April 15, 2015
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 ***** (the "Taxpayer") with the Department of Taxation. You appeal an assessment of Business, Professional and Occupational License (BPOL) taxes issued to the Taxpayer by the ***** (the "County") for the 2009 through 2014 tax years.
The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL tax assessment is deemed prima facie correct, i.e., the local assessment will stand unless the taxpayer proves that it is incorrect.
The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site.
FACTS
The Taxpayer had a definite place of business in the County where its single federal contract provided a broad array of support services to the United States armed forces and Department of Defense. Services provided included system integration, information technology (IT), systems engineering, IT enterprise solutions, management of large scale IT programs, and simulation and training. The Taxpayer filed returns and paid BPOL tax at the rates applicable to business services for the tax years at issue.
The County audited the Taxpayer. As part of the audit, it reviewed a particular delivery order for a branch of the military as an example of the services the Taxpayer provided. The County determined that the Taxpayer was performing engineering services and issued assessments at the rate applicable to professional services.
The Taxpayer appeals the County's final determination to the Tax Commissioner, contending that it was licensable as a business service because it was primarily engaged in business services and any professional services were ancillary.
ANALYSIS
Classification
The BPOL tax is imposed on businesses and professionals for the privilege of doing business in a locality. The tax is imposed at different rates according to the classification of an enterprise. See Va. Code § 58.1-3706 A. These classifications are regulated under Title 23 of the Virginia Administrative Code (VAC) 10-500-10 et seq. Classification of a specific business must be determined based on consideration of all the facts and circumstances. Some of the factors to be considered include:
1. What is the nature of the enterprise's business?
2. How the enterprise generates gross receipts.
3. Where the enterprise conducts its business.
4. Who are the enterprise's customers?
5. How the enterprise holds itself out to the public.
6. The enterprise's North American Industry Classification System (NAICS) code.
There are two separate classifications of services for purposes of the BPOL tax: "financial, real estate and professional services," and "repair, personal, business and other services." The Taxpayer contends that the services performed at the County facility fall under the service category. The County asserts that the Taxpayer was performing engineering services, which qualify as professional services.
Title 23 of the Virginia Administrative code (VAC) 10-500-10 provides that "profession" "implies attainments in professional knowledge as distinguished from mere skill, and the application of knowledge to uses for others rather than for personal profit." Under Title 23 VAC 10-500-450 A, the classification of a professional is limited to:
those occupations or vocations in which a professed knowledge of some department of science of learning, gained by a prolonged course of specialized instruction and study, is used in its practical application to the affairs of others, either advising, guiding, or teaching others, and serving their interests or welfare in the practice of an art or a science founded upon it.
Those businesses classified as providers of professional services are specifically enumerated in the regulation and include engineers, mathematicians, and physicists. The term engineer includes "petroleum engineer, mechanical engineer, chemical engineer, civil engineer, industrial engineer, electrical engineer, nuclear engineer, and agricultural engineer."
All other business services not clearly identified as financial, real estate or professional services fall under the classification of "repair, personal, business and other services." Services are "things purchased by a customer that do not have physical characteristic, or that are not goods, wares, or merchandise." The regulations specifically define "financial services" and "professional services" but do not define any other types of services. Title 23 VAC 10-500-500, however, provides a partial list of business services that includes "business and governmental research and consulting services" and "data processing, computer and system development services."
The County asserts that the Taxpayer holds itself out on its website as "a provider of IT, systems engineering, professional services and simulation and training to customers in the defense, federal civil government, health, homeland security, state and local government and commercial sectors." The Taxpayer argues that the term "systems engineering" falls within the context of network engineering and IT related services. It asserts that such services would be properly classified as data processing, computer and systems development services under Title 23 VAC 10-500-500. It also argues that the term "professional services," as used in its website, is a generic term for business services.
Virginia Code § 54.1-400 defines the practice of engineering as [a]ny service wherein the principles and methods of engineering are applied to, but are not necessarily limited to, the following areas: consultation, investigation, evaluation, planning and design of public or private utilities, structures, machines, equipment, processes, transportation systems and work systems . . . ."
The County reviewed one delivery order of the contract as an example of the services provided by the Taxpayer. It noted that under the statement of work it referred to one primary role as being "systems engineering, along with system concept design, program management, acquisitions management, program analyst and budgeting." The contract also referred to the Taxpayer performing a "variety of engineering disciplines" as well as "engineering studies and analyses."
The Taxpayer contends that the County merely reviewed one delivery order, rather than the entire contract with the armed service branch. It asserts that "systems engineering" is not engineering, but rather a form of IT processing. The Taxpayer also emphasizes that engineering services is one of many services it provided and that the word "engineering" was infrequently used in the broad context of the contract.
