If an out-of-state S corporation leases its employees to companies that use them to promote products in Utah, does the leasing company itself have Utah income tax nexus?

Plain-English summary

A law firm asked the Utah State Tax Commission, on behalf of an anonymous out-of-state client (the "Company"), whether the Company's nonresident shareholders would owe Utah individual income tax. The Company is an S corporation, incorporated and headquartered outside Utah with no Utah offices, whose business is leasing its employees to other companies. The customers who lease those employees then use them in Utah as "detailmen" -- representatives who visit doctors' offices to promote a pharmaceutical product by explaining its use, answering questions, and providing free samples supplied by the customer. The detailmen don't take orders, collect payments, extend credit, make deliveries, or do anything beyond this promotional activity, and the Company's only presence in Utah is through these leased workers.

The Company argued its detailmen's activities were pure "solicitation" protected from state income tax by federal Public Law 86-272 (15 U.S.C. § 381), relying on the U.S. Supreme Court's Wisconsin Dept. of Revenue v. Wrigley decision and detailman cases from Oregon and Connecticut. The Commission agreed that the detailing itself would not, standing alone, create nexus -- but it ruled that this analysis answered the wrong question. The relevant nexus question isn't about the detailmen's activities on behalf of the customers who use them; it's about the Company's own business of leasing employees. Under Utah Admin. Code R865-6F-6(E), a foreign corporation is subject to Utah franchise tax if it fulfills its contracts in Utah "whether through their own employees or by furnishing of supervisory personnel." Because the Company fulfills its leasing contracts through its employees' actions in Utah, the Commission held the Company itself has Utah income tax nexus.

Because the Company is a federal S corporation and Utah follows the pass-through treatment of IRC § 1363, the Company is not subject to corporate income tax at the entity level. Instead, Utah Code Ann. § 59-7-703 requires the S corporation to file an entity-level return on Form TC-20S. Each nonresident shareholder then has the option, not the obligation, to file an individual Utah return: filing lets a nonresident shareholder claim credit for the tax the S corporation already paid on their behalf, but a nonresident shareholder with no other Utah-source income can skip the individual return and forgo that credit.

What this means for you

Out-of-state staffing, leasing, or PEO companies with workers who visit Utah

If your business leases or supplies employees to other companies, and those employees' work fulfills your contracts by way of activity physically performed in Utah, the Commission's reasoning treats your company as having Utah nexus -- separate from any nexus analysis for the customer who actually directs the workers' day-to-day tasks. Whether your leased workers' activities would independently qualify as protected "solicitation" under P.L. 86-272 is beside the point; what matters is that you fulfill your own leasing contract through actions performed in the state.

Businesses that lease in workers from an out-of-state staffing company

This ruling is about the leasing company's nexus, not the customer's. The Commission noted that a separate nexus analysis -- including whether P.L. 86-272 solicitation protection applies -- would be relevant to determine whether the customer companies that actually use the detailmen for product promotion have their own Utah income tax nexus. That question wasn't decided here.

S corporation shareholders and their accountants

An S corporation with Utah nexus must file Form TC-20S at the entity level under § 59-7-703. Nonresident shareholders with no other Utah-source income are not required to also file individual Utah returns, but doing so is the only way to claim credit for the Utah tax the S corporation already paid on their behalf -- so weigh the cost of filing against the value of the credit.

Common questions

Q: My out-of-state company leases employees who work in Utah for a customer. Does that give my company Utah income tax nexus, even if I have no office or property there?
A: Under this ruling's reasoning, yes -- if your company fulfills its leasing contracts through your employees' actions performed in Utah, Utah Admin. Code R865-6F-6(E) treats that as nexus-creating, regardless of whether the employees' specific activities (like solicitation) would independently trigger nexus.

Q: Does federal Public Law 86-272 protect my leasing company from Utah income tax the way it might protect the customer?
A: Not according to this ruling. The Commission found P.L. 86-272's solicitation protection relevant to whether the customer company (the one directing the detailmen's promotional work) has nexus -- not to the leasing company, whose own nexus comes from fulfilling its leasing contract through in-state employee activity.

Q: My leasing company is a federal S corporation. Do we owe Utah corporate income tax?
A: No corporate-level income tax, because Utah follows the federal S corporation pass-through rule under IRC § 1363. But the S corporation must still file an entity-level return, Form TC-20S, under Utah Code Ann. § 59-7-703.

