisfied.
- The promotional dues were written into the lease agreement as mandatory for the tenant to pay, and the calculation was based in part on the squared footage of leased space. Further, the tenants were not entitled to specific advertising services in exchange for the dues; the mall owner had sole discretion over how to spend these funds. Thus, the second factor was satisfied.
- Failure to pay the promotional dues constituted a breach of the lease agreement, resulting in the tenant potentially being evicted. Thus, the third factor was satisfied.
Although the issue in the determination was limited to promotional dues, the same analysis could potentially be applied to a variety of other charges that are typically imposed on tenants by commercial and residential property owners/managers. It is unclear whether this would cause the Department to change its position on the taxability of ancillary charges; this may depend in part on whether the Department’s revenue auditors take note of this determination and how strictly they choose to apply the test it articulates.
Tax determinations are published by the Department of Revenue to make taxpayers aware of how statutes and regulations have been applied to a given fact pattern, but they may only be directly relied on by the taxpayer to whom the determination is issued. However, this analysis should be useful to landlords in addressing what can be a tricky issue and which has resulted in conflicts between property owners and the Department of Revenue in the past.
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