The International Council on Systems Engineering (INCOSE) defines "systems engineering" as using an interdisciplinary approach and the means to enable the realization of successful systems. It focuses on defining customer needs and requirements. Systems engineering integrates all the disciplines and specialty groups in a team effort forming a structural development practice. As such, systems engineering goes beyond the scope of mere network engineering and IT services. Substantiality
The Taxpayer argues that even if a portion of its activities could be considered engineering, they would be considered ancillary to the activities classified as business services. The County asserts that based on the contracts it reviewed, a substantial amount of the Taxpayer's activities were engineering.
The standard of substantiality was addressed by the Virginia Supreme Court in County of Chesterfield v. BBC Brown Boveri, 238 Va. 64 (1989). In that case, the percentage of receipts attributed to manufacturing during the years at issue ranged from 33.95% to 62.44% but was less than 50% for all but one of the years. The court concluded that BBC Brown Boveri's manufacturing activities were substantial enough to be its primary activity for purposes of BPOL classification. The court also found that BBC Brown Boveri's non-manufacturing activities were ancillary to its primary business of manufacturing.
The Department has adopted the BBC Brown Boveri substantiality test for local tax purposes when addressing whether a business is engaged in manufacturing in numerous public documents. Where an enterprise is substantially engaged in a primary business activity, it may be classified as such business for BPOL tax purposes so long as its other activities are ancillary to the primary business activity even if the ancillary activities constitute a higher percentage of the enterprise's operations.
In 1994 Va. Op. Atty. Gen 99, and in Public Document (P.D.) 04-114 (9/14/2004), the Attorney General and the Department respectively addressed whether a defense contractor that provided various engineering and other technical and nontechnical services was subject to multiple licenses, or whether the nontechnical services were ancillary to engineering.
Employee Titles and Education
Both the County and the Taxpayer place a lot of emphasis on the title and education of the Taxpayer's employees. The Attorney General opined in 1994 Va. Op. Atty. Gen 99:
simply labeling an employee an "engineer" does not, by itself, convert his or her duties into professional services. When employees of a firm hold no state regulatory license, the commissioner of the revenue must determine that those individuals are "engaged in [an] occupation or vocation in which a professed knowledge of some department of science or learning, gained by a prolonged course of specialized instruction and study is used by its practical application to the affairs of others . . .
The Attorney General also stated in a footnote that while "there is clearly no requirement that a majority of a firm's employees have professional training in order for the firm to be engaged in a profession, that a "low ratio of engineers to nonengineers is one important indicator the commissioner of the revenue must consider in deciding how to tax its gross receipts."
The County reviewed the list of employees provided by the Taxpayer and noted that approximately 20% of the workers had the work "engineer" in their job title. It presumed that a number of other employees who do not have the word "engineer" in their job title provided engineering assistance to the employees with engineering backgrounds.
The Taxpayer has provided a list of its employees, their titles, and their academic degrees. The documentation shows that 9.6% of its employees possess a degree in engineering, physics, mathematics, or chemistry. The documentation also shows that approximately 75% of the employees were designated as working in program management, IT, administration and finance by job title. According to the information provided, approximately 23% of the employees had an engineering title.
The Taxpayer argues that only those employees who have degrees in engineering, physics, mathematics, or chemistry and have engineer in their title should possibly be considered as performing professional services. These individuals accounted for 4.6% of the Taxpayer's workforce in the County. In P.D. 04-114, the Commissioner determined that 28% of a business' activities being classified as engineering fell short of the substantiality test in BBC Brown Boveri. As such, the Taxpayer asserts that any engineering services were merely ancillary to its business services because such services which could be classified as engineering were being performed by a small percentage of employees that also possessed a professional degree.
Subcontractors
The Taxpayer contends that all engineering work, if any, is performed by unrelated third party subcontractors. The County cites P.D. 99-257 (9/24/1999) asserting that the Taxpayer would be responsible for any engineering work performed as the general contractor. In P.D. 99-257, the Department addressed whether an architectural firm that subcontracted work could subtract payments made to the subcontractor from its gross receipts. The Tax Commissioner has held that a taxpayer may exclude from taxable gross receipts certain monies when acting as a fiduciary or agent for another, i.e., the taxpayer receives and disburses monies on behalf of a person or entity other than the taxpayer. See, P.D. 01-38 (4/12/2001). The Taxpayer cites P.D. 11-44 (3/23/2011) in which the Department held that when a taxpayer holds a certificate of incorporation from the State Corporation Commission (SCC) and has its own federal employer identification number for federal income tax purposes; it is considered a separate taxable entity for local business tax purposes.