Q: Do my nonresident shareholders have to file individual Utah income tax returns?
A: Not necessarily. A nonresident shareholder with no other Utah-source income can choose not to file and simply forgo the credit for tax the S corporation paid on their behalf. A shareholder who wants that credit must file an individual return to claim it.

Q: Can I rely on this ruling for my own leasing business?
A: Not as binding precedent. A Utah private letter ruling binds the Commission only for the taxpayer and facts it was issued to. This is also one of the Commission's older rulings (1998), and Utah's statutes and administrative rules have been renumbered and amended repeatedly since -- verify the current citations before relying on the reasoning here.

Citations and references

Rules and statutes cited:

• Utah Admin. Code R865-6F-6(E) -- foreign corporations are subject to Utah franchise tax when they fulfill contracts in Utah, whether through their own employees or furnished supervisory personnel; the basis for the Company's nexus
• Utah Code Ann. § 59-7-703 -- requires an S corporation with Utah nexus to file an entity-level return on Form TC-20S, and gives nonresident shareholders the option to file individually to claim credit for tax paid on their behalf
• Federal Public Law 86-272, 15 U.S.C. § 381 -- protects out-of-state businesses from state net income tax when their only in-state activity is solicitation of orders for tangible personal property; addressed here as relevant to the customer companies' nexus, not the leasing company's

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/98-026.htm

Original ruling text

98-026

Request
April 17, 1998

REQUEST
LETTER

February
24, 1998

Dear
Mr. Morrison:

We
are writing to you on behalf of our client (the "Company") and its
sole shareholder, in an anonymous fashion, with regard to obtaining a letter ruling
based upon the Company's activities that are conducted within Utah.

RULING
REQUEST

We
respectfully request whether the nonresident shareholders are subject to the
individual income tax in Utah.

Facts

The
Company is an S corporation for Federal income tax purposes as defined by
Internal Revenue Code ("IRC') �1361.
The Company is incorporated in COMPANY and its sole office location is
within STATE. It does not have any
corporate locations within Utah. In
addition, the Company has individual share- holders ("owner") who are
not residents of Utah and do not conduct any business activities within Utah.

The
Company provides its customers with leased employees who are considered
detailmen. Generally, detailmen visit doctor's
offices and other medical facilities to promote a pharmaceutical product. Such promotion consists of encouraging
sales, explaining products' usage and other product information, providing Mr.
Dennis Morrison samples owned by the Company's customer, and answering
questions relating to the products. The
ultimate purpose of the visits is to recommend purchases of these
products. The Company's employees do
not call on customers within the state to collect on delinquent accounts. They do not accept returned merchandise or
make adjustments on that merchandise.
In addition, they do not pick up damaged or out-of-date merchandise or
make adjustments for those products.
The employees do not authorize
credit for existing or potential customers, nor do they investigate complaints
by customers within Utah. The employees
do not receive purchase orders or make "spot sales" of samples that
they carry with them. They do not
accept or secure deposits or down payments, nor do they collect installment
payments for purchased merchandise. The
employees do not repossess products or perform any inspection of products. The employees do not set up

merchandising
or advertising displays, nor do they arrange cooperative advertising agreements
with their customers. They do not
conduct training courses or schools for their customers, agents, or
distributors. In addition, they do not
hold meetings, handle complaints, trouble shoot or give advice to potential
customers. Lastly, no deliveries are made into Utah by the Company since the
Company is detailing products for its customers. It is the Company's customers that handle deliveries, and all
related activities. The Company has no
presence in Utah except for the activities of the detailmen.

We
are requesting a letter ruling that will hold that the detailmen activities of
the Company's leased employees that are performed on behalf of its customers
within Utah are not nexus- bearing activities for individual income tax
purposes. Since it is difficult to
provide you with all relevant information, we request that you provide us with
a ruling strictly based on the information provided in this letter. However, if you need additional information,
we would present it to you at that time.

Discussion

Federal
Public Law 86-272 (15 U.S.C. �381) ("P.L. 86-272") states that:

No State or political subdivision, thereof
shall have power to impose... a net income tax on the income derived within
such state by any person from interstate commerce if the only business
activities within such state by or on behalf of such person during such taxable
year are either or both of the following:
1) the solicitation of orders by such person, or his representative, in
such State for sales of tangible personal property, which orders are sent outside
the state for approval or rejection... 2) the solicitation of order by such
person, or his representative, in such State in the name of or for the benefit
of a prospective customer of such person....

