Department of Finance and Administration

Transcription

1 STATE OF ARKANSAS Department of Finance and Administration REVENUE LEGAL COUNSEL Post Office Box 1272, Room 2380 Little Rock, Arkansas Phone: (501) Fax: (501) October 19, 2017 RE: Arkansas Gross Receipts Tax and Use Tax to a Smart Irrigation Control System Opinion No Dear, This is in response to your letter dated September 1, 2017 to Mr. Paul Gehring, Assistant Revenue Commissioner with the Arkansas Department of Finance and Administration ( DFA ), requesting a legal opinion on behalf of your client, ( Taxpayer ). Your request was forwarded to me for response. Your letter presented the following facts for consideration by DFA: Facts Presented The Taxpayer is an agricultural technology startup headquartered in, with product research and development located in Arkansas. It plans to begin offering smart irrigation control systems with Arkansas as its first market. The Taxpayer is a corporation. While it has not yet done so, the Taxpayer plans to register with the Department of Finance and Administration. The Taxpayer is developing smart farming technology for intelligent irrigation and water conservation. It will sell precision irrigation control systems to farmers. These systems will allow farmers to conserve water and energy, improve crop yields, and reduce labor and equipment maintenance costs. A sample diagram for a Taxpayer system is attached as Exhibit A. The initial target market for Taxpayer s system is Arkansas farmers, and particularly rice farmers and furrow irrigated row-crop farmers. It is critical for the Taxpayer to be able to explain the Arkansas sales and use taxation of its irrigation control system to customers.

2 Product details for the components of Taxpayer s system are provided in the Equipment Descriptions attached as Exhibit B. To summarize the equipment comprising the smart irrigation system: 1. Pump controls for electric irrigation pumps (EP1) and diesel irrigation pumps (DP1). The devices monitor and control the pumps. There is also an electric pump high voltage switch (HV1), and a diesel fuel tank level pressure sensor (FPS1) 2. Flow meters (FMK) that monitor the flow rate and total water extraction from irrigation wells. The flow meter is installed by screwing it into a flow meter saddle (SD8, SD10) that is attached to the piping coming out of the irrigation well. 3. Soil moisture and water level probes (PR1 and ULS1) and monitoring stations (MM1). The probes monitor soil moisture or water level and communicate that information to the monitoring station via a wired connection. The monitoring station then communicates wirelessly to the base station. 4. Weather monitoring station (WS1) that monitors local weather conditions. 5. Network equipment to operate a local wireless cellular communication network: a. Each field device that communicates wirelessly includes a remote telemetry device, commonly called a node. b. There is a central base station and antenna at the farm headquarters, essentially a computing device (BS1) connected via coaxial cable to an antenna (SS1) placed on a high part of the house or building from which the farm is managed. There also are other networking electronics (HQIT) used to set up the local network. The central base station connects to the internet via the farmer s ordinary, third party internet connection, using ethernet or Wi-Fi. The central base station also can connect to local computers. The base station can store up to a year s worth of data from the system. c. There may be other, repeater nodes (SR1), if needed, to relay signals between the base station and field devices. As part of the initial sale and installation of the system, the Taxpayer will charge an installation service fee. The system will be sold with a one-year warranty. After the warranty expires, the Taxpayer anticipates offering repair services on system equipment.

3 The initial system purchase includes software that has been installed on the hardware and that can be downloaded and installed on customer computers and mobile devices. The software allows a customer to monitor and control the irrigation system. Software details are enclosed as Exhibit C. The software can set up automation to turn irrigation pumps on or off based on data received by the system. Initial download of the software to customer computers and mobile devices is included with purchase of a system. Software runs on the system equipment and customer devices; the software is not cloud-based. Subsequent annual software updates (ASU1) will be made available for direct download for additional fees as discussed below. The Taxpayer s equipment is portable and modular. The system can be customized to fit various farm locations and sizes. The component items of equipment, however, are standardized and can be removed and reused in other locations on the farm or on other farms without any injury to the real property. As the Taxpayer initially brings its product to market, it will sell directly to farmers and subcontract installation through local third-party providers. It will have an employee sales representative in Arkansas to solicit customers. As its business becomes more established, the Taxpayer expects to move to a wholesaler / dealer model. Pricing for the Taxpayer s systems will be modular and quoted based on a custom design tailored to fit the customer s existing irrigation equipment. A sample quote sheet is attached as Exhibit D. Invoicing format will be similar to the quote sheet. The Taxpayer will also offer optional annual software updates for a fee. These annual software update charges are not required for continued operation of the system in place. Requested Opinions Based upon these facts, you ask that DFA agree with the following legal position regarding Taxpayer s irrigation control systems: 1. The sale and installation of the equipment will be considered the sale of tangible personal property and not the improvement of real property. 2. The sale of the equipment will qualify for the farm equipment and machinery exemption of Arkansas Code Annotated section , if the buyer will use the equipment exclusively in farming. 3. System installation charges will be exempt from tax. Subsequent equipment repairs will be taxable. 4. Software updates will not be subject to tax.

