Potential Partial Relief from CAT Tax
AGC members Frost Brown Todd (law firm) and Barnes, Dennig & Co. (accounting firm) have recently submitted the following proposed information release to the Ohio Department of Taxation in an effort to partially limit the impact of the new Commercial Activity Tax on general contractors. The ODT is in the process of considering the proposal. Comments or questions regarding this issue can be directed to:
CAT 2006-0X – Commercial Activity Tax: Application of Agency Exclusion to Construction Industry Contracts – February, 2006
This is version 1 of the draft rule explaining the agency exclusion from gross receipts as applied to the construction industry. The Ohio Department of Taxation (ODT) will be issuing several information releases concerning Ohio ’s new Commercial Activity Tax (CAT). Many of these releases will contain drafts of rules for the Ohio Administrative Code. Prior to adopting a rule explaining the agency exclusion from gross receipts, ODT is seeking public comment on the draft of that rule. Public comment should be made to Leslie Akers by email at Leslie_Akers@tax.state.oh.us or by calling her at (614) 644-6896 .
Reason for rule. R.C. 5751.01(F)(2)(l) excludes from gross receipts all “property, money, and other amounts received or acquired by an agent on behalf of another in excess of the agent’s commission, fee, or other remuneration.” The tax commissioner is promulgating this rule to provide guidance regarding how to apply this exclusion.
Draft of Rule _______ Agent’s commission, fee, or other remuneration.
(A) R.C. 5751.01(F)(2)(l) excludes from gross receipts all property, money, and other amounts received or acquired by an agent on behalf of another in excess of the agent’s commission, fee, or other remuneration. This rule explains the requirements that a taxpayer must satisfy to exclude gross receipts pursuant to this exclusion.
(B) Pursuant to section 5751.01(F)(2)(l), a taxpayer may exclude property, money, or other amounts from gross receipts if the property, money, or other amounts are:
- Received or acquired by an “agent”; and
- Received or acquired on behalf of another.
(C) Who Qualifies as an “Agent”?
(1) General Requirements. R.C. 5751.01(P) defines an agent as a “person authorized by another person to act on its behalf to undertake a transaction for the other.” This definition is consistent with general agency principles expressed in Ohio case law. An agency relationship exists for purposes of the commercial activity tax if the relationship requires the agent to act in the interests of its principal rather than in furtherance of the agent’s own interests. Generally, agency relationships are characterized by fiduciary duties, including duties of good faith, loyalty, and obedience, as well as the duty to disclose information to the principal, the duty to operate with reasonable skill, care, and diligence, and the duty to account for money or property. These duties as a whole imply a relationship of “trust and confidence” between the agent and the principal.
For example, a general contractor enters into a lump sum contract with a property owner for the general contractor to construct an office building. The general contractor agrees to provide specified services for a fixed price of $500,000, and the general contractor bears all risk involved in completing the project in a cost-effective manner. The general contractor may perform the necessary services itself or it may bid out some or all of the work to subcontractors. Because the general contractor is not required to act in the owner’s best interests with respect to cost issues, and because the general contractor does not have to disclose cost details with the owner, the general contractor does not qualify as an agent for purposes of the agency exclusion. For this reason, the entire contract price is includable in the general contractor’s gross receipts.
For example, a general contractor enters into a costs plus contract with a property owner for the general contractor to construct an office building. Under the terms of the contract, the general contractor agrees to provide specified services, and the owner agrees to pay the general contractor’s costs plus a five per cent (5%) fee. The general contractor bids out the work to subcontractors, acting as the owner’s agent in selecting, engaging, and paying the subcontractors, and performing these tasks based on guidelines provided by the owner.The contract requires the general contractor to share cost details with the owner, including information about the sums paid to satisfy obligations to the subcontractors for work performed on the project. The general contractor acts as a conduit with regard to any payments made to the subcontractors, in that the general contractor remits monies received from the owner to the subcontractors provided that certain conditions are met. Because the contract requires the general contractor to act in the owner’s interests and to disclose information to the owner, the general contractor acts as the owner’s agent. Accordingly, the general contractor may exclude from gross receipts the money that the general contractor receives from the owner to pay the subcontractors.
(2) Contract Requirement. For an agency relationship to meet the requirements of the agency exclusion, there must be a written contract signed by both parties which, through its terms and conditions, establishes a de facto agency relationship. The contract must identify the property, money, or other amounts that the agent is to receive on behalf of another, and the terms of the contract must clearly distinguish between such funds and any commission, fee, or other remuneration that the agent will receive pursuant to the contract.
For example, a general contractor contracts with a property owner for the general contractor to construct an office building. Under the terms of the contract, the general contractor agrees to provide specified services and to act as the owner’s agent with respect to subcontractor payments, and the owner agrees to pay the general contractor’s costs plus a five per cent (5%) fee. The general contractor bids out the work to subcontractors, and the subcontractor fees total $500,000. Under the terms of the contract, the owner pays the general contractor $525,000. The general contract must include only $25,000 in gross receipts because the general contractor’s fee is clearly distinguishable from the amounts that the general contractor receives on behalf of the subcontractors.
(D) When does an “Agent” Receive Amounts on Behalf of Another?
An agent meets this requirement when it either (i) receives payments from its principal with instructions to remit such payments to a third party, or (ii) receives payments from a third party with a duty to remit such payments to its principal. The construction contracts involving agency relationships described above typically involve payments received from the principal on behalf of a third party. The following are examples of each type of payment in contexts not involving the construction industry.
For example, a title agent receives $200,000 from a lender to complete the purchase of a property. After the parties to the purchase agreement have properly executed the closing documents, the title agent pays any third party lien holders and remits any remaining proceeds to the seller. The title agent, acting as an agent for the lender, does not include the $200,000 in its gross receipts.
For example, a lawyer represents a plaintiff in a personal injury case. Under their contract, the lawyer is entitled to 30% of any recovery that the client receives. The parties negotiate a settlement whereby the defendant agrees to pay $100,000 to the plaintiff. The defendant gives the payment to the plaintiff’s lawyer. Pursuant to the contract, the lawyer retains $30,000 and gives the remaining $70,000 to the client. The lawyer includes only $30,000 in gross receipts.