Basically,
this Federal statutory protection applies "if the only business activities
within such state by or on behalf of such person... are 1) the solicitation of
orders by such person... in such state for sales of tangible personal
property...." It is our opinion
that P.L. 86-272 provides income tax protection for the Company since the
Company's detailing activities are considered part of soliciting orders for
sales of tangible personal property (pharmaceutical products).

P.L.
86-272 provides income tax protection for businesses when the solicitation of
orders for goods is the only activity that is conducted within the state. If in-state activities exceed solicitation
functions, income tax nexus exists. The
detailing of prospective purchasers has been considered in several
jurisdictions and held to be part of solicitation activities. The United States Supreme Court in Wisconsin Department of Revenue v. William
Wrigley Jr., Co., 112 S.Ct. 2447 (1992) defined "solicitation" to
mean "asking for, or enticing to, something." The court further explained that in P.L.
86-272, the term "solicitation" meant "not just explicit verbal
requests for orders, but also any speech or conduct that implicitly invites an
order." Wrigley at 2453-2454.

The
conduct of the detailmen within Utah fall within the definition of
"solicitation" provided by the Supreme Court of the United
States. The promotion of products and
providing information on such products, including answering questions involving
the product and providing free samples, falls within the "asking for or
enticing to" parameters provided by the Supreme Court since the only
purpose of these activities is to ultimately obtain a sale. The Court in Wrigley also held that �381(a)
"covers those activities that are entirely ancillary to requests for
purchases--those that serve no independent business function apart from their
connection to the soliciting of orders."
The detailmen never conduct activities which serve an independent
function to solicitation, and therefore never exceed solicitation. Since these activities never exceed
solicitation, P.L. 86-272 affords protection from income tax on the activities
conducted within the state.

We
have reviewed and set forth certain states' court cases interpreting the
correlation between detailing and soliciting for purposes of income tax
nexus. In performing a search, we have
found two states, Oregon and Connecticut, which have provided definitive legal
precedences in this area. These cases,
along with the U.S. Supreme Court's interpretation of P.L. 86-272, provide a
proper foundation upon which treatment can be determined.

The
Oregon Supreme Court in Smith, Kline and French Laboratories V. State Tax
Commission, 403 P.2d 375 (Or. 1965) held that an out-of-state drug manufacturer
which uses detailmen to promote products is not subject to income tax since
these activities are protected from income tax by P.L. 86-272. The detailmen visited hospitals, doctors,
etc. for the purpose of explaining the use of their products and encouraging
their use and sale. The taxpayer in
this case had no property or other contacts within Oregon. The court held that
the activities of these detailmen were the equivalent of solicitation, and
therefore should be afforded the immunity from income tax as provided in P.L.
86-272.

In
addition, in 1994, the Connecticut Superior Court, in Muro Pharmaceutical, Inc.
v. Allan A. Crystal, Commissioner, 1994 WL 395266 (Conn.Super. 1994) held that
the detailing of medical doctors was within the concept of "solicitation
of orders" within which P.L. 86-272 was referring. In Muro, an out-of-state pharmaceutical
company had detailmen conduct in-person presentations to medical doctors, in
which a company representative would provide free samples and product
information. The Court held that the
detailing at issue was designed to begin a series of events that would
ultimately result in a prospective customer.
The Court held that "the detailing of medical doctors is immunized
from state income tax" by P.L. 86-272.
Muro.

In
both of the aforementioned cases, state courts have held that out-of-state
pharmaceutical companies will not be subject to income tax in their
corresponding states due to the activities of employee detailmen. Both decisions held that the detailing of
their products fell within the
solicitation provisions of P.L. 86-272.
Accordingly, the decisions held that P.L. 86-272 affords immunity from
income tax within the jurisdiction in question. Our client leases its detailmen
to its customers. In turn, these
detailmen conduct their activities on the customers' behalf to promote the sale
of tangible personal property. Our
client's detailmen perform the identical activities as the detailmen in the
aforementioned decisions. Although we have
not found relevant authority in this area in Utah, we believe guidance can be
drawn from the aforementioned states' treatment of this activity since the
decisions in Connecticut and Oregon are interpreting P.L. 86-272 as a federal
statute. Wrigley is a United States
Supreme Court case also interpreting P.L. 86-272 as a federal statute rather
than a specific state tax statute. In
applying P.L. 86-272 and these decisions to our client's situation, it is clear
that the Company's detailmen activities within Utah should not cause nexus for
income tax purposes.

