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Saturday, April 7, 2012

Tax oddities and challenges of compliance

An article in BloombergBusinessweek - "Yoga Gets Off the Mat to Fight New York's Tax Man" by Caroline Winter (4/4/12), is a reminder that when tax rules are odd, such as having narrow exemptions or complicated definitions of what is taxable and what is not, it can lead to compliance problems. For example, when some narrow category of items becomes subject to sales tax, those providing the service might not know and when a rule is odd, people would not logically think that the transaction is taxable.

The article notes that some yoga studios in New York City were not aware that since last April (2011) they have been subject to the city's sales tax. Per the article New York City decided "that yoga studios be categorized as fitness centers, instead of movement spaces, and thus subject to a sales tax rate of 4.5 percent. (Dance studios aren’t taxed.) The change isn’t very new—it went on the books last April—but New York studio owners say they were never notified. That is, not until auditors started showing up in January and fining studios for back taxes for as much as three years."

An April 2011 Tax Bulletin ST-329 (TB-ST-329) from the New York State Department of Finance and Taxation, is a great example of how peculiar and laughable a poorly designed tax system can be. For example, it states:

"New York State makes a distinction between health and fitness clubs and athletic clubs. New York State and local sales taxes are imposed on dues and membership fees paid to any athletic club in the state. An athletic club is any club or organization whose material purpose or activity is the practice, participation in, or promotion of any sports or athletics (for example, a Judo club or curling club). However, a facility that provides steam baths, saunas, rowing machines, or other exercise equipment, or that promotes exercising solely for health or weight reduction purposes, as contrasted to sports, is not considered to be an athletic club."

It seems a bit odd that both activities are described as a "club" and involve physical activity, yet taxed differently. 

So, it is not the state of New York that is taxing the yoga salons, but New York City.  Some states and their cities do not have the same sales tax base making compliance even more difficult for vendors!  Per the 2011 Tax Bulletin:

"New York City imposes its local sales tax on every sale of services by weight control salons, health salons, gymnasiums, Turkish and sauna baths, and similar facilities, including any charge for the use of these facilities. This tax does not apply to any of these facilities located outside of New York City. Therefore, dues, membership and initiation fees, and any charges paid for the use of these facilities located in New York City are subject to the New York City local sales tax. However, if a facility also provides access to participant sporting activities and facilities, such as a swimming pool or racquetball courts, to its members, the facility is not considered to be a weight control salon, health salon, gymnasium, or other establishment for New York City sales tax purposes"


How to simplify?  Apply sales tax to all goods and services consumed by individuals as final consumers and lower the rate.  Perhaps some necessities should be exempt such as non-elective medical services.  I suggest taxing food and finding another way to provide relief to low-income individuals such as through a refundable income tax credit or provision of debit cards for use throughout the year (ideally attached to the cardholder's bank account including accounts paid for by the state). The reason is that higher income taxpayers spend a lot more on food so exempting it provides a big tax break to individuals who do not need it.  With this design changes, we would not have oddities of knowing whether a yoga class or health club dues are subject to tax - they would be because purchased by a consumer.

What do you think?

More - see 21st Century Taxation website - here.


John L said...

This issue reminds me of confusion caused by a candy tax imposed in 2009 by the State of Illinois. Details can be found here:

In order to impose a tax on candy, the state had to define candy. Easier said than done. Consider the exclusion for “candy which contains flour.” Presumably the reason for this exclusion was the tax was to be on candy rather than cookies. In an attempt to exclude cookies, items containing flour were exempted. That being said under the exclusion Kit-Kat Bars are not considered candy. Kit-Kat Bars are sold in the candy aisle and given our as candy on Halloween. Seems like candy to me.

In short, the annoyance felt by the yoga studies is a recurring issue when a tax provision attempts to exclude certain items or services from a greater group.

J Drysdale said...

This New York City sales tax imposed on certain types of facilities seems to violate the Transparency and Simplicity principles of good tax policy.

Transparency is not met because the yoga studio owners did not know this sales tax existed until auditors walked into the doors of their businesses. The local government didn't do their job in educating the business owners of the applicable sales taxes. The lack of transparency may lead to bad business decisions by the owners and possibly the patrons because the true costs of the transactions are not known.

Simplicity is not met since the laws relating to the local sales tax are not known. How can a business owner operate if they can't comply with the tax laws in a cost effective manner? Shouldn't the law be simple enough so the business owners can comply?

I believe there should be some type of grace period given to these types of businesses so they can sort out the laws.

Srividhya said...

This issue in my opinion is a serious lack of equity in formulating the tax provision. While there is local sales tax on “weight control salons, health salons, gymnasiums, Turkish and sauna baths, and similar facilities” why these similar facilities do not include swimming pools and racquetball courts under New York City local sales tax? Further it is not transparent as to why such discrimination is made and what logic behind it is. One way of simplifying is to revise the existing definition to include a broader category of services. Revenue rulings and procedures could be issued to help taxpayers interpret the provisions. Equity and fairness is affected since for a single type of income there are three different rules at the federal, state and local level jurisdictions.

I am not sure how the single rate consumption tax would be a solution to this. Designing and implementing a new system to fit all levels of taxpayers and tax reforms at the same time ensuring both federal and local governments get enough revenue is going to be much more difficult than trying to simplify the existing system.