In June, Michael L. Colavito, Jr. and Grant Patterson hosted an informative webinar, “Virginia Businesses: STOP Overpaying Local BPOL Tax,” where they guided taxpayers in determining if they are paying too much in Virginia local business license tax, also known as BPOL tax. As a follow up to this webinar, Michael and Grant have prepared answers to the questions asked by the webinar attendees. To watch the complete webinar, please visit Aronson’s website.
Would government contractors who provide engineering services, logistics, or training be taxed under the contractor or retailer BPOL classification?
A government contractor that provides engineering, logistics, and training services would not be classified as a contractor for BOPL purposes. It is also unlikely that the taxpayer would be taxed as a retailer.
“Contractors” are defined for BPOL purposes under state law Va. Code Ann. § 58.1-3714(D) and are limited to construction contractors. “Retailers” or “retail” sales are not specifically defined under state law for BPOL purposes. Typically, local ordinances have their own definition. For example, Fairfax County defines a “retail merchant” as a person who sells goods, wares, or merchandise at retail only and not for resale. A business primarily providing services would not be classified as a retailer.
Most government contractors are likely to be classified as providing a “business service” or “specialized occupation.” Keep in mind that the correct classification will vary by locality. When separate service types are provided with respect to a taxpayers contracts rise to the level of being separate business activities, then separate licenses may be required for each business. For example, a service provider may have a substantial number of contracts related to procurement services and a number of contracts providing engineering services. In this case, the taxpayer may have to obtain a license under the “professional services” classification for the engineering services, and another license under the “business services” classification for the procurement services.
Are virtual manufacturing businesses exempt from BPOL?
Virginia does not define the term “manufacturer” for purposes of the BPOL exemption. The Supreme Court of Virginia has developed a test involving three essential elements in determining whether a manufacturing activity is being undertaken. These elements are:
In Virginia Public Document Ruling No. 99-239, 08/23/1999, the Department of Taxation states that “for BPOL purposes, a manufacturer is one engaged in a processing activity whereby the original materials are transformed into a product that is substantially different in character from the original materials. These three elements are all equally important; if any one of these elements is missing, a business cannot fairly be said to be engaged in manufacturing.”
If a business is designing a product, subcontracting out the building and processing activities, but is still the seller of the product being produced, the manufacturing exemption may still apply. The BPOL guidelines issued by the Department of Taxation, that addresses the scope of the manufacturing exemption, concluded that the “manufacturing process consists of work subcontracted out but under the taxpayer’s control at all times, work in the taxpayer’s shop, and work by the taxpayer’s employees at the customer’s location.”
Still, additional facts regarding the activity would be needed to reach a more definite conclusion.
Are rental receipts and other revenue, not normally business income sources, subject to the BPOL tax?
Per Virginia § 58.1-3703(C)(19), gross receipts from the sale and rental of real estate and buildings are taxable by the locality in which they are located, provided the locality is authorized to tax such businesses. Gross receipts from the rental of real estate are generally exempt from tax, unless the localities tax on the activity is “grandfathered” in because they imposed such a tax on January 1, 1974.
Ultimately, this activity would likely be considered a separate business activity for which an additional license would be needed.
Is revenue from employees who work onsite at government facilities located in DC and MD subject to the BPOL tax? What if the employees report to managers in the Virginia locality?
Government contractors that derive revenue from employees working at government facilities in other jurisdictions, such as DC and MD, should not report their revenue to the VA locality even if the activity is managed from there. These receipts would not be reported to the VA locality based on one of two filing positions.
First, the receipts derived from the employees’ activities in MD and DC would be sitused to those locations because it is considered a “definite place of business” outside of the VA locality. If the employees are working at the facility for at least 30 consecutive days, it would then be correct to situs those receipts. All services performed at the DC and MD locations would only be sitused to the VA locality if the locations where the services are performed are not “definite places of business.”
Second, even if the services are not performed from definite places of business in DC and MD, the out-of-state deduction would still apply. It is assumed that the government contractor is filing income and franchise tax returns in DC and MD. Although the receipts would initially sitused to VA, where the services are being managed and controlled from, the out-of-state deduction can be utilized to reduce these “otherwise” taxable receipts.
Does the deduction for the resale of hardware and software to the government apply if the resale is not performed in the Virginia locality?
This particular deduction is from “otherwise taxable receipts.” If the applicable receipts are sitused to the VA locality under the applied situsing rules, then the deduction would be available. However, depending on the facts, these receipts may not be sitused to the applicable locality to begin with. Review a recording of the webinar for a complete understanding on the process that is generally applicable to most taxpayers.
In this particular case, no deduction would be needed. For businesses that are reselling hardware and software to the government, it’s possible that the deduction can be performed first and the remaining receipts are sitused accordingly.
My company has no office, but we rent a building in Fairfax County with servers and other hardware to do cloud hosting, software development, and consulting services provided by remote employees. What is best way to situs receipts?
Typically, service revenue derived from remote employees should be sitused to the location from where they are managed and controlled. Their residence would only be considered a “definite place of business,” and the receipts can be sitused if the business has absolutely no other office location. This typically occurs only with sole proprietors. Services performed by remote employees should not be sitused to the building being rented in the County because the employee services are not managed and controlled there.
In terms of renting a building to maintain servers and other hardware, it would be difficult to argue that the building is not a “definite place of business,” for BPOL purposes. It is extremely likely that no services are being performed from that location. Therefore, no receipts would be sitused to the location for BPOL.