4 Applicable Law Arkansas law provides a sales and use tax exemption for the purchase of farm machinery and equipment. That exemption is codified at Ark. Code Ann and reads as follows: (a) As used in this section: (1)(A) Farm equipment and machinery means implements used exclusively and directly in farming. (B) Farm equipment and machinery includes: (i) Irrigation pipe used to carry water from an irrigation well to the crops produced in farming regardless of whether the irrigation pipe is used above ground or is buried underground; and (ii) Implements used to harvest crops produced in farming by others. (C) However, farm equipment and machinery shall not include implements used in the production and severance of timber, motor vehicles of a type subject to registration, airplanes, or hand tools; and (2) Farming means the agricultural production of food or fiber as a business or the agricultural production of grass sod or nursery products as a business. (b) The gross receipts or gross proceeds derived from the sale of new and used farm equipment and machinery are exempt from the Arkansas gross receipts tax levied by this chapter. (c) The Director of the Department of Finance and Administration shall promulgate rules and prescribe forms for claiming the exemption provided by this section. Gross Receipts Tax Rule GR-51 has been promulgated by DFA to assist in the implementation of the sales and use tax exemption for farm machinery and equipment. The relevant portion of that rule regarding the treatment of irrigation related equipment is quoted below: A. The gross receipts or gross proceeds derived from the sale of new and used farm equipment and machinery is exempt from gross receipts tax. B. DEFINITIONS. 1. Farm equipment and machinery means agricultural implements used exclusively and directly for the agricultural production of food or fiber as a commercial business or the agricultural production of grass sod or nursery products as a commercial business. Farm equipment and machinery does not include implements used in the production and severance of timber, motor vehicles that are subject to registration, airplanes, or hand tools. a. The following agricultural implements are exempt provided they meet the requirements of GR-51(C)(1) and GR-51(C)(2): Combines, cotton pickers, cotton module builders, cotton trailers, cultivators, discs, farm tractors, (other than garden tractors) harrows, irrigation equipment, milking equipment including milking machines, mechanical pickers, planters, plows, rotary hoes, sprayers, spreaders and threshing machines. (Emphasis added)

5 b. All terrain vehicles which are not subject to licensing or registration for use on the highways. c. Machinery and equipment used in poultry grow-outhouses including heaters, cages, feeding systems, storage bins for short term storage of feed, medicators, watering systems, augers, fans and generators. d. Egg racks, poultry loaders and module coop systems used by egg and poultry producers in farming operations. 2. Irrigation equipment means (i) pipes, hoses, tubing and accessories to the pipes, hoses and tubing which deliver irrigation water from the water source to the crops regardless of whether the equipment becomes affixed to real property; and, (ii) pumps, gates, and other equipment other than pipes, hoses and tubing, which is movable and does not become affixed to real property. Irrigation equipment, other than pipes, hoses, and tubing, which is designed or intended to be permanently attached or incorporated into real property is not exempt. (Emphasis added) C. The list of exempt items in GR-51(B)(1)(a) is not intended to be exclusive. Other agricultural implements may qualify for this exemption provided they meet the requirements of GR-51(C)(1) and GR-51(C)(2). Legal Analysis and Opinion Response Each question presented in your opinion request will be addressed separately. QUESTION No. 1: Should the irrigation control system be treated at tangible personal property or as an improvement to real property? RESPONSE No. 1: The information provided with your letter reveals that the various components of the irrigation control system are attached to real estate; however, that attachment is not intended to be permanent and these components can be easily removed without causing serious injury to the real estate. In fact, several components of the irrigation control system will be removed by the farmer before harvest. Those components that remain in place during harvest are typically attached with bolts or screws that can be easily removed without damage to the real property. Consequently, DFA considers the various components of the irrigation control system to be items of tangible personal property. QUESTION No. 2: Will the sale of the various components of the irrigation control system qualify for the farm machinery and equipment sales and use tax exemption under Ark. Code Ann ? RESPONSE No. 2: The sales and use tax exemption provided in Ark. Code Ann contains several requirements that must be satisfied before an item of farm machinery and equipment may be purchased tax free. Those requirements are: The machinery or equipment must be used exclusively in farming; The machinery or equipment must be used directly in farming;