In P.D. 05-119 (7/18/2005), a locality contracted with a taxpayer to provide healthcare services to inmates in their local jail. The taxpayer subcontracted out specialized professional medical care to qualified local physicians while its employees performed nursing care. The Tax Commissioner held that the Taxpayer was subject to licensure as a business service, but that the local physicians were required to acquire their own BPOL licenses. Based on the rationale of P.D. 05-119, any third-party engineering firm that the Taxpayer subcontracts engineering work would need to get its own BPOL license. However, the Taxpayer would be classified in accordance with the service it subcontracted out. As such, if it contracted out engineering services, it would be classified as an engineer. If it contracted out business services, it would be classified as a business service provider.
Multiple Businesses
The County indicated that the Taxpayer may be engaged in multiple licensable businesses. The County requested a breakdown of gross receipts for professional and business services because it determined that the Taxpayer could be engaged in multiple lines of business. The Taxpayer maintained that 100% of its gross receipts were generated from business services.
Virginia Code § 58.1-3703.1 A 1 provides that a separate license shall be required for each definite place of business and for each business a taxpayer is operating. The gross receipts generated under each license are subject to tax in accordance to the rates provided for each business classification. See Va. Code § 58.1-3706 A.
In order to obtain multiple licenses, a business must be engaged in clearly identifiable separate business activities and not merely activities ancillary to the primary business. In P. D. 97-257 (6/11/1997), the Department concluded that the term "ancillary" refers to business activities that are subordinate, subservient, auxiliary, or in aid of the business' principal business activity. Distinguishing between an ancillary activity and an activity that rises to the level of a separate business can often be accomplished by determining if the activity under scrutiny exists independently of the principal business. In general, an activity for which no separate charge is made will be presumed to be ancillary to the activity for which a charge is made, but separately stating charges for different activities will not create a presumption that each such activity is a separate business. See Title 23 VAC 10-500-110 B.
The contract does show that the Taxpayer was responsible for performing activities, in addition to the activities that used the term "engineering", such as technology development, concept exploration, design, specification development, construction/production, test and evaluation, certification, operations and maintenance, improvement and modernization, overhauls and refueling, and salvage and disposal. Neither the contract nor any documentation provided by the Taxpayer demonstrates the percentage of the Taxpayer's performance dedicated to each activity.
Local tax officials are responsible for making the determination as to whether a taxpayer is engaged in a single business or in two businesses, each of which could operate independently of the other. In order to make this determination, the local tax official must be provided with documentation demonstrating the substantiality of each business. See 1994 Op. Va. Att'y Gen. 99.
NAICS Codes
The County contends that because the Taxpayer's business was classified as engineering under the NAICS system, it should also be classified as providing engineering services for BPOL tax purposes. Industrial classification systems such as the NAICS may serve as useful guideposts for determining classifications for BPOL tax purposes, but they do not control, or even create a presumption as to the correct classification for BPOL purposes. See Title 23 VAC 10-500-140.
DETERMINATION
The services provided by the Taxpayer for the tax years at issue were conducted in accordance with a contract with the United States military. The documentation provided with the appeal, including the contracts and website, indicate that professional engineering services were performed by the Taxpayer. The County requested that the Taxpayer provide a breakdown of gross receipts for professional and business services in order to determine whether multiple licenses were required, or whether the engineering services were merely ancillary. The Taxpayer responded that no gross receipts should be applied to a separate license for professional services because it was only a business service provider.
Pursuant to Va. Code § 58.1-3703.1 A 5 b, a local assessing officer may require the submission of additional information or documentation deemed necessary in order to make a proper and equitable determination of an application for correction. Because the Taxpayer did not provide the requested documentation regarding the breakdown of its gross receipts, the County was unable to accurately determine whether multiple licenses were required.
Virginia Code § 58.1-3109 6 grants local assessing officers the authority to require records and other information necessary to verify the accuracy of a taxpayer's BPOL tax returns. The County only reviewed one delivery order of the contract. As such, because the County did not review the entire contract, it did not utilize all the information needed to properly determine the Taxpayer's classification.
Accordingly, I am remanding the case back to the County with instructions to reconsider the Taxpayer's request to change its classification for the 2009 through 2014 tax years. When a taxpayer requests a change in classification, it is incumbent upon the taxpayer to provide sufficient documentation in order for the local assessing authority to make an informed decision. Accordingly, the Taxpayer will provide a breakdown of the gross receipts between business and professional services in order to assist the County in making a determine whether the engineering services were substantial, the engineering services were the Taxpayer's primary business, or multiple licenses were required.
Based on its review of all the gross receipts schedules and any other information the County may require, the County must determine the proper classification of the Taxpayer and make the appropriate adjustments and issue refunds, or issue a new final determination for the 2009 through 2014 tax years. If the Taxpayer disagrees with the County's new final determination, it may appeal pursuant to Title 23 VAC 10-500-720.
If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5897434756.B