Complexities of Tax Exemptions

The September 2008 Tax Information Bulletin of the CA Board of Equalization has an interesting blurb about the taxation of vitamin enhanced water drinks. I'm including it here because it illustrates so well how special exemptions complicate the law:

"Sales of vitamin enhanced water beverages may be non-taxable

Noncarbonated, vitamin enhanced, water beverages that come in packages similar in size and volume to non enhanced beverages are generally considered food products. Sales of these food products by grocery stores and other retailers on a togo basis are not subject to tax.

However, sales of vitamin enhanced water beverages are taxable when these products’ labels, packaging or product literature make specific medicinal claims, describe the product as a food supplement, food adjunct (additive), or a dietary supplement or come in small packages designed to give a quick, concentrated boost or shot of vitamins and nutrients. The word "vitamin" in the product name or description does not constitute a dietary supplement claim which may render the product subject to tax."

It refers readers to Regulation 1602 on Food Products for more details.

The whole area of how the California sales tax applies to food products is a bit complicated. Generally, food products are not subject to sales tax. But there are various exemptions. One notable one you're probably aware of is that sales tax is added to your restaurant bill. Also, some food establishments ask if your order is "for here or to go" and then only charge you sales tax if it is for "here."

The complication with vitamin water is that the definition of non-taxable food products does not include certain food or dietary supplements. So, per the Bulletin, if the bottle just has the word "vitamin" without making a medicinal or food supplement claim, it is not taxable. This also shows the oddity of some of our tax laws. Here, the contents of the bottle - what the buyer is going to consume, is the same whether just labeled as "vitamin water" or labeled as "water with a health boost from 15 essential vitamins" but the first one is not subject to sales tax but the second one is. YET ... it's the same beverage inside each bottle!

Rules like these are also sometime referred to as being part of the tax practitioner's full employment act!

And more ... If you recall years ago when the state legislature enacted the "snack tax" where snacks became subject to sales tax despite the general exemption for food products, it wasn't popular because it was so difficult to define a snack. For example, chocolate chips were a food product while M&Ms were a snack. The public hated the snack tax so much that not only did they repeal it by the inititative process, but that proposition also made a change to the California constitution that food products could not be taxed (Prop 163 of Nov. 1993). So, any changes to how sales tax applies to food likely can't just be done by the state legislature who should be the ones in charge of tax law design, but needs to go through the process of modifying the state constittution.

I've written on this before - that California's sales tax base is too narrow (and the rate is too high) - please click here.

Do you think any changes are needed to the sales tax base such as to add food products (with a corresponding income tax refundable credit for low-income taxpayers), digital downloads, personal services, and entertainment?