Commercial Activity Tax: Possible Contract Language for Limited Agency Exemption for General Contractors

May 15, 2006

Proposed rule 5703-29-13 (the "Rule") provides guidance on the definition of an “agent” for purposes of the Ohio Commercial Activity Tax (the “CAT”). This definition is important because certain amounts received by an “agent” are excluded from the definition of “gross receipts” for purposes of the CAT. Specifically, an agent is required for purposes of the CAT to report only the portion of gross receipts the agent retains as a commission or fee, and is not required to report amounts received that are paid to or on behalf of others as a “gross receipt.”  The logic is that the agent is not required to report amounts paid to or on behalf of others because the agent is acting as a conduit for such payments on behalf of its principal.  

To qualify as an “agent” under the Rule, there must be a “consensual fiduciary relationship” between the parties and the agency relationship must otherwise meet the general agency principals under Ohio common law. As an example, the department stated in the Rule that a general contractor operating under a lump sum contract with an owner will generally not qualify as an “agent,” but that a general contractor operating under a costs-plus contract with an owner will qualify as an “agent.”

Unfortunately, the Rule does not indicate specifically which types of construction contracts would qualify for the agency exemption and which would not. We believe that other types of construction contracts (other than just a costs-plus contract) may enable the general contractor to qualify as an “agent.”  Due to the many variations of construction contracts and relationships between owners and general contractors, we have not attempted here to discuss which types of construction contracts we believe should qualify and which types should not qualify.  However, we would be happy to discuss this matter with you further should you require assistance.

It is important to note that in addition to the requirements above, the agency relationship must be explicitly stated in a contract that is available to the tax commissioner to inspect.  In the example listed in the Rule for a costs-plus contract, the Rule states that “when bidding out the work to subcontractors, [the general contractor shall] have an agreement in writing with the subcontractors that states that the general contractor is acting as the owner’s agent and not as an agent of the subcontractor.” An example of the required contract language would be to modify Section 2.1 of the AIA Document A401 (Standard Form of Agreement between Contractor and Subcontractor) as follows (with the modifications noted in bolded italics):

§ 2.1 The Contractor and Subcontractor shall be mutually bound by the terms of this Agreement and, to the extent that the provisions of the edition of AIA Document A201 current as of the date of this Agreement apply to this Agreement pursuant to Section 1.2 and provisions of the Prime Contract apply to the Work of the Subcontractor, the Contractor shall assume toward the Subcontractor all obligations and responsibilities that the Owner, under such documents, assumes toward the Contractor, and the Subcontractor shall assume toward the Contractor all obligations and responsibilities which the Contractor, under such documents, assumes toward the Owner and the Architect. The Contractor shall have the benefit of all rights, remedies and redress against the Subcontractor which the Owner, under such documents, has against the Contractor, and the Subcontractor shall have the benefit of all rights, remedies and redress against the Contractor which the Contractor, under such documents, has against the Owner, insofar as applicable to this Subcontract. The Subcontractor acknowledges that the Contractor is acting as an agent of the Owner, and not as an agent of the Subcontractor. The agency relationship, including its scope, is defined in the Prime Contract. Where a provision of such documents is inconsistent with a provision of this Agreement, this Agreement shall govern.

A general contractor may also wish to include the above language in its bid requests to subcontractors, as the Rule states that the required agreement should be in place “when bidding out the work to subcontractors.”  Further, including such language in bid requests is also prudent for general business and legal reasons as the subcontractors will then know from the beginning the nature and scope of the agency relationship.

An agency relationship under common law imparts many fiduciary duties on an agent with respect to its principal. These duties are often said to be “implied” in that they are not required to be in writing. Many of these implied fiduciary duties are not included in typical contracts between a general contractor and the owner. In most cases, the general contractor will not want to expand its duties to the owner beyond those already provided in its current standard contracts.  While the Rule does not expressly require that the agency relationship be stated in the Prime Contract, we believe that is prudent to do so and to limit the duties imposed by such relationship. 

For example, to express the agency relationship in AIA Document A114 (Standard Form of Agreement between Owner and Contractor where the basis of the payment is the Cost of the Work Plus a Fee without a Guaranteed Maximum Price), we recommend adding the following language to Sections 3.1 and 12.1.8 (with the modifications noted in bolded italics):

§ 3.1 The Contractor accepts the relationship of trust and confidence established by this Agreement and covenants with the Owner to cooperate with the Architect and exercise the Contractor's skill and judgment in furthering the interests of the Owner; to act as Owner’s agent with respect to payments made on the Owner’s behalf to Subcontractors; to furnish efficient business administration and supervision; to furnish at all times an adequate supply of workers and materials; and to perform the Work in an expeditious and economical manner consistent with the Owner's interests. The Owner agrees to furnish or approve, in a timely manner, information required by the Contractor and to make payments to the Contractor in accordance with the requirements of the Contract Documents.

§ 12.1.8  Contractor shall act as Owner’s Agent with regard to any payments to be made to Subcontractors. Except with the Owner's prior approval, payments to Subcontractors shall be subject to retainage of not less than       (       ). The Owner and Contractor shall agree on a mutually acceptable procedure for review and approval of payments and retention for Subcontractors.

In order to limit the duties imposed under the agency relationship expressed above, we recommend adding a new section to AIA Document A114, as follows:

§ 14.7 Limitations on Agency.

§ 14.7.1  The duties imposed on Contractor as a result of its agency relationship with Owner as provided in Section 12.1.8 shall be limited to those duties contained in the Contract Documents.

Assuming an agency relationship exists, similar language may be adapted to other types of contracts (e.g. AIA Document A111 - Standard Form of Agreement between Owner and Contractor where the basis of the payment is the Cost of the Work Plus a Fee with a Negotiated Guaranteed Maximum Price).

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You should consult with your legal advisor before using the above contract language. The information provided herein is intended to exemplify possible contract language for the CAT agency exemption but may not address all of the issues relating to whether a general contractor qualifies for the agency exemption in a particular situation.  Further, the Rule is a proposed rule and there is no guarantee that the Rule will be enacted as a final rule. The Rule may be withdrawn or modified. If the Rule is modified, the above language may also need to be modified.

Should you have any questions or need assistance with any of the matters above, please contact Scott Gurney or Jeremy Hayden at (513) 651-6800 or by email at sgurney@fbtlaw.com and jhayden@fbtlaw.com.

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