Subchapter
S of the IRC treats the S corporation as a passthrough entity similar to a
partnership. Therefore, the S
corporation must pass through income and loss items separately to its
shareholder(s), and generally, the corporation is not subject to tax on those
items for federal income tax purposes.

Utah
follows the corporate nontaxation provisions of IRC �1363. Since these
provisions state that no corporate income tax is imposed on the S corporation
at the entity level, the Company should not be liable for corporate income tax
in Utah.

P.L.
86-272 provides protection for individuals from income tax when the
solicitation of orders for tangible personal property is the only activity that
is conducted within the state. �381(b)
of P.L. 86-272 provides that this law will not apply to "any individual
who, under the laws of such state, is domiciled in or a resident of, such
state. Since the owners are not
residents of Utah, P.L. 86-272 and the relevant existing case law indicates
that the owners would not have income tax nexus in Utah. Therefore, the owners should not be
responsible for individual income tax on the pass-through income that is
derived from the detailing activities conducted in Utah.

Please
provide us with a ruling confirming or opposing our individual income tax
conclusions at your earliest convenience.
We appreciate your cooperation in this matter. Please send the ruling to:

NAME

ADDRESS

CITY,
STATE ZIP

If
you need any additional information or have any questions, please feel free to
call NAME at ##### or NAME at #####.

Very
truly yours,

NAME

April
17, 1998

NAME

ADDRESS

CITY
STATE ZIP

RE: Advisory
Opinion - Leased Employees Working in Utah and the Income Tax Consequences for
an Out-of-State S Corporation Which Leases Them

Dear
NAME,

We have received your request for an
advisory opinion concerning the Utah income tax consequences for your client, a
COMPANY S corporation whose business consists of leasing employees to other
companies. These other companies, in
turn, use the leased employees in Utah as �detailmen� to visit doctors� offices
and promote pharmaceutical products.
You have specifically asked if these activities result in Utah income
tax nexus for the S corporation and, if so, what is the procedure for the S
corporation and its shareholders to file income taxes in Utah.

Nexus. Does the S corporation have nexus with Utah
for income tax purposes because of its leasing activities? Yes. Utah Admin. Code R865-6F-6(E) provides
that �[f]oreign corporations ... are subject to the [Utah] franchise tax if
performing the necessary duties to fulfill contracts or subcontracts in Utah,
whether through their own employees or by furnishing of supervisory personnel.�

Your letter explains that the S
corporation enters into contracts with other entities, leasing them the S
corporation�s employees. These other
entities then use the S corporation�s employees as detailmen in Utah. It is these other entities, not the S
corporation, which are in the business of conducting product promotions through
the use of detailmen. The S corporation,
on the other hand, is in the business of leasing employees. It receives its income from having its
employees fulfill the terms of the contracts it has signed with these other
entities. As these contracts are
fulfilled by actions performed in Utah by the S corporation�s employees, rule
865-6F-6(E) does impose income tax nexus upon the S corporation.

Your discussion of income tax nexus
based on the activities of detailmen would be relevant in determining if these
other entities, the ones in the business of conducting product promotions, have
income tax nexus with Utah. As the S
corporation�s activities in Utah involve fulfilling leasing contracts, it is
these activities, not the detailmen activities, that determine its income tax
nexus.

Filing Income Taxes. Having determined that the S corporation
does have income tax nexus with Utah, you ask what filing requirements exist
under Utah law. You have provided
information that the S corporation�s shareholders are not Utah residents and
that they do not conduct any other business activity in Utah. Given these facts, Utah Code Ann. �59-7-703
requires that the S corporation file an income tax return at the S corporation
level on Form TC- 20S (enclosed).

This statute also gives each
individual shareholders the option of whether or not he or she files an
individual Utah income tax return. A
shareholder who is not a Utah resident is entitled to a credit on the Utah
individual return for the amount of tax paid by the S corporation on behalf of
the nonresident shareholder. However, a
nonresident shareholder who is an individual and has no other Utah source
income may forego this credit and not file a Utah individual income tax
return. Please remember that if the
individual is entitled to a credit under Utah law, an individual income tax
return must also be filed to claim that credit.

Please contact us if you have any
other questions.

For
the Commission,

Joe
B. Pacheco

Commissioner

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