Does an out-of-state direct-sales company owe Utah corporate franchise tax just because independent-contractor 'Members' solicit and make sales in Utah?

Plain-English summary

An out-of-state direct-sales/network-marketing company sold dietary supplements to independent-contractor "Members" and consumers in Utah. All orders went to the company's out-of-state home office for approval, processing, and shipment by common carrier; Members didn't collect payment for the company, didn't hold company inventory, offices, or bank accounts in Utah, and paid only a nominal ($5.95) sales-kit fee to join. Members set their own hours, supplied their own equipment, could resell products at a profit, and earned commissions on their network's purchases -- but had no authority to bind the company.

The company asked for a written determination that it was protected from Utah corporate income/franchise tax reporting under federal Public Law 86-272 (15 U.S.C. § 381(c)), which bars a state from taxing income derived from in-state activity that consists only of soliciting orders for sales of tangible personal property.

The Commission agreed: under Utah Admin. Rule R865-6F-6, independent contractors may solicit and make sales in Utah -- and may even maintain a Utah office -- without destroying the company's P.L. 86-272 immunity. Since the Members here were independent contractors only soliciting and making sales, with no Utah inventory, the company's activities stayed protected and it owed no Utah franchise tax on this record.

The Commission flagged two important limits on that protection:

• Holding inventory breaks it. If an independent contractor keeps an inventory of the company's products in Utah, P.L. 86-272 no longer applies.
• Exclusive reps get narrower protection. A sales representative who represents only a single principal is treated as a "company representative," not an independent contractor, for P.L. 86-272 purposes -- and company representatives get somewhat narrower protection than independent contractors under Rule R865-6F-6.

The ruling addresses only the corporate franchise tax question; it does not resolve the company's separate request about whether its shareholders must file individual Utah income tax returns after the company elected S-corporation status.

What this means for you

Direct-sales, network-marketing, and MLM companies

Using independent, non-exclusive contractors to solicit and close sales of physical products in a state -- without those contractors holding your inventory there -- can keep you under P.L. 86-272's protection from that state's net income/franchise tax. Watch two triggers that can break the shield: contractors warehousing your product locally, or contractors who sell for you exclusively (they may be reclassified as "company representatives" with narrower protection).

Multistate businesses relying on independent contractors

This ruling is a useful, concrete example of how Utah applies R865-6F-6's independent-contractor and company-representative distinctions. If your facts differ -- inventory storage, exclusivity, or activities beyond solicitation -- the outcome can flip.

Accountants and tax professionals

Note what this ruling does not resolve: the shareholders' individual income tax filing question tied to the company's S-corporation election was raised in the request letter but not answered in the Commission's response. Don't assume it was addressed.

Common questions

Q: Does having independent contractors solicit and sell in Utah create franchise tax nexus?
A: Not by itself, if their activity is limited to soliciting and making sales of tangible personal property and they don't hold your inventory in the state -- that stays protected under P.L. 86-272 and Rule R865-6F-6.

Q: What breaks P.L. 86-272 protection for a direct-sales company?
A: Under this ruling, an independent contractor holding an inventory of your products in Utah breaks the protection. A contractor who represents your company exclusively is also treated differently (as a "company representative") with narrower protection.

Q: Did this ruling decide whether shareholders must file individual Utah income tax returns?
A: No. The company asked that question too, but the Commission's response only addressed the corporate franchise tax / P.L. 86-272 issue.

Q: Does this ruling apply to my company?
A: No. It binds the Commission only for the requesting company and the facts described. Another taxpayer can't rely on it as binding, though it may carry some persuasive weight in a dispute with closely similar facts.

Citations and references

Statutes and rules:

• Public Law 86-272, 15 U.S.C. § 381(c) (income tax immunity for mere solicitation of sales)
• Utah Admin. Rule R865-6F-6 (independent contractor and company representative activities)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original PDF: https://files.tax.utah.gov/tax/commission/ruling/97-072.htm

Original ruling text

97-072

Response December 16, 1997

REQUEST
LETTER

November
13, 1997

Dear
Ms Rees'

On
behalf of our client, Company A ("Company"), COMPANY A ("COMPANY
A") previously submitted to Julie Goins a letter dated October 20, 1997,
in which we informed Julie of Company's desire to pursue the possibility of
disclosing a potential income/franchise tax liability within the State of Utah.
In our subsequent contact by telephone, we requested information as to the
appropriate procedure to obtain a written determination from the State of Utah
as to whether Company is protected from income tax reporting requirements in
your State pursuant to P.L. 86-272. As we indicated, we have gathered
information about this Company to submit to you for purposes of obtaining such
a determination.

COMPANY'S
BUSINESS ACTIVITIES IN THE STATE OF UTAH

Company
is a direct sales/network marketing company based in another state. The Company
sells dietary supplements and other products to independent distributors
("Members") and consumers in your State. Orders for products, whether
for their own consumption or for resale, are submitted to Company's home office
(located in another State) for credit approval, processing and shipment. Products are shipped via common
carrier. Members do not collect payment
for products on behalf of the Company.