6 The item purchased must be an item of farm machinery or equipment and does not include motor vehicles subject to registration, airplanes, or hand tools; The machinery or equipment must be used in the agricultural production of food, fiber, grass sod or nursery products as a business. Assuming the irrigation control system is used exclusively and directly in farming by a farmer engaged in the agricultural production of food, fiber, grass sod or nursery products, the irrigation control system is considered to be an item of farm machinery or equipment entitled to the exemption contained in Ark. Code Ann GR-51(B)(1)(a) provides that irrigation equipment is farm machinery and equipment for purposes of this sales tax exemption. While irrigation pipe, hoses, gates, and tubing that carry water to crops are identified by the rule to be irrigation equipment, the rule clearly provides that irrigation equipment will include other equipment used in the irrigation process. DFA is of the opinion that the various components of the irrigation control system perform an irrigation function and come within the scope of farm machinery or equipment entitled to the sales tax exemption. When the various components of the irrigation control system are employed by a farmer to maintain proper moisture levels for growing crops, the used directly requirement will also be satisfied. If moisture levels are too low, plants become stressed, are more susceptible to diseases, and crop yields decline. Similarly, too much moisture can create plant stress and reduce yields. The components of the irrigation control system operate in unison to test moisture and water levels, to ensure irrigation equipment is functioning properly, to turn irrigation equipment on or off, and to provide current information to the farmer regarding irrigation needs. These functions directly contribute to maximizing crop yields. Consequently, the components of the irrigation control system are used directly in farming when used to monitor and control irrigation needs for growing crops. A related question arises regarding purchases of individual components of the irrigation control system for purposes of expanding the system to cover additional acreage or to replace broken or outdated equipment. Since each of the components of the irrigation control system are separate items of irrigation equipment, subsequent purchases of the components (e.g. Headquarters IT Equipment Kit, Diesel or Electric Pump Controller, Soil Moisture or Water Level Monitoring Node, Smart Farm Repeater Node, Electric Pump High Voltage Switch, Flow Master and Flow Meter Saddle, Soil Moisture Probe, Water Level Sensor, Weather Station, and Fuel Tank Level Pressure Sensor) will be exempt. The purchase of repair parts and repair services to repair a broken component will be subject to sales tax. QUESTION No. 3: Are installation charges billed by Taxpayer to its customers for installation of an irrigation control system subject to sales tax? RESPONSE No. 3: Installation charges billed to customers for the installation of an irrigation control system are not taxable if the purchase of the system qualifies for the farm machinery and equipment exemption. Ark. Code Ann (3)(B)(ix) provides that:

7 The gross receipts tax levied in this section shall not apply to the service of initial installation of any property that is specifically exempted from the tax imposed by this chapter. Based on this provision of state law, charges for the initial installation of an irrigation control system purchased tax free under the farm machinery or equipment exemption in Ark. Code Ann are exempt from sales tax. QUESTION No. 4: Will annual software updates be subject to sales or use tax? RESPONSE No. 4: Your letter explains that annual software updates are accomplished through an electronic download of the software. Ark. Code Ann (a) levies Arkansas sales and use tax on sales of computer software; however, taxable computer software is defined to exclude electronically delivered software. Consequently, the tax imposition statute levying sales tax on computer software does not apply to the annual software updates provided by Taxpayer to its customers as long as those updates are accomplished through an electronic download of that software. This opinion is based upon my understanding of the facts as set out in your inquiry and as current law and rules apply to those facts. Any changes in the facts or law could result in a different opinion. You may rely on this opinion for three years pursuant to Arkansas Gross Receipts Tax Rules GR-75(B). Sincerely, John H. Theis, Attorney Arkansas Department of Finance and Administration Office of Revenue Legal Counsel