The South Carolina Department of Revenue (DOR) has issued a proposed Revenue Ruling which will have a significant impact on South Carolina tobacco retailers, if finalized in its present form. The proposed Revenue Ruling, to be effective on January 1, 2020, addresses tobacco manufacturer rebates and refunds to retailers, and which DOR characterizes as “buydowns” and “promotional payments”- i.e. sales volume discounts. The proposed Revenue Ruling determines that these payments to retailers are subject to sales tax.
Tobacco manufacturers have provided their retailers with incentives for years – just as in any business. In the industry, these incentives are often referred to as “rebates”, “refunds”, and by other names. These manufacturer rebates/refunds are often based on purchases by their retailers – not the retailer’s sale of the tobacco products. The manufacturer knows what their retailers buy from them and how much the retailer pays for their products (cost) – but not necessarily the volume and price of the same goods sold by the retailer to its customers.
For income tax purposes, the taxation of tobacco rebates/refunds is fairly well-established. If a retailer receives a rebate/refund from a tobacco manufacturer, the receipt of the refund by the retailer is not taxable income, provided the retailer adjusts its product costs down through cost of goods sold (COGS); however, if the retailer does not reduce COGS, then the receipt of the rebate becomes taxable.
In its proposed Revenue Ruling, SCDOR, characterizes tobacco manufacturer rebates paid to retailers as either a “buydown” or “other promotional payment”, and where the retailer receives the manufacturer payment for agreeing to lower the price of the tobacco product sold to the customer or where the retailer otherwise meets “specific sales goals” required by the manufacturer. SCDOR then identifies the following transactions as subject to South Carolina sales tax:
- Example A – A retailer sells a brand of cigarettes for $5 a pack. During the buydown promotion period, the retailer agrees to lower the sales price to its customers and sell this brand of cigarettes for $4.75 a pack. The retailer receives a $0.25 per pack buydown payment from the tobacco company at a later date. The gross proceeds of sales, upon which the sales tax is calculated, is $5 for each pack of cigarettes sold by the retailer (i.e., the $4.75 sales price received from the customer and the $0.25 to be received from the tobacco company).
- Example B – A retailer sells a brand of cigarettes for $5 a pack. During the promotion period, the retailer does not discount the sales price of this brand of cigarettes. The retailer meets the specific sales goals specified by the tobacco company and receives a $0.25 per pack payment from the tobacco company at a later date. The gross proceeds of sales, upon which the sales tax is calculated, is $5.25 for each pack of cigarettes sold by the retailer (i.e., the $5 sales price received from the customer and the $0.25 to be received from the tobacco company).
DOR’s conclusion in Example A that a buydown payment is subject to sales tax is not surprising. The buydown is the equivalent of a manufacturer’s coupon and DOR has long found that a retailer must pay sales taxes on these manufacturer’s coupon. Also, if the price of a pack of cigarettes to a customer is typically $5.00, the manufacturer pays the retailer 25 cents to discount the sale to the customer to $4.75, and the retailer sells the pack at this price, the 25-cent rebate reimburses the retailer for that portion of the sales price not received – and which the retailer would have otherwise received from its customer. This could certainly be DOR’s rationale here; however, it fails to recognize that the retailer in discounting the price of a pack of cigarettes may be motivated to make more sales, and related profit, by volume due to the discount. Increases sales, volume increases sales taxes paid. The rebate by the manufacturer – who of course also benefits because the retailer is then making more purchases of cigarettes from the manufacturer – should not be considered taxable but simply a promotional payment to generate increased taxable sales.
DOR’s conclusion in Example B, involving a straight sales volume rebate, is more troubling. In Example B, the retailer receives the 25-cent rebate, but does not reduce the sales price to the customer. This is a pure incentive to increase taxable sales through volume. DOR’s Example B conclusion creates all sorts of problems. Retailers will be forced to predict the future in order to determine the appropriate sales tax to collect when a sales volume rebate may be received, or be forced to pay the sales tax out of the retailer’s own funds. For example, if there is a 25-cent/pack sales rebate where the retailer meets a sales quota, how much sales tax should the retailer collect from a customer before the sales quota is met? If the retailer has not met the volume requirement for a sales rebate and a pack of cigarettes is sold for $5.00 will the retailer collect sales tax on $5.00 or $5.25? If the retailer only collects sales tax on $5.00 the retailer may then later be required to pay sales tax on the 25-cent rebate out of its own pocket.
Lastly, the proposed DOR Revenue Ruling contains the following important footnote:
While not the subject of this advisory opinion, tobacco promotional payments may be based on a retailer’s purchases from a tobacco company. For example, a retailer and tobacco company enter into an agreement where the tobacco company will pay the retailer $1 for each carton of cigarettes purchased by the retailer in a calendar quarter. Since the promotional payment is based on purchases, and not based on sales, the payment is not includable in “gross proceeds of sales” and not subject to sales tax.
If DOR will be issuing a ruling in this area of sales tax, it should “elevate” this footnote to its formal guidance. Tobacco manufacturer rebates to retailers are also based on purchases. SCDOR should make clear in its Revenue Ruling that where the rebate is based on purchases from the manufacturer – and not on sales by the retailer to its customers – the receipt of the rebate by the retailer is not subject to sales tax.
Tobacco manufacturers and retailers have until February 6, 2020 to submit comments on DOR’s proposed Revenue Ruling. A public conference, if requested by February 6, 2020, will be held on February 11, 2020 at 10:00 am at DOR’s headquarters in Columbia, South Carolina. Tobacco manufacturers and retailers will need to make their voices heard if they hope for DOR to change the proposed Revenue Ruling.
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