May 11, 2016
Re: Request for Ruling: Corporate Income Tax
Retail Sales and Use Tax
Dear *****:
This will respond to your letter in which you request rulings regarding nexus and the apportionment of income for corporate income tax purposes, nexus for sales and use tax purposes and whether certain sales to Virginia customers are subject to sales tax. I apologize for the delay in responding to your request.
FACTS
You represent that your client (the "Taxpayer") is a foreign corporation that sells medications and other healthcare products. The Taxpayer has a contract with an unrelated third party to provide certain web hosting services for the Taxpayer's website. In connection with the contract, the Taxpayer rents servers and related equipment located in Virginia. The Taxpayer presents several questions regarding the application of Virginia's corporate income tax and retail sales and use tax laws to its business operations.
DETERMINATION
Question 1
Does the Taxpayer have nexus for Virginia income tax purposes, and if so, is it required to include the rented equipment in the numerator of the property factor?
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).
The Taxpayer rents servers and related equipment in Virginia. Virginia Code § 58.1-409 provides that the property factor consists of the ratio of the average value of a taxpayer's real and tangible personal property owned or rented and used in Virginia over the like property located everywhere. See Title 23 of the Virginia Administrative Code (VAC) 10-120-160 through 10-120-180. Therefore, the Taxpayer would be required to include the average value of the rented equipment in the numerator of its Virginia payroll factor. The resulting positive payroll factor would establish income from Virginia sources provided that the equipment rental is not merely ancillary to the solicitation of sales or de minimis in nature.
In Wrigley, the United States Supreme Court held that automobiles used by the sales professionals are included in activities considered to be ancillary to solicitation. The Department has extended such treatment to computers that are provided to the sales professionals for the purpose of preparing sales presentations, reports to record the sales professional's activities, and other administrative functions. In Public Document (P.D.) 12-36 (3/28/2012), however, the Department held that servers that were used to provide online business profiles and marketing services for the taxpayer's customers were not included in activities considered to be ancillary to solicitation.
In addition, Title 23 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.
The facts presented do not indicate whether the rented equipment in Virginia is connected with any solicitation activities. Without a full examination of the web hosting services for which the equipment is rented, a determination cannot be made as to whether such activities would be considered to be ancillary to solicitation or de minimis to the extent any are not ancillary.
Question 2
Is the Taxpayer required to file a Virginia corporate income tax return?
Virginia Code § 58.1-441 requires every corporation organized under Virginia law or having income from Virginia sources to file a return. In addition, Title 23 VAC 10-120-310 A 1 requires every foreign corporation registered to do business in Virginia with the State Corporation Commission (SCC) to file a return even if it has no income from Virginia sources and no income tax is due.
If the Taxpayer determines it has nexus, it must file a return if it has income from Virginia sources. In addition, even if the Taxpayer does not have nexus or any Virginia source income, it must still file a return if it is registered with the SCC to do business in Virginia. See Title 23 VAC 10-120-310 A 4.
Question 3
Is the Taxpayer considered a retail company for purposes of income apportionment?
In Virginia, multistate corporations are generally required to use a three-factor formula of property, payroll and double-weighted sales. The sum of the property factor, payroll factor and twice the sales factor is divided by four to arrive at the final apportionment factor. This amount is then multiplied by Virginia taxable income.
In 2012, the General Assembly modified the corporate apportionment formula by requiring retail companies to use a single factor apportionment based on sales to determine their Virginia taxable income. See House Bill 154 (Chapter 86, Acts of Assembly) and Senate Bill 49 (Chapter 666, Acts of Assembly), codified at Va. Code § 58.1-422.1. This modification was to be phased in as follows:
1. For taxable years beginning on or after July 1, 2012, but before July 1, 2014, qualifying corporations must use a triple-weighted sales factor;
2. For taxable years beginning on or after July 1, 2014, but before July 1, 2015, qualifying corporations must use a quadruple-weighted sales factor; and
3. For taxable years beginning on or after July 1, 2015, and thereafter, qualifying corporations must use the single sales factor method to apportion Virginia taxable income.
For the purposes of applying the modified formula, "retail company" is a domestic or foreign corporation primarily engaged in activities that, in accordance with the North American Industry Classification System (NAICS), would be included in Sectors 44-45. See Va. Code § 58.1-422.1 B. The Taxpayer states that its NAICS classification code is included in Sector 44. Therefore, provided that the code accurately reflects the Taxpayer's primary activities, it would be considered a retail company subject to the special apportionment formula under Va. Code § 58.1-422.1.
Question 4
Does the Taxpayer become subject to Virginia sales and use tax collection obligations if its websites are hosted on servers located in Virginia at web hosting facilities.
