Could a media-buying business exclude client money paid to media vendors from BPOL gross receipts as pass-through agency funds?

Subject

Taxpayer must offer clear proof of separate accounting of "pass through" funds

Plain-English summary

Virginia upheld BPOL tax on the media buyer's total client receipts because it failed to prove that vendor payments were excluded pass-through agency funds.

The ruling required three elements: contracts establishing relationships among the taxpayer, client, and third-party vendor; a separate accounting or fiduciary system that did not commingle the client funds; and federal reporting that did not treat those pass-through amounts as the taxpayer's own gross income and then deduct them as costs.

The taxpayer did not provide sufficient contracts despite requests, did not prove a separate accounting system, and reported the full client payments on Schedule C while deducting vendor payments as cost of goods sold. It also had not pursued corrected federal information returns.

Because the business could not substantiate all three agency criteria, Virginia agreed with the county's final assessment.

What this means for you

• Put the client's responsibility to the vendor and the taxpayer's agency status clearly in written contracts.
• Segregate pass-through money in fiduciary accounts or a demonstrably separate accounting system.
• Align federal reporting with the claimed BPOL agency treatment.
• Keep proof that unused client money is returned and that vendor payments are made for identified clients.

Common questions

Was earning only a commission enough? No. Compensation structure alone did not establish agency.

Could ordinary accounting records prove segregation? Potentially, but the taxpayer did not provide clear proof of a qualifying system.

Why did federal reporting matter? Reporting all client money as gross income and deducting vendor costs was inconsistent with treating the money as another person's funds.

Citations and references

• Va. Code § 58.1-3700.1.
• City of Alexandria v. Morrison-Williams Associates, Inc., 223 Va. 349, 288 S.E.2d 432 (1982).
• P.D. 01-38, P.D. 06-94, P.D. 04-66, and P.D. 04-81.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-140

Original ruling text

September 5, 2007

Re: Appeal of Final Local Determination

Taxpayer: *

Locality: *

Business, Professional and Occupational License Tax

Dear *:

This final state determination is issued upon the application for correction filed by you on behalf of * (the "Taxpayer") with the Department of Taxation. You appeal a final local determination upholding an assessment of business, professional and occupational license (BPOL) taxes made by the Commissioner of the Revenue of the *** (the "County") for tax years 2003 and 2004.

The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department of Taxation's web site.

FACTS

The Taxpayer is engaged in the business of purchasing media for its clients. The Taxpayer secures media services for its clients and keeps a percentage of the cost of providing such services as a commission. In filing its federal tax returns, the Taxpayer reports its total gross receipts, then deducts expenditures related to its business as cost of goods sold.

The County issued BPOL tax assessments for 2003 and 2004. In its appeal to the County, the Taxpayer maintained that for BPOL tax purposes, it should be classified as (1) a commission merchant; (2) that its pass through costs are deductible, or alternatively; (3) because its business activity is virtually 100% broadcast-related, it is conducting a radio or television broadcasting service and as such, it is exempt from BPOL taxation.

According to the County, it met with the Taxpayer on a number of occasions in order to gather sufficient information to make a determination as to the accuracy of the assessments. In its final local determination, the County held that the Taxpayer did not meet (1) the criteria to be classified as a commission merchant; (2) the three criteria required to establish an agency relationship, and (3) the criteria necessary to be classified as a radio or television broadcasting service. The Taxpayer's appeal to the Department contests the County's assessment solely on the issue of agency relationship.

ANALYSIS

The BPOL tax is a gross receipts based tax imposed upon business, trades, professions, occupations and callings and the persons engaged therein for the privilege of conducting business in a local jurisdiction. Virginia Code § 58.1-3700.1 defines "gross receipts" as the "whole, entire, total receipts, without deduction." However, there are specific exemptions, deductions and exclusions that are either provided by statute or affirmed through Supreme Court decisions, opinions of the Attorney General and rulings by the Department. One such area is that of agency relationships.

The definition of "agency relationship" has been created through case law and affirmed through both opinions of the Attorney General and rulings by the Department. In City of Alexandria v Morrison-Williams Associates, Inc. , 223 Va. 349, 288 S.E.2d 432 (1982), the Virginia Supreme Court ruled that an advertising agency that charged its clients a commission on media charges was taxable on total receipts from clients without deduction for the media charges.

