Did pharmaceutical salespeople, Virginia clinical trials, and employee recruiting and lobbying create Virginia corporate-income-tax nexus?

Subject

Drug-company nexus depended on trials and other activities

Plain-English summary

Virginia found the drug company's ordinary sales solicitation apparently protected by P.L. 86-272, but it could not decide the company's overall income-tax nexus without more facts. Presentations, literature, samples, company cars, and solicitation-related computers could remain ancillary to protected sales activity.

Clinical trials themselves were not protected solicitation. Whether the Virginia trials were attributed to the company depended on whether the research organizations and investigators were genuinely independent contractors serving multiple principals.

Employees also entered Virginia to recruit trial participants and conduct medical education, lobbying, and outreach. Those activities were unprotected, and the company had to evaluate their nature, continuity, frequency, and regularity together—not rely only on their percentage or visit count—to decide whether they exceeded a de minimis connection.

What this means for you

• P.L. 86-272 protects only a narrow range of tangible-goods solicitation and ancillary activities.
• A service provider's in-state work may be attributed to the out-of-state company if the provider is not truly independent.
• Clinical research, recruiting, education, lobbying, and association outreach are not ordinary sales solicitation.
• All unprotected activities are evaluated together; low percentages or limited visits are not conclusive.

Citations and references

• Va. Code § 58.1-400; 15 U.S.C. §§ 381-384; 23 VAC 10-120-90 G.
• Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-145

Original ruling text

August 26, 2014

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will respond to your letter in which you seek a ruling regarding corporate income tax nexus in Virginia on behalf of your client (the "Taxpayer").

FACTS

The Taxpayer, a * (State A) partnership, is a developer and manufacturer of prescription drugs. The Taxpayer markets its products in Virginia through sales personnel. The Taxpayer maintained a sales office in Virginia until 2006. Although some of the Taxpayer's sales representatives continue to reside in Virginia, the Taxpayer no longer maintains an office or owns any real property in Virginia. The Taxpayer contracts with independent third party research organizations to arrange and manage clinical trials of its products in Virginia and other states. These organizations, in turn, contract with independent investigative entities to conduct the trials. The Taxpayer also sends other employees into Virginia to recruit participants for the clinical trials and to engage in other activities related to medical education, lobbying, and outreach to state associations and licensing boards. The Taxpayer requests a ruling as to whether it has nexus for Virginia income tax purposes.

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. 86­272 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).

Sales Personnel

The Taxpayer's salespersons solicit sales from doctors, hospitals, clinics, hospices, managed health care organizations, wholesalers and retail pharmacies. They also promote sales by providing presentations, literature and samples to doctors. These activities of the sales personnel do not appear to exceed the protection afforded under P.L. 86-272. See also Public Document (P.D.) 12-192 (11/29/2012).

Clinical Trials

The Department would not consider clinical trials conducted for the purpose of testing pharmaceuticals to be an activity protected under P.L. 86-272. See P.D. 12-192. In this case, however, the Taxpayer contracts with independent third party research organizations to arrange and manage trials in Virginia and other states. These organizations, in turn, hire independent investigative entities to conduct the trials. The Taxpayer provides the study protocol, the drugs and certain equipment. At the end of the study, the equipment is returned to the Taxpayer, and any remaining drugs are destroyed.

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 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 the Taxpayer. 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 the Taxpayer is considered to be providing services on behalf of the Taxpayer to the Taxpayer's customers. See P.D. 99-278 (10/14/1999).

In this case, the research organizations are retained by other principals besides the Taxpayer. Likewise, the investigative entities that the research organizations hire to conduct the trials operate on a non-exclusive basis. The Taxpayer, however, has provided no information concerning possible relationships with any research organization or investigative entity involved in clinical trials in Virginia. As such, the question as to whether the Taxpayer is subject to Virginia tax on its income could rest on whether or not any such research organization or investigative entity is an independent contractor. The Taxpayer will have to evaluate its relationships with any such organization or entity to determine if it meets the definition of an independent contractor under P.L. 86-272.

Physical Presence

Several of the Taxpayer's sales representatives reside in Virginia. The Taxpayer provides these employees with company cars for use in their solicitation activities. Although the Taxpayer does not maintain an office or own any real property in Virginia, the Taxpayer has not provided any further information as to its physical presence in Virginia. Certain types of property may be considered to be ancillary to the solicitation process and, therefore, not deemed to create a physical presence in a state. Automobiles used by the sales representatives are included in activities considered to be ancillary to solicitation according to the United States Supreme Court in Wrigley . In P.D. 96-281 (10/11/1996), the Department found that computers provided to sales professionals for the purpose of preparing sales presentations, reports to record the sales professional's activities, and other administrative functions were considered to be ancillary to solicitation of sales.

De Minimis Activities

Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G 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.

The Taxpayer periodically sends employees into Virginia to recruit participants for the clinical trials and to engage in activities relating to medical education, lobbying, and outreach to state associations and licensing boards. The Taxpayer does not contend that such activities should be afforded protection by P.L. 86-272. Rather, the Taxpayer asserts that its unprotected activities do not create more than a de minimis connection to the Commonwealth because less than 3% of the clinical trial activities occur in Virginia and its non-sales representatives visit Virginia 50 or less times annually.

Frequency, however, must be considered along with the nature, continuity and regularity in determining if a taxpayer's activities are de minimis . In Wrigley , the Court reasoned that a "nontrivial additional connection" with the state will be established when all unprotected activities are considered together. See Wrigley , 505 U.S. at 235. One of the activities, the sales through agency stock checks, accounted for only 0.00007% of sales in the state. Id . Accordingly, without a full examination of the specific activities conducted in Virginia by these employees, a determination cannot be made as to whether such activities create more than a de minimis connection.

CONCLUSION

Based on the facts presented, it appears that the activities of the Taxpayer's sales personnel do not exceed the protection afforded by P.L. 86-272. The Taxpayer, however, will need to verify its relationship with any third party research organization or investigative entity involved in clinical trials in Virginia and how any tangible personal property provided to employees residing in Virginia is being used. Further, the Taxpayer must determine how frequently and regularly any unprotected activities occur in Virginia compared to the continuity, frequency and regularity of such activities conducted outside Virginia. The Taxpayer must then analyze whether all unprotected activities, when considered together, create more than a de minimis connection to Virginia. If the Taxpayer concludes its activities create nexus with Virginia, it should take the appropriate steps to file all applicable income tax returns.

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 section, regulation 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/1-5601265552.M