Paying sales tax is part and parcel of buying products, but in a complex legal case, Home Depot is seeking a sales tax refund from the State of Rhode Island, in conjunction with the bank that issues its store-brand credit cards.

THE PROVIDENCE JOURNAL / KRIS CRAIG

Rhode Island tax officials are engaged in a nasty legal dispute with Home Depot over state sales-tax refunds.

It’s strictly a business issue, not a typical MoneyLine matter, but it’s intriguing just the same. And depending on how it’s resolved, it could have far-reaching implications.

You probably know how Rhode Island’s 7-percent state sales tax works: If you buy something that’s subject to the tax — such as an appliance, a computer or building materials — you pay the retailer for the cost of the item, plus the sales tax. The retailer then forwards the tax to the state.

But suppose you buy the merchandise using a so-called “private label” credit card — and then fail to pay your credit card bill. Does the retailer get to claim a refund from the state for the sales tax paid?

That’s what this controversy is all about. It involves the Home Depot credit card, which is issued by a bank, not by Home Depot itself.

When you buy something at Home Depot, using the Home Depot credit card, the credit card issuer pays Home Depot for the merchandise and the sales tax, less a discount to compensate the credit card issuer.

“It is Home Depot that pays the sales tax to the Division [of Taxation] on credit sales, and it is Home Depot that suffers the economic loss resulting from customers who subsequently refuse to pay their accounts,” the company asserted in court documents.

Thus, Home Depot says it should receive a sales-tax refund from the state in such situations.

State tax officials disagree. Ordinarily, when a customer buys something and later fails to pay the bill, the retailer generally treats the transaction as a bad debt, and gets to claim a refund of the sales tax it handed over to the state.

But when a Home Depot credit card is involved, the transaction isn’t really between the consumer and Home Depot, but between the consumer and the bank that issued the credit card, state tax officials assert.

So Home Depot can’t treat the transaction as a bad debt; only the credit card issuer can. And because the credit card issuer isn’t a retailer, it doesn’t qualify for a refund of the sales tax paid, state lawyers argue.

In such situations, the state keeps the sales tax revenue; the retailer — and the bank that issued the Home Depot credit card — are out of luck when it comes to sales-tax refunds.

It may seem a fine point, but there’s a lot at stake. Home Depot — which bills itself as the world’s largest home-improvement retailer — applied to the Rhode Island Division of Taxation in 2003 for a refund of nearly $100,000 in sales tax paid on items bought at Home Depot stores — with credit cards carrying the Home Depot brand — over a three-year period ended in July 2003.

The state tax agency refused. Home Depot then went through an “internal” state appeals process and lost. So the company, which is based in Atlanta, filed an appeal in District Court, Providence.

And that’s where the case now stands, awaiting a decision by Judge Patricia D. Moore.

The case shines a light on a practice that’s common, especially among big, national retailers. They often don’t own and service their credit card accounts.

Instead, they hook up with a third-party financial institution — such as a bank — to issue credit cards in the retailer’s name.

In this case, Home Depot long relied on Monogram Credit Card Bank of Georgia to issue credit cards — carrying the Home Depot brand — to certain Home Depot customers.

“Whether Home Depot owns its own accounts or partners with a financial institution, however, should be irrelevant for determining whether Home Depot is entitled to a sales tax refund” under Rhode Island sales tax rules, the company said in court documents.

By denying Home Depot’s refund claim, the state tax agency “is unjustly retaining sales tax that was paid by Home Depot . . . ” the company said.

“No legal or equitable principle authorizes the Division [of Taxation] to retain sales tax under these circumstances,” the company said. As a result, Home Depot says it should be entitled to a refund.

Rhode Island tax officials argue that, in order to claim a sales-tax refund for any given sale, a business must clear some hurdles.

For instance, the business must be a retailer that turns over to the state the sales tax that it collects on a transaction. The business also must have suffered a loss on the account. In addition, the business must have treated the loss as a bad debt on its books for income-tax purposes.

In this case, Home Depot did not claim the transactions as bad debts — the credit card issuer did. And the credit card issuer (Monogram Bank) can’t claim a sales tax refund because it’s not a retailer, the state says.

Rhode Island Tax Administrator David M. Sullivan declined to discuss the pending case, but acknowledged the stakes involved. “If we lose it, it would be a revenue loss,” Sullivan said in an interview at state tax agency headquarters in Providence.

Some other retailers could make similar claims. If they were upheld, the state would have to issue additional refunds of sales tax, said Patricia A. Thompson, a former president of the Rhode Island Society of Certified Public Accountants.

