September 8, 2017
Re: Request for Ruling: Corporate Income Tax
Dear *****:
This will reply to your letter in which you request rulings on behalf of your client ***** (the “Taxpayer”) regarding nexus for corporate income tax purposes and payroll apportionment. I apologize for the delay in responding to your request.
FACTS
The Taxpayer, an affiliated group of corporations, manufactures, markets and sells motor vehicles. The Taxpayer sells its cars and trucks through a network of dealers, some of which are located in Virginia. The Taxpayer's members are incorporated and based outside Virginia, and do not own or lease any real or tangible personal property in Virginia. The Taxpayer's contacts with Virginia are generally limited to sending nonresident sales representatives into Virginia to solicit sales of motor vehicles. All orders are sent outside Virginia for acceptance, and vehicles are delivered from locations outside Virginia by common carrier. The Taxpayer questions whether certain activities would create income tax nexus for three of its affiliates, Company A, Company B and Company C.
RULING
Virginia Code § 58.1-400 imposes an income tax “on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources.” Generally, a corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. The existence of positive Virginia apportionment factors clearly establishes income from Virginia sources.
Public Law (P.L.) 86-272, codified at 15 U.S.C. §§ 381-384, however, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. The Department has a long established policy of narrowly interpreting the provisions of P.L. 86-272. The Department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992).
Scenario #1
Are warranty repair activities performed by the dealers deemed conducted by Company A for purposes of determining whether Company A has income tax nexus with Virginia?
Vehicles are usually sold with a warranty. The dealers are responsible for handling warranty repairs, and Company A reimburses the dealership for the costs. Company A does not generally instruct the dealers as to how the warranty repairs are to be made.
Pursuant to P.L. 86-272, there are different standards that apply to the activities of a representative versus the activities of an independent contractor. An entity is not protected from taxation by a state pursuant to P.L. 86-272 if its representatives maintain an office in such state or engage in activities that go beyond the mere solicitation of orders. However, an independent contractor can engage in a broader range of activities within a state without subjecting its out-of-state corporate customer to that state's income tax.
An independent contractor is defined in P.L. 86-272 as a “commission agent, broker, or other independent contractor who is engaged in selling, or soliciting orders for the sale of, tangible personal property for more than one principal and who holds himself out as such in the regular course of his business activities . . . .” This definition sets forth a two-part test, both of which must be met, in order for an agent to be considered an independent contractor. The agent must represent two or more principals and the agent must be, in fact, independent from the principals.
When a corporation contracts with a third party service provider in Virginia, the Department views such activities as if a corporation is purchasing services only if a third party service provider is an independent contractor. See Public Document (P.D.) 01-136 (9/18/2001). Under such circumstances, the corporation is not considered to be conducting the activities in Virginia and the unrelated third party would not create nexus for a corporation that is otherwise protected under P.L. 86-272.
The Department-will, however, take a different approach if a third party provider is not independent of Company A. The Department attributes unprotected activities performed by an entity that is not independent to a business entity for purposes of determining whether or not the entity has nexus with Virginia. As such, a third party service provider that is not independent of Company A is considered to be providing services on behalf of Company A to Company A's customers. See P.D. 99-278 (10/14/1999).
The dealers perform warranty repairs on the vehicles once such repairs have been authorized by Company A, if authorization is required. Once the repairs have been completed, Company A pays the dealers for the cost of the repairs. Generally, Company A does not instruct the dealers as to him the repairs are to be made.
The Taxpayer asserts that all the dealers are independent of, and unrelated to, Company A. If the dealers represent two or more principals and they are truly independent of Company A, then the Department would not attribute the warranty repair services to Company A for nexus purposes. Company A, however, will have to evaluate its relationships with the dealers to determine if they are independent contractors under P.L. 86-272.
Scenario #2
Does the fact that Company B occasionally sends a technician into Virginia to investigate unusual repair issues create nexus as to Company B?
In addition to the facts in Scenario #1, Company B occasionally sends a technician to Virginia when a dealer encounters a highly unusual repair issue, but no such visits have been made in the last ten years.
Normally, the Department will consider a visit by a taxpayer's representative to investigate repair issues as an activity that is not protected under P.L. 86-272. Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G, however, exempts activities that are de minimis in nature. Pursuant to this regulation, consideration is given to the nature, continuity, frequency and regularity of the unprotected activities, in Virginia, compared to the nature, continuity, frequency and regularity of such activities outside Virginia. Under Wrigley, all nonancillary activities are examined to determine if, when considered together, they create more than a de minimis connection to Virginia.
Company B has not sent a representative into Virginia to investigate a special warranty repair issue in the last ten years. It is unclear, however, how often these visits occurred prior to that. Without a full examination of such activities, a determination cannot be made as to whether they created a more than de minimis connection.
Scenario #3
Are the activities of Company C's employee protected under P.L. 86-272 and if not, should the employee's wages be included in the numerator of Company C's Virginia payroll factor?
Nexus
Company C employs a part-time, home-based employee in Virginia. Company C also provides the warranties addressed in Scenario #1. The employee's activities primarily involve organizing events for owners of Company C's vehicles. The employee travels extensively and organizes such events throughout the United States. One such event takes place in Virginia annually. For unemployment compensation purposes, Company C reports her wages to the state in which it is based and not to the Virginia Employment Commission (VEC). The Taxpayer contends that the employee's activities are ancillary to the solicitation of sales because they serve to drive future sales of Company C's products by promoting goodwill and product loyalty within Company C's ownership group.