Based on that decision, it has been established that three criteria must be met if a taxpayer is to establish that it has an agency relationship with its clients. These criteria are: (1) contractual relationships exist between the taxpayer and both the client and the contracted third party, and there is a stated relationship between the client and the contracted third party; (2) the taxpayer does not commingle its "agency" funds with other sources; rather it must have a separate accounting system or a fiduciary account where the pass through receipts from its clients are recorded and; (3) the taxpayer does not report these "pass through costs" on its federal income tax returns. See also Public Document (P.D.) 01-38 (4/12/2001) and P.D. 06-94 (9/28/2006).

Contractual relationships

In its appeal, the Taxpayer states that it could not find a definition of a third party contractual relationship. This is clearly defined in P.D. 01-38. In that case, the taxpayer's contract created a connection between the client and the media that did not exist in Morrison . The contract between the taxpayer and the media also specifically stated that the taxpayer was "acting as the legal agent for the principal named on the face of this contract. As such, [the taxpayer] shall be liable to the [media] for the payment of sums due on this order, but only to the extent that the advertiser has made payment to the [taxpayer]. " [Emphasis and inserts added.]

Furthermore, in the case addressed in P.D. 01-38, the taxpayer's contract with the client specified that the "[c]lient agrees to assume full and final responsibility for fulfilling all contracts with the media and suppliers and further agrees to furnish signature on all contracts to indicate assumption of such responsibility."

In the instant case, specific requests made to the Taxpayer for copies of contracts have not been met. A copy of a portion of the Taxpayer's contract with the vendor that was provided is not sufficient for the Department to make a determination as to the relationship between the Taxpayer and its clients.

Commingling of funds

The Taxpayer has expressed some confusion as to what "separate accounting systems" mean. In P.D. 01-38, it was found that the taxpayer's clients deposited funds with the taxpayer, and those funds were designated for the payment of specific expenses that the client otherwise would have incurred directly. Any excess funds that were not applied to purchase advertisements on behalf of a client were refunded to the client. This was made clear in the contractual relationship between the taxpayer and the client.

Taxpayers may establish fiduciary funds for these monies, or establish a clear accounting system that segregates these monies from all other income the taxpayer receives. Examples of these approaches are addressed in P.D. 04-66 (8/23/2004) and P.D. 04-81 (8/25/2004). In either event, to claim an agency relationship for purposes of the BPOL tax, a taxpayer must be able to offer clear proof of a separate accounting of these "pass through" funds.

In the instant case, the Taxpayer contends that it has maintained a separate accounting system that registers its transactions associated with its business. Despite several requests, the Taxpayer did not supply the County or the Department with proof demonstrating the existence of such a system.

Pass through Costs

In order to qualify for the BPOL tax exemption, a taxpayer cannot deduct pass through funds on its federal income tax return. In this case, the Taxpayer states that its clients reported gross amounts remitted to the Taxpayer including those funds that pass through to media vendors for federal information forms (Form 1099). The Taxpayer reported the gross amounts as income on Schedule C and deducted the pass through funds as cost of goods sold.

Under rules established by the Internal Revenue Service (I.R.S.), taxpayers that receive an incorrect information form should contact the payer and request a corrected form. If the payer fails to correct the information form, the taxpayer should contact the I.R.S. for assistance. With the proper information, the I.R.S. will initiate a request for the missing or incorrect form from the payer on behalf of the taxpayer.

The Taxpayer does not appear to have made any attempt to obtain corrected Forms 1099 as required by the I.R.S. Therefore, the Taxpayer cannot claim to have an agency relationship for purposes of the BPOL tax.

DETERMINATION

There are three criteria that must be met if a taxpayer is to establish an agency relationship between itself and its clients for purposes of the BPOL tax. In the present case, the Taxpayer has failed to provide evidence to either the County or the Department substantiating its claim of an agency relationship. Therefore, I find the County's final determination is correct.

If you have any questions regarding this determination, you may call *, Office of Policy and Administration, Appeals and Rulings at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1227900717H