Virginia Code § 58.1-612 A provides that the sales or use tax is collectible from all persons who are dealers and have sufficient contact with the Commonwealth. As provided in Va. Code § 58.1-612 B 3, a dealer is defined to include every person who "[s]ells at retail, or who offers for sale at retail, or who has in his possession for sale at retail, or for use, consumption, or distribution, or for storage to be used or consumed in this Commonwealth, tangible personal property . . . ." Based on the information provided, the Taxpayer qualifies as a dealer because it sells tangible personal property at retail.
Virginia Code § 58.1-612 C sets forth activities within the Commonwealth that would require a dealer to register for the collection of the retail sales and use tax. Subsection 2 of Va. Code § 58.1-612 C provides that a dealer shall have sufficient activity in Virginia to require registration if such dealer "solicits business in this Commonwealth by employees, independent contractors, agents or other representative." Based on the information provided, the Taxpayer solicits sales in Virginia through on-line transactions between the Taxpayer and the Virginia customers.
In Public Document (P.D.) 00-53 (4/14/00), the Tax Commissioner addresses the Virginia sales and use tax collection obligations for an out-of-state business selling automobile parts on websites hosted on servers located in Virginia at web-hosting facilities. The Tax Commissioner determined that nexus does not exist for an out-of-state seller whose only presence in Virginia is the use of a computer server to create or maintain a site on the Internet. Accordingly, nexus will not be established for out-of-state vendors whose only presence is the use of computer servers provided to them under a Virginia "managed hosting" service. Nor will nexus be established for out-of-state vendors whose only presence is the use of computer servers owned by them in connection with a Virginia “co-location hosting” service.
Based on the facts presented, the Taxpayer would not be required to register and collect the Virginia retail sales tax because the Taxpayer has no nexus with Virginia as the Taxpayer's only presence in Virginia is the use of a website hosted by a third party hosting service. The responsibility for payment of the use tax rests with the Virginia customer on taxable purchases. The Virginia customers would make payment directly to the Virginia Department of Taxation for the use tax that would be due on taxable goods purchased on which the Virginia retail sales tax was not paid.
Question 5
If the Department determines that the Taxpayer has nexus in Virginia, is the Taxpayer required to collect the Virginia sales and use tax on: (i) prescription and nonprescription medications and (ii) prescription and nonprescription pet medications sold to Virginia customers.
As stated in Question 4, the Taxpayer is not required to collect the Virginia retail sales tax provided the Taxpayer's only presence in Virginia is the use of a website hosted by a third party hosting service to sell tangible personal property to Virginia customers.
General Guidance
In a recent conversation with a member of the Appeals and Ruling staff, the Taxpayer requested the Code of Virginia sections that address the application of the sales and use tax for prescription and nonprescription drugs and the sale of prescription pet medications.
Prescription Drugs
Virginia Code § 58.1-609.10 9 provides a retail sales and use tax exemption for the following:
Medicines, drugs, hypodermic syringes, artificial eyes, contact lenses, eyeglasses, eyeglass cases, and contact lens storage containers when distributed free of charge, all solutions or sterilization kits or other devices applicable to the wearing or maintenance of contact lenses or eyeglasses when distributed free of charge, and hearing aids dispensed by or sold on prescriptions or work orders of licensed physicians, dentists, optometrists, ophthalmologists, opticians, audiologists, hearing aid dealers and fitters, nurse practitioners, physician assistants, and veterinarians; controlled drugs purchased for use by a licensed physician, optometrist, licensed nurse practitioner, or licensed physician assistant in his professional practice, regardless of whether such practice is organized as a sole proprietorship, partnership, or professional corporation, or any other type of corporation in which the shareholders and operators are all licensed physicians, optometrists, licensed nurse practitioners, or licensed physician assistants engaged in the practice of medicine, optometry, or nursing; medicines and drugs purchased for use or consumption by a licensed hospital, nursing home, clinic, or similar corporation not otherwise exempt under this section. . . .
Nonprescription Drugs
Virginia Code § 58.1-609.10 14 provides an exemption from the retail sales and use tax for nonprescription drugs and proprietary medicines. Virginia Tax Bulletin (VTB) 13-5 (3/15/13) defines nonprescription drugs as any substances or mixtures of substances containing medicines or drugs for which no prescription is required and which are generally sold for internal or topical use in the cure, mitigation, treatment, or prevention of disease in human beings. The tax bulletin specifically lists pet medicines as items that would not qualify for the nonprescription drug exemption. P.D.s 14-98 (7/2/14) and 15-146 (7/2/15) provide further guidance regarding the application of the Virginia sales and use tax to nonprescription drugs and proprietary medicines.
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, bulletin 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 Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5988474619.M