Avalara : You may be liable for your customer’s breach of contract – Wacky Tax Wednesday

We all know everyone makes honest mistakes, and that some folks do things they know they shouldn't do. But did you know that if you're in business in New York, you could be held liable for sales tax if your customer breaks a contract? Even if you're honest and they're unscrupulous?

How New York sales tax applies to tangible photos or the right to use them

In advisory opinion TSB-A-20(66)S, the New York Department of Taxation and Finance explains that the transfer of a tangible photograph is taxable when the transfer is permanent and occurs via tangible mediums (e.g., CD, negative, paper, or slide). However, if the transfer of a tangible photograph is temporary, for reproduction purposes, and payment takes the form of a royalty, the sale is generally exempt from New York sales tax.

To qualify as an exempt temporary sale, both of the following conditions must be met:

• The original photograph must be returned unaltered at the end of the contract
• Payment must take the form of a royalty, meaning it must be related to the continued exercise of the copyright rather than a lump sum

An example of this type of agreement would be when a news agency buys the right to reproduce a photograph in their journal during 2020. Once the calendar hits January 1, 2021, the agency can no longer use the photo; they must return it, unaltered, to the photographer, and cease to use any digital copies they may have made.

The taxability of an exempt transfer of a tangible photo for temporary use could be jeopardized if the customer does any of the following in breach of the contract:

• Retains possession of a tangible photo permanently
• Makes unauthorized alterations to a tangible photo
• Makes a digital copy of a tangible photo for subsequent use
• Grants reproduction rights to third parties without the photographer's consent

The photographer may not realize a customer has done any of the above. Nonetheless, if a customer does hang on to a photo, alter it, copy it, or give a third party the rights to use it, it's the photographer who could suffer the consequences.

Wacky tax law is serious business

The New York Department of Taxation and Finance advised the photographer to charge a customer sales tax if that customer was found to have done any of the above. It also said the department could hold the photographer liable for sales tax that should've been collected if they discover any such unauthorized use, particularly if there's 'a pattern of such action.'

You read that right: If a customer acts in breach of a contract, the photographer could be responsible for tax on a transaction they thought was (and that should've been) exempt. That's something.

It's critical to understand how tax laws can affect your business because battles over sales tax liability can be long and expensive. Read more about tax enforcement efforts and how to successfully navigate them in Sales and use tax audits in 2021.