Two years ago, when Jackson-based Cubla Inc.’s state income tax return was audited, the company’s president, James Day, wasn’t concerned.
But on Nov. 17, 2000, after the Mississippi State Tax Commission assessed the IT consulting firm for not charging a sales tax rate of 7% on all consulting labor, Day was stunned.
“I couldn’t believe it,” he said. “I knew that consulting labor was categorized as a professional service and therefore not subject to sales tax under Mississippi code. I could only speculate the reasoning behind it was the state budget shortfall.”
Even though Day appealed the assessment, he had a tough decision to make: consider filing bankruptcy or bill his clients for back taxes to 1998. He choose the latter.
On the company Web site, he posted a note prior to sending a letter to clients dated Oct. 26, 2001: “This letter will ask for all taxes to be paid to Cubla. This will be the worst day in Cubla history and we have, again, tried very hard to avoid it.”
Cubla’s clients, most of whom were attorneys, were incredulous.
“We took a very large risk,” said Day. “It was a decision that gave me an ulcer and took months to make to ask for the taxes. Almost all our clients agreed to pay their part pending the decision of the state tax commission. They were upset about it, not at us, but at the state tax commission.”
Ted Sanderson of Copeland, Cook, Taylor & Bush, P.A., of Jackson, tax attorney for Cubla, said the main complaint concerned contradictions in Rule 75, part of which states: “Professional services not directly related to the technical design and programming of computer software are not taxable and may be excluded from the gross taxable income.”
“James does not design and program computer software,” he said. “He and his staff are technicians and troubleshooters. They are consultants.
The state tax commission auditors seem to take a broad brush approach that anything done on a computer is subject to tax.”
Randy Ladner, deputy director of the office of revenue for the state tax commission, agreed that Rule 75 is a “very broad general provision.”
“That’s what’s causing the problem, but I think it’s more confusion than anything else,” he said. “Basically, what I think it’s trying to tell you is that if you’re doing custom programming for somebody, that certain things may not be taxable. But if you look down a couple of paragraphs, it says charging for installing, testing or modifying a computer program is taxable regardless of how such charges may be billed. Even if you’re doing some other things that are incidental to that, it’s taxable. They’re taking one sentence out of the rule, but they’re not reading another sentence in the rule.
“I agree there is some confusion and this rule is probably 10 years old. The computer software industry and computers have changed a lot since then.”
Ladner also said there seems to be some uncertainty among taxpayers about taxing professional services.
“There’s really not an exemption for professional services,” he said. “The sales tax law is structured to tax tangible personal property unless there’s a specific exemption. Services are different. Nothing is taxable unless there’s a specific provision to tax it in the law. When you build a house, for example, plumbing is taxable, but carpentry is not. Electricians are taxable, but masonry is not. I don’t know why. It’s just what the legislature put in there. One in the list of services that is taxable is computer software sales and service. That’s what the tax is imposed on. It’s not that there’s an exemption related to professional services.”
After the board upheld the assessment of tax in August, Day appealed the decision and requested a hearing with the full commission. Representatives from nearly 30 law firms — clients of Cubla’s — wanted to participate. The state tax commission scheduled the hearing for Dec. 5, and then postponed it until “they could reconsider their position,” Day said.
After reading the story in the Dec. 17-23, 2001 edition of the Mississippi Business Journal regarding the state tax commission assessing sales tax to Web site designers, Day said he realized “that the problems my company have been experiencing over the past year have not been in solitude.”
“A lot of other companies that we know about don’t want to talk about this because they are afraid it would make them seem vulnerable to their clients,” Day said. “We want to talk about it because the more companies that band together, the sooner this will be addressed.”
Day said he believed the reason the tax commission audited Cubla was because an engineering firm they dealt with was audited and assessed a substantial amount of money.
“They came across our invoices in their records and came after us,” he said. “One of the auditors sat here and made a joke about wanting to see our client list so he could look for more people to assess and the whole situation rubbed me the wrong way.”
Concerning the hearing that has not yet been rescheduled, Day said,
“They told us the first part of December that they were rescheduling the hearing until further notice, but we’ve heard nothing. They told us over the phone that they don’t put anything in writing, that they don’t have to, and I think that’s ridiculous. We want their explanation in writing as to why they think we owe back taxes and they won’t do it.”
Addressing suggestions by Day and Sanderson and unnamed sources in the creative arts and computer fields that auditing activity had been stepped up since state revenues declined, Bobby Long, administrative assistant for the state tax commission, said no.
“There haven’t been any increased efforts in that regard,” he said. “It’s been business as usual.”
One reason, Long said, was because the state tax commission is understaffed.
“It’s hard to find auditors,” he said. “We’re usually always short.”
Even though several states have recently put in place an amnesty program that would waive penalties for delinquent taxes, Mississippi isn’t one of them.
“Mississippi did it about 10 years ago, but we’re not under that now,” he said. “Legislation would have to be passed this session to allow that. I don’t know whether bills will be introduced, but there have been discussions about it.”
Ladner said there’s been discussion about modifying and clarifying Rule 75.
“We’ve had a couple of hearings lately where people were confused about what we meant because of changes in the industry,” he said. “We’ve talked about clarifying the rule to go into more detail, explaining what is and what is not taxable and to use more modern terminology.”
The current notification system for rule changes at the state tax commission requires the agency to post an intent to change the rule with the Secretary of State’s office for 30 days.
“If there’s no comment, the rule becomes effective on the signature of the tax commissioner,” Ladner said. “We also post it on our Web site.”
Letters are not sent to taxpayers that might be affected. It’s their job to stay abreast of changes in the tax law, Ladner said.
Rep. Cecil Brown (D-Jackson), member of the appropriations committee, recently introduced legislation that would allow Mississippi residents more input into regulations issued by government agencies.
“I’m aware of how the state tax commission has been trying to tax the creativ
e arts i
ndustry in their layout work and things like that,” he said. “That’s one of the things we’re trying to stop. This (proposal on the administrative procedures act) would address the whole issue of agencies out there making law on their own without public input on how laws are made.”
Even if he is exonerated of assessed taxes and accruing penalties, Day said he’s concerned about the message it’s sending to companies outside Mississippi.
“I’ve been to the Mississippi