If you have any additional question about Virginia BPOL, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200 or email@example.com.
The Virginia General Assembly has enacted legislation requiring the Department of Taxation to adopt regulations consistent with recently issued guidance pertaining to the Local Business License Tax (BPOL) deduction for receipts attributable to other states. This development does not change the state of the applicable law, as the Virginia Supreme Court addressed the particular issue in 2015. However, having a regulation will hopefully give taxpayers clear guidance in a single source instead of having the rules spread out over a lengthy court decision, and multiple Department letter rulings. Additional background on the out-of-state deduction can be found here.
The legislation itself (HB 1961) is brief and to the point. It simply states that the Department must adopt regulations regarding the methodology for determining deductible gross receipts attributable to business conducted in another state consistent with the holding in The Nielsen Company v. County Board of Arlington County and rulings issued by the Department. Assuming the regulation will merely address the particular application of the out-of-state deduction at issue in Nielsen, taxpayers can expect the regulation to provide guidance on how to determine the allowable deduction when the BPOL tax base is computed using the payroll apportionment method.
Essentially, a taxpayer that uses payroll apportionment in initially computing its gross receipts attributable to the locality must be able to provide evidence that employees in the locality earn, or participate in earning, receipts attributable to customers in other states where the taxpayer filed an income tax return. If the taxpayer can provide such evidence, the taxpayer can claim a deduction from the tax base that is determined by multiplying the payroll factor percentage for the locality by the amount of gross receipts assigned to the states where the taxpayer filed an income tax return. Initially, this methodology was proposed and applied by the Department in a handful of rulings, and was affirmed as a reasonable approach by the court in the Nielsen ruling.
The more telling aspect of the developments on this issue is that they further support that the out-of-state deduction is not based on income tax apportionment rules. This is a common position taken by Virginia localities on audit or when deciding if a taxpayer is due a refund. Granted, the ability to claim the deduction is contingent upon a taxpayer filing an income tax return in the jurisdiction for which the deduction of the receipts is based. However, multiple Virginia rulings as well as the Nielsen decision make it clear that the amount of the deduction is not somehow tied to the amount of a taxpayer’s sales sourced to that state on its income tax returns. Indeed, such a requirement could result in similarly situated taxpayers ending up with different deduction amounts merely because the deduction is claimed with respect to states that have different sales factor sourcing rules for income tax purposes.
Whether a particular taxpayer has the ability to reduce their BPOL tax liability using the out-of-state deduction depends on how a taxpayer provides its services to its customers. Thus, the facts in each case become very important in assessing whether a taxpayer has been over reporting its BPOL tax. The best approach for any Virginia service provider is to seek out an experienced tax practitioner before filing that first BPOL tax return so the reporting is correct from the start. While refund claims can be great, the localities typically put up a fight even in the clearest cases. Taxpayers are typically required to provide extensive substantiation to support the claim. Still, many taxpayers overstate their BPOL tax base by such a large amount that the refund is substantial enough to endure dealing with a locality that is understandably reluctant to accept such a drastic change in the tax base without sufficient substantiation.
If you have concerns about whether your business is overpaying its BPOL tax, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.
Register here for our upcoming webinar “Virginia Businesses: STOP Overpaying Local BPOL Tax”.
Will Virginia Adopt Market-Based Sourcing? The Virginia Department of Taxation is currently conducting a study to determine the “desirability and feasibility” of adopting market-based sourcing. For businesses conducting the bulk of their services in the D.C. Metro area, the adoption of such a rule by Virginia would at least spare them the headache of dealing with Virginia applying a different rule than Maryland and D.C. Currently, Virginia utilizes the costs-of-performance method of sourcing sales from services and intangibles, which assigns such sales to the state where most of a taxpayer’s costs are incurred. On the other hand, a market-based rule sources a sale of a service or intangible to the location of the customer or the delivery location.
Virginia’s adoption of market-based sourcing is in no way a done deal. The study, requested by the Virginia House Finance Committee, has received push back from certain taxpayers in the communications and government contracting industries, respectively. For example, Northrop Grumman, a business that could possibly benefit from Virginia’s adoption of market-based sourcing, said that the change “would disrupt the long-standing stability of the Commonwealth’s tax laws that many businesses find attractive.”
Moreover, in last year’s meeting on the potential change, the Department was very concerned about the difficulties in estimating the revenue impact that might be caused by a change to market-based sourcing. There are options in that regard. For example, North Carolina, which is also considering market-based sourcing, requires larger corporate income taxpayers to file an informational report showing what their tax liability would be if the state were to adopt a market-based sourcing rule.
In recent years, a number of states have adopted a market-based sourcing method. It’s certainly no longer accurate to characterize the shift as a trend, as over 20 states use a market-based method as opposed to a cost-based rule. For tax year 2015 alone, the District of Columbia (D.C.), New York, and Rhode Island will all begin applying a market-based sourcing rule. Virginia should not make the jump to market-based sourcing without considering the impact on its overall method of taxing multi-state businesses. The rule would have multiple implications; for instance, Virginia’s rule for when a business has nexus with the Commonwealth would likely have to be altered, and whether market-based sourcing would apply to pass-through entities as well as corporations will also be up for consideration.
For now, taxpayers are left with Virginia as the outlier in the D.C. Metro area for sourcing of revenue from services and intangibles. For Virginia-based taxpayers, this means the continued aggravation of potentially double counting a significant amount of sales, especially now that D.C. uses a market-based rule.
If you have question about the varying rules used to source multi-state revenue, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.