As stated above, the Department has a longstanding policy of narrowly interpreting the provisions of P.L. 86-272. Although the employee's activities may be ancillary to improving Company C's sales, the precise question is whether the employee's activities are ancillary to the solicitation of sales. In this case, the employee organizes owner events throughout the United States, one of which occurs annually in Virginia. Although the ultimate goal of such events may be to cultivate customer loyalty and thus drive future sales, there is no indication that such events primarily involve the actual solicitation of sales. As such, the Department would not consider the organization of such events to be a protected activity under P.L. 86-272.
The Taxpayer contends that even if the employee's activities are not considered ancillary to the solicitation of sales, they should be considered de minimis in nature because she travels extensively throughout the United States, she spends only a limited amount of time in Virginia, and only one event occurs in Virginia annually. As stated above, consideration is given to the nature, continuity, frequency and regularity of the unprotected activities, in Virginia, compared to the nature, continuity, frequency and regularity of such activities outside Virginia. See Title 23 VAC 10-120-90 G. In Wrigley, the Court reasoned that a “nontrivial additional connection” with the state will be established when all unprotected activities are considered together. Taken together, the Department considers a multi-day customer event held annually in Virginia to constitute a nontrivial additional connection to Virginia. As such, it appears that the activities of Company C's employee create nexus for Company C.
Payroll Factor
Even if the employee's activities are not ancillary to solicitation or de minimis in nature, the Taxpayer contends her wages should not be included in the numerator of Company C's payroll factor. Virginia's payroll factor is a fraction, the numerator of which is the total amount paid or accrued in Virginia during the tax period by the corporation for compensation, and the denominator is the total compensation paid everywhere during the taxable year. See Va. Code § 58.1-412. Pursuant to Title 23 VAC 10-120-190, total wages reported to the VEC are presumed to be compensation paid to employees in Virginia.
Under Va. Code § 60.2-217 A 2, compensation must be reported to the VEC if the employment is not localized in any state but is performed to some extent in Virginia and either:
- the base of operations is located in Virginia,
- the place from which such employment is directed or controlled is in Virginia,
- the base of operations or place from which such employment is directed or controlled is not in any state in which a portion of the employment is performed, but the employee resides in Virginia.
Because the Department does not administer the Virginia Unemployment Compensation Act (Title 60.2 of the Code of Virginia), Company C should request guidance from the VEC to determine if it is required to report the employee's wages. Even if the compensation is not subject to the Act, however, it must nevertheless be included in the numerator of the Virginia payroll factor if it is deemed paid or accrued in Virginia under Va. Code § 58.1-413. See Title 23 VAC 10-120-190 C.
In this case, the employee performs services both within and without Virginia. Under such circumstances, compensation will be deemed paid or accrued in Virginia under Va. Code § 58.1-413 3 if:
- The base of operations or, if there is no base of operations, the place from which the service is directed or controlled is in the Commonwealth; or
- The base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the employee's residence is in the Commonwealth.
Pursuant to Title 23 VAC 10-120-200 B 2, a “base of operations” is defined as:
[A] place of more or less permanent nature from which the employee starts his work and to which he customarily returns in order to receive instructions from the taxpayer or communications from his customers or other persons, or to replenish stock or other materials, repair equipment, or perform any other functions necessary to the exercise of his trade or profession at some other point or points.
In addition, “place from which the service is directed or controlled” means the place from which the power to direct, control or supervise the employee's service is exercised by the taxpayer. See Title 23 VAC 10-120-200 B 3.
According to the Taxpayer, the employee's activities are not directed or controlled from Virginia. As long as the employee performs part of her services in the state where her activities are directed and controlled and she has no base of operations in Virginia, her compensation would not be attributed to Virginia. If the employee does not perform part of her services in such state, however, her compensation would be attributable to her place of residence in Virginia by default.
In addition, with the proliferation of employees working remotely from their homes (i.e., teleworking or telecommuting), Company C will have to consider whether the employee's residence or any other location may be a base of operations. While an employee's residence has been designated as the default base of operations in certain circumstances under Va. Code § 58.1-413 3 b, nothing in the relevant statutory or regulatory provisions precludes the residence itself from being a base of operations. If the employee's residence meets the requirements of a base of operations in Virginia, her compensation would be attributable to Virginia regardless of where her activities are directed or controlled.
CONCLUSION
If, as a result of this ruling and any further review the Taxpayer may undertake, the Taxpayer wishes to enter into a voluntary disclosure agreement, it may submit a proposal to Virginia Department of Taxation, Voluntary Disclosure Program, P.O. Box 5640, Richmond, Virginia 23220. The Taxpayer may find further information concerning the voluntary disclosure program on the Department's web site. Further questions may be directed to ***** at (804) 225-3560.
This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result. The Taxpayer should be aware that nothing contained in this ruling should be construed to mean the Taxpayer is not engaged in other unprotected activities that may have not been described herein. Determinations of nexus are highly dependent on the facts and circumstances of each case, and any number of activities may exceed the protections of P.L. 86-272.
The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/726.M