The dollar amount at stake “really is hard to quantify, because you don’t know how many other retailers have a similar arrangement,” involving private-label credit cards, Thompson said in an interview at Piccerelli Gilstein & Co. LLP, a CPA firm in Providence, where she is tax partner.

There are a number of angles in this case that I find interesting. For example:

•Home Depot is seeking a refund of nearly $100,000 on sales tax paid over a nearly three-year period. Here’s the implication: Over that three-year period, an unspecified number of Rhode Island customers used Home Depot credit cards to buy more than $1.4 million of taxable items from the company’s Rhode Island stores — and never paid their credit card bills.

This point isn’t specifically spelled out in court documents, but you can figure it out easily enough, based on the sales tax figures involved. (In its original complaint, filed in court in February 2006, Home Depot said only that, “In some instances, the purchase price and the tax have not been paid by the customer.”)

•You might think that a case like this would bring to the surface all sorts of juicy details, mainly about Home Depot’s business operations. However, Home Depot earlier this year applied for — and was granted — a so-called “protective order” to keep a bunch of information under wraps.

This protective order “shall apply to all information, documents and things regarding Home Depot,” including depositions, the court order says. “All such information shall be deemed confidential . . . . ”

•Despite the protective order mentioned above, an interesting little kernel slipped through the cracks: Home Depot filed its refund claim in order to pay for a settlement between the company and Monogram, according to a post-trial document filed by lawyers representing the state tax agency.

Monogram had been the provider of Home Depot-brand credit cards since 1997. But because of a financial dispute, that long-standing arrangement ended, the lawyers said.

Under a settlement reached between Home Depot and Monogram in 2003, Home Depot “expressly promised to pay off Monogram Bank — not out of its own pocket, but by filing sales-tax refund claims against various states . . . and giving the net proceeds (after expenses) to Monogram Bank,” the state’s lawyers asserted.

Three months after reaching that agreement, Home Depot filed its refund claim with the Rhode Island Division of Taxation, the state’s lawyers said. In other words, “Monogram Bank and Home Depot expressly combined to raid the public coffers of the various states to fund their settlement agreement,” the state’s lawyers asserted.

A Home Depot witness denied this assertion when confronted with it at trial, according to court documents.

Home Depot declined to comment on the case, except to provide the following statement:

“The State of Rhode Island, like most states, allows retailers to seek a refund for sales tax that it remits to the State at the time of a credit sale, but that it does not receive from the taxpaying customer because the customer later defaults on his or her account.”

“Such refunds are available to all retailers that meet the statutory requirements, and Home Depot has filed for a refund in the state of Rhode Island. Currently, Home Depot’s refund claim is proceeding through the applicable administrative and legal processes. Home Depot cannot provide further information on the specific refund request because it does not comment on ongoing administrative actions or litigation,” the statement said.

The Home Depot case is one of a number of similar cases that have been raised nationwide — by Home Depot and other companies, said Carol Kokinis-Graves, senior writer and analyst in the sales and use tax group at CCH, a national publisher of tax information for accountants and other tax professionals.

“This is a state-by-state issue,” she said. How such a case is resolved “depends on the definitions that apply,” she said.

In Connecticut, for example, DaimlerChrysler Services of North America essentially provided loans to some consumers who bought cars from certain auto dealerships. The company said it reimbursed the dealers for sales tax that the dealers turned over to the state. The company later sought sales-tax refunds.

But the Connecticut Supreme Court in 2005 ruled against the company. The court said that state law clearly defines a “retailer” as the dealer that makes the original sale to the consumer and turns over the required sales taxes to the state. The financial services company is not a retailer, and so is not entitled to a refund of sales taxes under state law involving bad debts, the court found.

In Massachusetts, Household Retail Services essentially provided loans to some consumers who bought furniture from certain furniture retailers. The company sought refunds of sales tax involving loans on which consumers had defaulted.

But the Massachusetts Supreme Judicial Court earlier this year ruled against the company, saying it could not claim reimbursement of Massachusetts sales tax because the company was not a vendor.

These and other cases will undoubtedly be reviewed by Judge Moore before she renders a decision. She has her hands full: The Rhode Island Home Depot case is a complicated matter, but it bears watching.

Rhode Island sales-tax collections represent one of the biggest sources of state revenue. Should Home Depot win, it could open the floodgates for refund claims by other retailers. And Rhode Island — which faces a budget deficit for the current year and a steeper deficit for the coming fiscal year — would have to find a way to pay.

So a local tax case that turns on a seemingly fine point could have a big and broad impact depending on how it plays out. Stay tuned.

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