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LLC v. Iowa Department of Revenue

Supreme Court of Iowa

December 14, 2018


          Appeal from the Iowa District Court for Polk County, Lawrence P. McLellan, Judge.

         Taxpayer appeals district court judgment upholding department of revenue's assessment of sales tax on labor installing home improvements.

          E. Kendrick Smith of Jones Day, Atlanta, Georgia, and Allison M. Heffern and Desirée Kilburg of Shuttleworth & Ingersoll, Cedar Rapids, for appellant.

          Thomas J. Miller, Attorney General, and Hristo Chaprazov and James D. Miller, Assistant Attorneys General, for appellee.


         In this appeal, we must determine whether the Iowa Department of Revenue (the Department) erred by assessing sales tax on labor installing building components sold by Lowe's Home Centers, L.L.C. Iowa Code section 423.2(6) (2007) imposes sales tax on many services including "carpentry," "electrical and electronic repair and installation," and "pipe fitting and plumbing," terms defined in regulations promulgated by the Department. But the statute exempts from sales tax services performed in connection with "new construction, reconstruction, alteration, expansion, remodeling, or the services of a general building contractor, architect, or engineer." Id. § 423.3(37). The regulations distinguish between services performed for "repairs" and "installation" subject to sales tax and "remodeling" services exempt from tax. The parties disagree whether the sales tax applies to labor installing items sold by Lowe's to homeowners through installation contracts, specifically windows, doors, dishwashers, garbage disposals, faucets, toilets, sinks, vanities, and ceiling fans installed by subcontractors.

         Lowe's protested the Department's sales tax assessment, and an administrative law judge (ALJ) on summary judgment found the disputed transactions were properly taxed as "repairs" and that the services of a general building contractor are only exempt when performed in connection with new construction, reconstruction, alteration, expansion, or remodeling. On intra-agency appeal, the director upheld the sales tax assessment as taxable "installation" services. On judicial review, the district court affirmed. We retained Lowe's' appeal. Lowe's does not challenge the validity of the regulations promulgated by the Department but contends the agency erred in applying the Iowa Code and regulations. The parties disagree on the deference owed to the Department's rulings.

         On our review, we conclude the Department's application of law to fact is entitled to deference and should be upheld unless it is "irrational, illogical, or wholly unjustifiable." Iowa Code § 17A.19(10)(m). For the reasons elaborated below, we uphold the sales tax assessment except as to carpentry services. The Department's own regulations limit the definition of carpentry services subject to sales tax to those performed for repairs. The director's final order disavowed the ALJ's finding that the installation services constituted repairs, which in our view means the sales tax did not apply to carpentry for installations other than repairs. By contrast, the regulations expressly define the electrical and plumbing services to include installations. The director correctly determined these installation services by electrical and plumbing subcontractors, which involved no structural changes to the homes of customers, did not fall within the statutory exemption for "new construction, reconstruction, alteration, expansion, remodeling, or the services of a general building contractor." Id. § 423.3(37). We strictly construe exemptions to tax statutes. We therefore affirm in part, reverse in part, and remand with instructions for the district court to direct the Department to recalculate the sales tax assessment consistent with this opinion.

         I. Background Facts and Proceedings.

         Lowe's operates eleven big-box home improvement stores in Iowa. It sells a variety of products, including lumber, siding, shingles, paint, electrical and plumbing supplies, doors, windows, cabinets, sinks, ceiling fans, and appliances. Lowe's primarily engages in two types of customer transactions: over-the-counter retail sales of merchandise and installation sales contracts.

         To make an over-the-counter retail purchase, the customer selects products in the store and takes them to a checkout counter. The cashier scans the products' bar codes, and the store's computer system calculates the sales tax based on the item's retail price. The customer pays the sales price and tax at checkout and departs with the merchandise. These transactions are not at issue in this case.

         The home improvements at issue here are installed custom storm windows and doors, faucets, toilets, built-in dishwashers, ceiling fans, patio doors, interior and exterior doors, sinks, vanities, and garbage disposals. Based on the Department's regulations, the retailer must pay tax on the cost of materials used during installation. The fighting issue is whether Lowe's is required to collect taxes on the installation labor. The Iowa Code imposes a sales tax on sixty-six categories of services. Id. § 423.2(6). At issue are "carpentry," "electrical and electronic repair and installation," and "pipe fitting and plumbing." Id. The Iowa Administrative Code provides guidance on which types of activities fall under each category of taxable services. These services are exempt from taxation when performed in connection with "new construction, reconstruction, alteration, expansion, remodeling, or the services of a general building contractor, architect, or engineer." Id. § 423.3(37).

