Divergent Use - The Real-Life Tale of Little Red Riding Hood

Posted by Mary Thomas on May 25, 2018 10:03:37 AM

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Don't play Little Red Riding Hood to the Big Bad Wolf, i.e. divergent use.  Divergent use is a big gotcha for companies that expand lines of business without reconsidering Texas sales and use tax consequences.

Divergent use occurs for Texas  equipment rental companies when equipment purchased tax-free is used in  a taxable manner.  When an equipment rental company issues a resale certificate in lieu of paying sales/use tax and uses the equipment to perform services divergent use has occurred.  It is common for equipment rental companies to decide to lease equipment with an operator.  But when a resale certificate is issued in lieu of paying sales or use tax, a company may not use the equipment to perform services for clients without paying sales or use tax on the divergent use.  Sales or use tax is owed on the fair market rental value for the “normal” term of a rental to third parties or the original purchase price.

It is not uncommon for companies to purchase equipment, issue the resale certificate, use the equipment to service their clients, and not pay use tax. When an auditor identifies this situation, Texas law is crystal-clear. Divergent use has occurred and sales/use tax is due. Taxpayers have tried to argue that tax is not due because there was no “sale” etc. Those arguments have not prevailed. 

An ounce of prevention is worth a pound of cure.  Plan how the fleet is going to be used and pay sales or use tax on it as dictated by the planned usage.  If the actual usage of the equipment changes, your tax responsibilities may change.  Revisit the past and prospective issuance of resale certificates.

If divergent use is discovered during an audit- if there is no other issue- time and money would be better spent on trying to make a deal with the taxing authority or executing a payment plan rather than spending gobs of money arguing a case that is doomed to fail. Be honest with yourself about what has occurred. If there is an issue of fact or law, pursue it. If not, don’t pretend that there is. The pretense is more expensive than facing reality.

Learn more Texas Taxes for the  Construction Industry

Topics: Sales Tax, divergent use, texas construction sales tax

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