Tax Type
Retail Sales and Use Tax
Description
Tax on the management fee paid by the Taxpayer to the Partnership.
Topic
Accounting Periods and Methods
Appropriateness of Audit Methodology
Date Issued
10-06-2002
October 6, 2002
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in reply to your letters in which you seek correction of the retail sales and use tax assessments issued to ***** (the "Taxpayer") for the period June 1992 through December 1998. I apologize for the delay in responding to your letters.
FACTS
The Taxpayer is a professional corporation of physicians who own and operate a cancer treatment clinic. The Taxpayer purchased the clinic through a stock sale resulting from the restructuring and merger of the clinic and a number of professional corporations. A number of the physicians that make up the Taxpayer previously owned and operated the clinic as a partnership. After the purchase, the Taxpayer entered into a contract with a management partnership (Partnership) to manage the administrative operations of the clinic. The Taxpayer pays the Partnership a monthly management fee and a percentage of its gross revenue.
The primary transaction at issue in this case is the application of the tax to the management fee paid by the Taxpayer to the Partnership. In this regard, the contract requires that the Partnership provide certain tangible personal property to the Taxpayer. As such, the contract was initially assessed as a lease agreement, and the entire management fee was included in the audit assessment. You maintain that the true object of the contract is for the provision of nontaxable services.
In addition to the management fees, you contest the assessment associated with recurring purchases. You maintain that extrapolating such purchases to periods prior to the stock sale overstates the Taxpayer's liability. You also contest the assessment of certain fixed assets acquired prior to the stock sale and maintain that tax was previously paid on these items by the predecessor clinic. Finally, you suggest that tangible personal property purchased by the Taxpayer from the predecessor clinic qualifies for exemption as an occasional sale.
DETERMINATION
Services versus Lease
The management contract states that the Taxpayer desires to focus on the practice of medicine and that it desires to delegate the business functions of its medical practice to persons with business expertise. The Partnership agrees to provide business, administrative, and management services, including without limitation the provision of equipment, supplies, support services, nonmedical personnel, office space, management, administration, financial recordkeeping and reporting, and other business office services. The Partnership is granted a Power-of-Attorney and agent authorization to act on behalf of the Taxpayer. Purchases are made in the name of the Taxpayer. As compensation, the Partnership is paid a monthly management fee that consists of a fixed amount and an amount based on a percentage of gross revenue.
Code of Virginia § 58.1-609.5(1) provides an exemption from the sales and use tax for "professional, insurance, or personal service transactions which involve sales as inconsequential elements for which not separate charges are made..." Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 interprets the statutory exemption and provides that in determining whether a particular transaction which involves both the rendering of a service and the provision of tangible personal property constitutes an exempt service or a taxable retail sale, the "true object" of the transaction must be examined.
The "true object" sought by the Taxpayer is to obtain the professional services and expertise of the Partnership to manage the day-to-day business operations of the clinic. As such, the Partnership is providing an exempt service as set out in Code of Virginia § 58.1-609.5(1). The management fees are not taxable and will be removed from the audit.
As a service provider, the Partnership is considered the user and consumer of all tangible personal property consumed in the provision of services to the Taxpayer. The Partnership should pay the sales tax to its suppliers at the time of purchase. If a supplier is not registered to collect the sales and use tax, the Partnership is responsible for reporting and paying the use tax on a Consumer's Use Tax Return, Form ST-7.
Sales of Business and Successor Liability
-
- Code of Virginia § 58.1-629 addresses the sale of a business and provides:
-
- If any dealer liable for any tax, penalty, or interest levied hereunder sells out his business or stock of goods or quits the business, he shall make a final return and payment within fifteen days after the date of selling or quitting the business. His successors or assigns, if any, shall withhold sufficient of the purchase money to cover the amount of such taxes, penalties, and interest due and unpaid until such former owner produces a receipt from the Tax Commissioner showing that they have been paid or a certificate stating that no taxes, penalties, or interest is due. If the purchaser of a business or stock of goods fails to withhold the purchase money as above provided, he shall be personally liable for the payment of the taxes, penalties, and interest due and unpaid on account of the operation of the business by any former owner.
In Public Document 96-161 (06/28/96), a taxpayer contemplating the purchase of a business asks a number of questions relating to the tax liability associated with such purchase. In applying Code of Virginia § 58.1-629, the Tax Commissioner ruled that a purchaser of the stock of a business may be held responsible for the sales and use tax liability of a prior owner when such liability might be disclosed upon audit.
I will address the extrapolation and fixed assets issues in light of the above statute and public document.
Method of extrapolation: The recurring purchases were sampled for the year 1996. The stock sale occurred in August 1995. The error factor was computed and then extrapolated for the periods prior to the stock sale and subsequent. You agree that the sampling is valid for the periods subsequent to the stock sale but not before because it does not take into account (1) the change in ownership and (2) an increase in purchasing subsequent to the stock sale.
To limit the sampling to the periods you suggest would remove the tax from purchases for which you have presented no verification of the payment of the tax. Therefore, the extrapolation method will stand. In accordance with Code of Virginia § 58.1-629 and P.D. 96-161, the Taxpayer as the successor business is liable for the payment of the tax for the periods prior to the stock sale. In addition, Code of Virginia § 58.1-205 deems any tax assessment issued by the Department of Taxation as prima facie correct. Thus, the burden of proof is upon the Taxpayer to establish through convincing evidence that a tax assessment is erroneous. Consequently, as no such evidence has been submitted, I must deny the Taxpayer's appeal in regard to this issue.
Fixed assets: The auditor applied the tax to certain fixed assets acquired by the clinic prior to the stock sale. This was done using local property tax records because the invoices and depreciation schedules were not made available to the auditor. The tax was applied to these assets in detail and was not extrapolated as you maintain. You assert that the tax was paid on these assets, but you provide no documentation to support your assertion. Therefore, the tax remains due on these assets. In accordance with Code of Virginia § 58.1-629 and P.D. 96-161, the Taxpayer as the successor business is liable for the payment of the tax.
Occasional Sale Exemption
In your December 11, 2001 letter, you assert that the occasional sale exemption in Code of Virginia § 58.1-609.10(2) applies to tangible personal property purchased by the Taxpayer from the clinic. However, the auditor did not apply the tax to tangible personal property transferred as a result of the stock sale.
Conclusion
The audit will be returned to the ***** for removal of the management fees. The Taxpayer will receive a revised audit report and a revised bill. The bill, which will include updated interest, should be paid within 30 days of the bill date to avoid additional interest charges. If you have questions concerning the audit revision, please contact ***** at *****. Questions regarding this letter may be directed to ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
Sincerely,
Kenneth W. Thorson
Tax Commissioner
AR/23033J
Rulings of the Tax Commissioner