         To have Lowe's arrange installation, the customer visits a service station within the store. The customer describes the project and selects the products to be installed. Lowe's issues a printed estimate that states in part,

Lowes is a supplier of materials only. Lowes does not engage in the practice of engineering, architecture, or general contracting. Lowes does not assume any responsibility for design, engineering, or construction; for the selection or choice of materials for a general or specific use; for quantities or sizing of materials; for the use or installation of materials; or for compliance with any building code or standard of workmanship.

         (Capitalization modified.). Lowe's subcontracts with third-party "installers" who install the products in the customer's home. The installer may first visit the customer's home to outline the scope of the project, take measurements, and estimate the labor cost and quantity of materials needed to complete the project. Lowe's charges the customer a detailing fee for this service.

         If the installation process is standard, or once an installer has completed an estimate, a description of the materials and the labor cost estimate is entered into the store's computer system. The computer tracks the cost of goods and materials and the installation labor charge. Lowe's then prepares an "installed sales contract," which sets forth the cost of materials, cost of labor, sales tax charges for materials and labor (if any), the total cost, and other terms of the sale.

         If the customer agrees to the price and terms, the customer and a Lowe's representative sign the contract. Lowe's deducts any prior detailing fee and the customer goes to the checkout counter to pay the total project cost. The customer typically leaves the store without the products and materials purchased through the contract, but with a contractual right to their installation in his or her home. Lowe's holds any in-stock items for the installer to pick up. The customer does not own the items purchased until they are installed at the customer's home. The installer returns surplus materials to the store when the project is complete.

         The terms of the installed sales contracts expressly "assume[] sound existing substructures, superstructures and points of attachment" at the purchaser's home. The contracts typically also include disclaimers such as noting the installation services do not include "alterations to existing structure[s]," "[c]hanging or moving venting," "[c]hanging or moving electrical lines," "[c]hanging or moving plumbing/supply lines," or "[i]nstalling new electrical line, additional boxes or switches." Craig Price, Lowe's' Director of Sales and Use Tax, testified by affidavit and described Lowe's' role in the installation contracts is to

(1) serve as the general building contractor to ensure the installations are performed correctly;
(2) complete each home improvement for the specified fixed price; and
(3) absorb any excess costs if the actual labor and/or material costs exceed the amounts estimated.

         If the installation does not meet the customer's approval, Lowe's arranges for corrective measures. Lowe's is responsible for obtaining licenses and building permits if needed and warrants that the installation will be completed in a workmanlike manner. Lowe's is also responsible for ensuring the installation work complies with safety rules and building codes, zoning ordinances, and other laws.

         Under the terms of the installed sales contracts, Lowe's is required to sell the goods, materials, and installation services at the prices set in the contract. The contract price includes the cost of goods sold, installation services, and taxes. Lowe's pays sales and use tax based on the cost of the goods and materials sold under installed sales contracts at the time Lowe's withdraws the items from its inventory. But Lowe's does not collect or pay sales tax on the price customers paid for installation services. Nor do the installers or customers pay sales tax for the installation services.

         In 2007, the Department conducted a sales tax audit of Lowe's for the three-year period beginning January 1, 2004, and ending December 31, 2006. On January 17, 2008, the Department issued a sales tax assessment of $1, 794, 450.40 plus interest on the labor performed for the installation of various home-related products sold by Lowe's. The Department determined that homeowners who received the installed home improvements should have been separately assessed sales tax on the labor. Because Lowe's did not collect this additional tax from its customers, the Department assessed the tax plus interest against Lowe's. This sales tax on the labor was in addition to the sales tax Lowe's already paid on the items sold. The Department found this incidental work was independently taxable as enumerated repair services under Iowa Code section 423.2(6). The Department concluded that Lowe's' installation contracts did not involve structural changes to real property, which according to the Department, is a prerequisite to exempting the labor from sales tax under Iowa Code section 423.3(37) and its implementing regulations.

         Lowe's and the Department resolved most of the assessment through informal procedures. Lowe's filed a timely protest for the sum remaining in dispute: $249, 806.22 including interest through November 30, 2012. Interest continues to accrue monthly. The Department rejected Lowe's' protest and the matter proceeded to an appeal before an ALJ. The parties conducted discovery and submitted the matter to the ALJ for summary adjudication.