There
is no service fee or franchise fee to become a Member of Company in your state,
however, all new Members are required to purchase a sales kit, at Company cost
($5.95) 1, 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 Member of Company. Members can purchase

Company's
products at discount "Member" prices and resell the products for a
profit. In

addition,
Members solicit and Sponsor individuals into their network to purchase products
and

are
paid commissions by Company, based on the purchases of products by other
Members in

their
network. Company 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 your State. Company
does not maintain a regular sample or display room at any location within your
state however, sample products are brought into your state for display purposes
only in connection with one day promotional tours for Members conducted by the
Company.

Company
was incorporated in another state in 1994 Company began making sales into your

state
in 1995. Company initially filed federal income tax returns as a C Corporation
and then

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 Utah. Neither Company nor any of its

shareholders
have filed state income tax returns in your state because they believe they are

protected
by P.L 86-272 Company has not been contacted by any Utah State Tax Commission

personnel
regarding potential income tax liability, and is not currently under audit by
your state

PUBLIC
LAW 86-272

Public
Law 86-272 prohibits a State or political subdivision thereof from imposing a
net income

tax
on income derived within such State from certain limited business
activities Specifically, a

company
is not considered to be engaged in business activities within a State merely by
reason

of
independent contractors making sales, or the solicitation of orders for sales
in such State, of

tangible
personal property. See 15 USCS � 381(c). COMPANY A believes that Company's
activities within the State of Utah are protected from state income tax
pursuant to P.L 36-272.

Members
are independent contractors, not employees or partners of Company. The Members

have
no authority to bind the Company to any obligation. It is each Member's responsibility to

pay
all applicable income, social security or other local taxes. Company collects and remits to

the
various state taxing authorities sales taxes on behalf of its Members.

Members
are not eligible for employee benefits such as unemployment compensation or

worker's
compensation. Each Member determines
his or her own hours and supplies all of his or her own equipment and tools for
operating his or her business, such as telephones, transportation, professional
services, office equipment and supplies.
Members can determine his or her own methods of sale, although Members
must comply with the policies and procedures of Company to prevent improper,
abusive or illegal acts. Thus, Members are independent contractors making sales
and soliciting sales in Utah. Such activities are protected by PL. 86-272.

CONCLUSION

As
described above, Members are only engaged in sales and solicitation activities
in the State of

Utah. As independent contractors, Members are
allowed to make sales of tangible personal property, and to solicit orders for
such sales, without causing Company to lose the protection

against
a net income tax afforded by P.L 86-272.
Consequently, we believe that Company is protected from corporate income
tax in your state

REQUEST
FOR WRITTEN DETERMINATION

In
order to provide Company with the assurance it desires regarding its income tax
reporting

requirements
in the State of Utah, we hereby request a written determination from the State
of

Utah
regarding the issue of protection pursuant to P.L., 86-272. In addition. we
would like a

determination
as to whether any shareholders of Company are required to file individual
income

tax
returns in Utah after Company made the election to file as an S Corporation for
federal

income
tax purposes.

We
would like to obtain this determination as expeditiously as possible, and would
greatly

appreciate
your prompt attention to this matter.
If you need any additional information or have

any
question regarding this matter, please give me a call at #####.

Very
truly yours,

NAME

December
16, 1997

NAME

ADDRESS

CITY
STATE ZIP

Advisory
Opinion - Activities protected under Public Law 86-272

Dear
NAME,

We have received your request for corporate
franchise tax guidance pertaining to Public Law 86-272. We offer the following:

By the facts presented, your client
is a direct sales/network marketing business that is incorporated and located
outside of Utah. Independent
contractors within Utah purchase your client�s goods for personal consumption
in Utah or for resale within the state.
All orders are placed with your client outside of Utah. The orders are processed and accepted
outside of Utah and products are shipped into Utah by common carrier. Except for the solicitation of orders by
in-state sales contractors, the client maintains no physical presence in Utah.

Public Law 86-272 bars the state
from imposing tax on income derived within Utah if the only business activity
in this state consists of the solicitation of orders for sales of tangible
personal property. Your client�s
activities are protected even though your client uses independent in-state
sales contractors under the conditions stated Utah Administrative Rule
R865-6F-6 (copy enclosed). To
summarize, independent contractors may solicit and make sales in this state and
may maintain an office in Utah without jeopardizing your client�s immunity.
However, if an independent contractor maintains an inventory of your client�s
products in Utah, Public Law 86-272 does not apply. You should also be aware that sales representatives who represent
a single principal are considered company representatives rather than
independent contractors for purposes of Public Law 86-272. The protection afforded to company
representatives is somewhat narrower than that afforded to independent
contractors. Please refer to R865-6F-6
for additional information pertaining to activities of company representatives.

Under the facts presented in your
request, your client�s activities in Utah are protected by Public Law
86-272. If your client engages in any
other activities other than those activities that are protected under
R865-6F-6, your client may be liable for Utah franchise tax.

Please let us know if you have any
other questions.

For
the Commission,

Joe
B. Pacheco,

Commissioner

^^