Did an out-of-state S corporation create Virginia income-tax nexus through one remote employee handling accounting, HR, payroll, legal, and customer support?

Subject

Accounting support services are sufficient to create nexus for corporate income tax purposes. Withholding

Plain-English summary

An out-of-state S corporation sold internet-based website templates. One employee worked from her Virginia home on bookkeeping, accounting, human resources, payroll, email customer support, and legal consultation. She did not develop the product or solicit new customers.

Virginia found that these administrative and support services went beyond protected solicitation under P.L. 86-272. Accounting support alone could create corporate income-tax nexus, and the legal and customer-support work also exceeded the statute's protection.

The only unresolved limitation was whether the activities were de minimis when compared with the company's overall operations. Virginia could not finally decide that point without a fuller examination, but said the employee's work appeared to create nexus and a positive Virginia payroll factor.

The corporation therefore had to file Virginia corporate returns. If it elected pass-through treatment, it had to file under the pass-through rules, and Virginia-source income allocated to nonresident owners could require entity-level withholding. Nonresident owners generally also had to file Virginia returns and receive credit for the withheld amount.

Common questions

Does P.L. 86-272 protect a remote employee doing accounting and customer support? No. Its narrow protection covers solicitation and ancillary activities, not these administrative, legal, and customer-service functions.

Was nexus absolutely final in the ruling? Virginia said the activities appeared to create nexus but left open whether they were de minimis after comparison with the company's full operations.

What factor became positive? The Virginia employee created a positive payroll factor.

Citations and references

• Va. Code §§ 58.1-392, 58.1-400, 58.1-408 through 58.1-416, and 58.1-486.2.
• 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).
• P.D. 99-260, P.D. 07-148, P.D. 07-150, and P.D. 15-240.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 16-15

Original ruling text

March 3, 2016

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"). I apologize for the delay in responding to your request.

FACTS

The Taxpayer, an S corporation headquartered outside Virginia, provides internet based templates for customers to produce their own websites. The Taxpayer has an employee who resides in Virginia and works from her home office. The employee's primary responsibilities include bookkeeping and accounting matters, human resources and payroll, customer support conducted entirely by e-mail, and legal consultative matters. This employee does not develop software, program computers, work on website templates, or solicit new customers.

The Taxpayer acknowledges it will need to withhold Virginia income tax from the employee's compensation. Based on the facts presented, the Taxpayer requests a ruling that it does not have nexus with Virginia for purposes of corporate income tax.

RULING

Nexus

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. 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).

In this case, the employee is performing administrative services on behalf of the Taxpayer at her Virginia residence. These services appear unrelated to the sale of websites. Accounting support services are sufficient to create nexus for corporate income tax purposes. See Public Document (P.D.) 99-260 (9/27/1999). Further, such services as customer service on legal matters, consulting, and customer support would also exceed the protections afforded by P.L. 86-272. Thus, the employee's services would create nexus for the Taxpayer in Virginia unless they are found to be de minimis .

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 employee, as compared to the Taxpayer's overall operations, a determination cannot be made as to whether such activities would be a de minimis connection with Virginia.

Based on the facts presented, the employee's activities in Virginia would appear to create nexus, allowing the Commonwealth to impose tax on the Taxpayer's income apportioned to Virginia. A pass-through entity 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 58.1-416, P.D. 07-150 (9/21/2007) and P.D. 15-240 (12/22/2015). The existence of a positive Virginia apportionment factor establishes income from Virginia sources. In this case, the Taxpayer would have a positive payroll factor. Thus, the Taxpayer would be required to file Virginia corporate income tax returns because its employee performs administrative work in Virginia. If the Taxpayer elects to file as a pass-through entity, it would be required to file returns under Va. Code § 58.1-392.

Pass-Through Entity Withholding

Pass-through entities that have taxable income from Virginia sources and that must allocate any portion of that income to at least one nonresident owner during any portion of the taxable year must pay the withholding tax unless an exception applies. See Va. Code § 58.1-486.2 and P.D. 15-240.

Generally, pass-through entities must remit the required withholding tax with the Pass-Through Entity Return of Income and Return of Nonresident Withholding (Form 502). In such cases, the pass-through entity withholding must be remitted by the 15 th day of the fourth month following the close of the taxable year on the Pass-Through Entity Withholding Tax Payment form (Form 502W).

Nonresident Owners

Nonresident owners are required to file a Virginia Nonresident Income Tax Return (Form 763) to report their income from Virginia sources, unless certain exceptions apply or Virginia adjusted gross income from all sources does not exceed the filing threshold. See P.D. 07-148 (9/12/2007). When nonresident owners file their nonresident Virginia return, they will receive a credit for the amount of income tax that was withheld by the pass-through entity. The nonresident owner is then liable for any income tax liability in excess of the credit. Any overpayment of tax would be refunded.

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, regulation, and public document 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/1-6072284418.B