Did customer meetings by employees of an out-of-state design consultant create Virginia income-tax nexus, payroll, sales-factor, and withholding duties?

Plain-English summary

Virginia could not determine corporate-income-tax nexus from the facts supplied. The consulting and design company did all drawing work in its home state and mailed or electronically transmitted designs to customers, but employees traveled into Virginia for customer meetings. The company did not explain what happened at those meetings.

P.L. 86-272 protected only solicitation, ancillary conduct, and de minimis activity under the Department's extended policy for service sales. Nexus depended on the nature, continuity, frequency, and regularity of all unprotected Virginia activities. Without those details, the Department could not decide whether the visits exceeded protected or de minimis conduct.

The company appeared not to have a Virginia payroll factor because its employees' services were directed and controlled from the home state, no employees were Virginia residents, and wages did not appear reportable to the Virginia Employment Commission. The ruling advised verifying that point with the Commission.

Payroll-factor treatment did not eliminate withholding. Employees performing services in Virginia earned Virginia-source wages, so the company had Virginia withholding responsibilities.

For design fees and subscriptions, the ruling applied a transaction-by-transaction costs-of-performance test. A sale was entirely Virginia or entirely outside Virginia depending on where the greatest portion of the transaction's costs occurred.

Common questions

Q: Did customer meetings automatically create corporate-income-tax nexus?
A: The ruling did not decide; it needed the purpose, frequency, and extent of the Virginia activities.

Q: Did the apparent absence of a payroll factor eliminate wage withholding?
A: No. Withholding applied to employees performing services in Virginia.

Q: How were service sales assigned under the ruling?
A: Each transaction went to the state with the greatest portion of its costs of performance.

Citations and references

• Va. Code §§ 58.1-400 and 58.1-408 through 58.1-414.
• 15 U.S.C. §§ 381-384 (P.L. 86-272).
• Va. Code §§ 58.1-412, 60.2-217(A)(2), 58.1-460, 58.1-461, and 58.1-416.
• 23 VAC 10-120-90(G), 10-120-190, and 10-120-230.

Subject

Determination as to whether a transaction is a Virginia transaction

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-151

Original ruling text

September 21, 2012

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will reply to your letter in which you request a ruling concerning corporate income tax nexus on behalf of your client * (the "Taxpayer").

FACTS

The Taxpayer, an entity headquartered in * (State A), is a consulting and design business. The Taxpayer does not have a facility in Virginia and all design and drawing work is conducted in State A. The design drawings are transmitted to customers, including those in Virginia, via mail or electronic transmission. Employees of the Taxpayer travel into Virginia to meet with customers. The Taxpayer requests a ruling that its activities in Virginia are not sufficient for it to be subject to Virginia's corporate income tax.

RULING

Nexus

Virginia Code § 58.1-400 imposes 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 the applicable apportionment factor positive. See Va. Code §§ 58.1-408 through 58.1-414. The existence of a positive Virginia apportionment factor establishes income from Virginia sources.

Public Law (P.L.) 86-272, codified at 15 U.S.C. §§ 381-384, 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. Although P.L. 86-272 applies to tangible property, the Department's policy has been to extend the "solicitation test" of P.L. 86-272 to situations involving the sale of other than tangible personal property. See Public Document (P.D.) 91-33 (3/18/1991) and P.D. 93-75 (3/17/1993). 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). The Department has a long-established policy of narrowly interpreting the provisions of P. L. 86-272.

The Taxpayer indicates that its employees travel into Virginia to meet with customers. No descriptions of the employees' activities have been provided. In Wrigley , the United States Supreme Court set forth a number of activities that constitute mere solicitation of sales. Such activities include in-state recruitment, training, and evaluation of sales representatives, use of hotels and homes for sales-related meetings, provision of product displays and promotional materials, and the use of a business owned automobile by sales personnel. In addition, the Department has issued numerous public documents addressing whether specific activities would be considered to be ancillary to solicitation. See P.D. 92-150 (8/24/1992), P.D. 94-111 (4/14/1994), P.D. 95-57 (3/28/1995), P.D. 96-1 (1/4/1996), P.D. 96-281 (10/11/1996), 97-232 (5/21/1997), P.D. 97-447 (11/10/1997), P.D. 01-157 (10/19/2001), 08-142 (7/30/2008), and P.D. 09-142 (10/23/2009). The Taxpayer should analyze the activities conducted in Virginia by its employees to verify if any of the activities exceed the mere solicitation of sales.

