Tax Type
Corporation Income Tax
Description
Federal limitation on taxation of interstate commerce; Activity by independent contractors.
Topic
Constitutional Provisions
Date Issued
01-14-1998
January 14, 1998
Dear**********:
This will reply to your letter in which you are requesting a ruling on behalf of your client (the "Taxpayer') in which you request a ruling regarding the Taxpayer's Virginia corporation income tax obligations.
FACTS
The Taxpayer is a direct sales/network marketing company based in another state. The Taxpayer sells products to distributors ("Dealers') and consumers in your state. Orders for products, whether for their own consumption or for resale, are submitted to Taxpayer's home office (located in another state) for credit approval, processing and shipment. Products are shipped via common carrier. Dealers do not collect payment for products on behalf of the Taxpayer.
In Virginia, Dealers do not pay a service or franchise fee to the Taxpayer. However, all new Dealers are required to purchase a sales kit, at Taxpayer cost, with their first order and are required to renew their memberships annually at the same nominal cost. No purchase of product is necessary to become a Dealer of the Taxpayer. Dealers can purchase Taxpayer's products at discount "Dealer' prices and resell the products for a profit. In addition, Dealers solicit and sponsor individuals into their network to purchase products and are paid commissions by Taxpayer, based on the purchases of products by other Dealers in their network.
The Taxpayer has no warehouses or other structures in which inventory is stored, no offices or other property, maintains no bank accounts nor holds corporate meetings in Virginia. The Taxpayer does bring sample products into Virginia for display purposes only in connection with one-day promotional tours for Dealers.
The Taxpayer was incorporated in another state in 1994 and began making sales into Virginia in 1995. The Taxpayer made the federal election to file as an S Corporation effective with the tax year beginning April 1, 1997. None of the shareholders are domiciled in Virginia.
You have requested a ruling regarding the Taxpayer's protection from taxation pursuant to Public Law (P.L.) 86-272 (15 U.S.C.A. Secs. 381-384). In addition, you request a ruling as to whether any shareholders of Taxpayer are required to file individual income tax returns in Virginia after Taxpayer made the election to file as an S Corporation for federal income tax purposes.
RULING
A tax is imposed on the Virginia taxable income of every foreign corporation having income from Virginia sources, unless specifically exempted. Under P.L. 86-272, Virginia is prohibited from imposing an income tax on a corporation whose only business activity within the state is the solicitation of orders for the sale of tangible personal property. The Taxpayer derives income from Virginia sources through the sale of tangible personal property. In addition, the membership renewal fees the Taxpayer receives from Virginia Dealers represents, at least in part, the income from intangible property. Although P.L. 86-272 only applies to "tangible' personal property, Virginia applies the same "solicitation' test to the sales of other than tangible personal property. See Public Document (P.D.) 93-75, 3/17/93, copy attached. The department has a long established policy of narrowly interpreting the provisions of P.L. 86-272.
Based on the facts as described in your letter, the Taxpayer's only business activities that could subject it to Virginia income tax are those conducted with and through the Dealers. Thus the question becomes whether the Dealers are independent contractors or representatives (employees, partners, etc.) of Taxpayer.
Pursuant to P.L. 86-272, there are different standards which apply to the activities of a taxpayer's representative versus the activities of an independent contractor. A taxpayer is not protected from taxation by a state pursuant to P.L. 86-272 if its employees and/or representatives maintain an office in such state or accept orders for sales. On the other hand, an independent contractor can "make' a sale (solicit and accept an order) and maintain an office in the state without subjecting his principal to taxation.
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- An independent contractor is defined in P.L. 86-272 as:
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 . . .
- An independent contractor is defined in P.L. 86-272 as:
The Taxpayer's activities in Virginia consist of products in transit to and through Virginia and occasionally sending representatives into Virginia to promote products among the Dealers. Based on the presentation of the facts, these activities do not exceed the solicitation of orders or activities ancillary to solicitation.
The facts as described indicate that the Taxpayer would exempt from income tax pursuant to P.L. 86-272. It must, however, file a tax return in accordance with Title 23 of the Virginia Administrative Code 10-120-310, copy attached, and state the basis for its exemption clearly thereon. Assuming that the Taxpayer's shareholders only Virginia source income is from the S corporation, they will have no Virginia adjusted gross income and will therefore not be required to file nonresident Virginia individual income tax returns. See P.D. 95-197, 7/31/95, copy attached.
The Taxpayer should be aware that a change in the facts or in its Virginia business activities could alter this ruling. In the event that the facts do change, the out-of-state shareholders will be required to file nonresident individual income tax returns to report income from Virginia sources.
If you have additional questions concerning this matter, please contact ***** in the Office of Tax Policy at *****.
Rulings of the Tax Commissioner