         After a hearing, the ALJ issued a proposed decision granting summary judgment in favor of the Department. The ALJ found (1) the installations were taxable as enumerated repair services under Iowa Code section 423.2(6); (2) the home improvements were not sufficiently large in scale to qualify as new construction, reconstruction, alteration, expansion, or remodeling of a building or structure under section 423.3(37); and (3) the services of a general building contractor are only exempt if they are performed on or in connection with new construction, reconstruction, alteration, expansion, or remodeling.

         Lowe's appealed the proposed order to the director of the Department. The director issued a final order affirming the proposed order from the ALJ. The director modified the order to conclude that under the definitions promulgated by the Department, the home improvement installations Lowe's performed were not repair services but were subject to sales tax as installation services.

         Lowe's petitioned the district court for judicial review of the final order. The district court affirmed the final order, concluding that the Department's "application of the law to the facts . . . was not irrational, illogical or wholly unjustifiable." Lowe's appealed the district court decision, and we retained the appeal.

         II. Standard of Review.

         Our review is governed by the Iowa Administrative Procedure Act, Iowa Code section 17A.19. Nance v. Iowa Dep't of Revenue, 908 N.W.2d 261, 267 (Iowa 2018). The district court acts in an appellate capacity in exercising judicial review of agency action. Id. We apply the standards of Iowa Code section 17A.19(10) to determine if we reach the same result as the district court. Id.

         Lowe's does not challenge the validity of the rules promulgated by the Department to implement chapter 423.[1] Rather, Lowe's contends the Department has misinterpreted and misapplied the governing provisions. "We defer to the agency's interpretation of law when the legislature has clearly vested that interpretation in the agency's discretion." Kay-Decker v. Iowa State Bd. of Tax Review, 857 N.W.2d 216, 222 (Iowa 2014). Otherwise, we review the interpretation for correction of errors at law. Id. We find no Iowa Code provision expressly granting the Department authority to interpret the sales tax provisions in chapter 423. We need not decide whether the Department has interpretive authority over chapter 423 because even without any deference to the agency, we agree with the Department's interpretation of the governing statutes and rules. See KFC Corp. v. Iowa Dep't of Revenue, 792 N.W.2d 308, 312 (Iowa 2010) (declining to decide whether the Department had interpretive authority because we agreed with the agency's interpretation).

         Factual determinations as to sales tax obligations are vested in the Department. Iowa Ag Constr. Co. v. Iowa State Bd. of Tax Review, 723 N.W.2d 167, 173 (Iowa 2006). We are bound by the agency's factual findings that are supported by substantial evidence in the record when the record is viewed as a whole. Iowa Code § 17A.19(10)(f)); Iowa Ag Constr. Co., 723 N.W.2d at 173. "Because factual determinations are by law clearly vested in the agency, it follows that application of the law to the facts is likewise vested by a provision of law in the discretion of the agency." Iowa Ag Constr. Co., 723 N.W.2d at 174. "We can therefore reverse the agency's application of the law to the facts only if we determine such application was 'irrational, illogical, or wholly unjustifiable.'" Id. (quoting Iowa Code § 17A.19(10)(m)).

         Our review of constitutional questions is de novo. KFC Corp., 792 N.W.2d at 312.

         III. Analysis.

         This case turns on the application of law to undisputed facts. The governing law includes the sales tax provisions and exemptions in Iowa Code chapter 423 and the implementing regulations promulgated by the Department. We begin our analysis with the applicable canons of construction for tax statutes and exemptions. Next, we set forth the operative provisions of the Code and regulations and apply our deferential review to the Department's application of that law to the facts.

         A. Construction of Tax Statutes.

         "Statutes which impose taxes are construed liberally in favor of the taxpayer and strictly against the taxing body." Iowa Auto Dealers Ass'n v. Iowa Dep't of Revenue, 301 N.W.2d 760, 762 (Iowa 1981). But "taxation is the rule, exemption is the exception." Iowa Network Servs., Inc. v. Iowa Dep't of Revenue, 784 N.W.2d 772, 776 (Iowa 2010). "Exemptions from taxation, therefore, are 'construed strictly against the taxpayer and liberally in favor of the taxing body.'" Id. (quoting Ranniger v. Iowa Dep't of Revenue & Fin., 746 N.W.2d 267, 269 (Iowa 2008)). All doubts must be resolved in favor of taxation. Dial Corp. v. Iowa Dep't of Revenue & Fin., 634 N.W.2d 643, 646 (Iowa 2001). "A taxpayer seeking to come under a tax exemption statute has the burden of proving an entitlement to the ...

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