Further, Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G exempts activities that are de minimis in nature. Under 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. Pursuant to Wrigley , all nonancillary activities are examined to determine if, when considered together, they create more than a de minimis connection to Virginia. Without a full examination of the activities conducted in Virginia by the Taxpayer, a determination cannot be made as to whether such activities discussed in the preceding sections would be a de minimis connection with Virginia.

Based on the facts presented, it cannot be determined whether the Taxpayer's activities in Virginia would create nexus, allowing the Commonwealth to impose tax on the Taxpayer's income apportioned to Virginia. As previously stated, however, a corporation or pass-through entity will have income from Virginia sources if there is sufficient business activity within Virginia to make the applicable apportionment factor positive. The Taxpayer states it would not have positive property and payroll factors, and its sales result from the performance of services.

Apportionment Formula

Payroll Factor

It appears that the Taxpayer would not have a positive payroll factor even though it sends employees into Virginia to perform services on its behalf. 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 of the VAC 10-120-190, total wages reported to the Virginia Employment Commission (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:

1. the base of operations is located in Virginia,

2. the place from which such employment is directed or controlled is in Virginia,

3. 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.

Based on the facts presented, the Taxpayer's employees conduct a portion of its services in Virginia, but the services are directed and controlled from State A where a portion of the services are performed, and none of the Taxpayer's employees are Virginia residents. As such, it appears that the Taxpayer would not be required to report compensation to the VEC and would not have a positive payroll factor. In order to verify this analysis, the Taxpayer should request guidance from the VEC.

Virginia Code § 58.1-461, however, requires employers to withhold taxes from employee wages for each payroll period. Virginia Code § 58.1-460 defines "employer" as "[t]he person, whether a resident or nonresident of the Commonwealth, for whom an individual performs or performed any service as an employee ...." (Emphasis added). Further, this section defines "employee" as "[a]n individual, whether a resident or a nonresident of the Commonwealth , who performs or performed any service in the Commonwealth for wages ...." (Emphasis added).

In P.D. 94-192 (6/20/1994), the Department held that the presence of employees within Virginia constitutes the requisite nexus to impose withholding tax collection responsibilities in accordance with Article 16, Chapter 3 of Title 58.1 (§ 58.1-460 et seq.) of the Code of Virginia . Consequently, the Taxpayer would be required to withhold Virginia income taxes from an employee who is not a resident of Virginia when that employee earns income from Virginia sources by traveling into Virginia to perform services on behalf of the Taxpayer.

Sales Factor

Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are deemed in Virginia if:

1. The income-producing activity is performed in Virginia; or

2. The income-producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. "Income producing activity" is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.

In General Motors Corporation v. Commonwealth of Virginia , 268 Va. 289, 602 S. E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Va. Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining "cost of performance" and “income producing activity" in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.

In response to the General Motors decision, the Department issued Tax Bulletin (VTB) 05-3 (4/18/2005). This bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department's adoption of policies in response to the General Motors decision. Because the Department administers Va. Code § 58.1-416 in a manner similar to Va. Code § 58.1-418, taxpayers with sales other than tangible personal property may also elect to file returns prepared in accordance with Title 23 VAC 10-120-230 pending the adoption of policies in response to the General Motors decision.

Based on facts presented in your letter, direct costs for planning and preparing design drawings would be incurred outside Virginia. In addition, the Taxpayer would incur some direct costs associated with its employees traveling into Virginia. The question becomes whether the greater portion of the income producing activity for each design fee and subscription charge is performed in Virginia or another state.

The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct cost associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would not be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.

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 Code of Virginia sections, regulations, public documents, and tax bulletin cited are available on-line at www.tax.virginia.gov in the Tax Policy Library 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

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