The Ohio Supreme Court recently issued a decision upholding a sales tax assessment against a company that purchased employment services. In doing so, it provided significant guidance for the evidence necessary to support a claim that employment might be exempt from taxation because the employees were “permanently assigned” to the consumer. Bay Mechanical & Elec. Corp. v. Testa, Slip Opinion No. 2012-Ohio-4312.
Background: Bay Mechanical & Electrical Corp. (“Bay”) is a specialty mechanical contractor. In addition to a stable of its own employees, Bay obtained the services of additional employees from two vendors. Bay, the holder of a direct payment permit, failed to accrue sales tax on the transactions with the two vendors on the basis that the employees were permanently assigned to it such that the transactions were exempt from taxation pursuant to R.C. 5739.01(JJ)(3).
During the audit, Bay produced copies of its contracts with the vendors. The tax agent requested additional information in an effort to determine the nature of the transactions. The information that was requested included individual employment agreements with the various employees that were provided to Bay, as well as detailed invoices from the vendors and supporting information. Bay refused to produce the information and an assessment that included tax imposed upon the transactions with the two vendors was issued.
Upon administrative review, Bay again refused to produce the requested detail information and argued that because the contracts in question were for a period of at least a year and provided that the employees were proved on an indefinite basis, the additional information was not necessary. The Tax Commissioner upheld the assessment and Bay appealed to the Board of Tax Appeals (“BTA”).
Before the BTA, Bay’s controller produced summary exhibits that were based upon the detailed records that had previously been requested, but not produced and provided testimony regarding the transactions. The BTA found that the controller’s testimony and exhibits, gleaned from records not presented to the BTA, did not rise to the level of proof necessary to establish Bay’s right to the exemption and upheld the assessment. Bay then appealed to the Ohio Supreme Court.
The Court’s Decision: The court first discussed the legal test to be followed in applying the permanent assignment provision of R.C. 5739.01(JJ)(3). Referring to its decision in H.R. Options, Inc. v. Zaino, 100 Ohio St. 3d 373, 2004-Ohio-1, the court reiterated that a two-prong analysis was required. The language in the contracts was one element to be considered, while the actual facts and circumstances surrounding the individual assignments of employees also needed to be considered.
With respect to the contracts themselves, the court noted that while no particular language was required to establish a right to the exclusion, similarly the presence of any particularly language was not determinative either. This only addressed the first element of proof relating to the contract itself. It did not address the facts and circumstances related to each individual employee assigned to the consumer.
Regarding the facts and circumstances of the assignments and Bay’s refusal to provide additional information, the court noted that the burden of proof to contest an assessment and prove its entitlement to an exemption rested with the taxpayer. This, combined with the second element of proof from H.R. Options, placed the burden upon Bay to present evidence to establish the “facts and circumstances” relating to the transactions.
However, Bay refused to present such information and presented summaries based upon the information instead. As a result, the primary documentation never became a part of the record before the BTA. Under that circumstance, the BTA was within its province as the trier of fact to reject the summary evidence and to uphold the assessment.
In reaching its decision, the court was constrained to address another issue that it deemed non-dispositive of the appeal. The Tax Commissioner had insisted that Bay produce the individual employment agreements with each of the employees who had been assigned to it. This was based upon the fact such documents were produced in H.R. Options. The court noted that the taxpayer in H.R. Options was the vendor of the employment services; as such, the taxpayer in that case had access to, and could produce, those employment agreements. However, it distinguished the present case on the basis that Bay was the consumer of the services and, as such, would not normally have access to those agreements. Therefore, the court concluded that the absence of the individual employment agreements was not a necessary condition for exemption under R.C. 5739.01(JJ)(3).
Comments: This case lends some additional guidance on how this exclusion from the employment services that are subject to sales tax is to be applied. The court reiterated that it was important to consider both the terms of the agreements in question, as well as the particular facts and circumstances surrounding the transaction.
With respect to the contracts, just as no particular language was required in order to qualify for the exemption, neither would any particular language be conclusive of the issues. Rather, it was important that the contract be for a term of at least one year and that it demonstrate that the assignment was indefinite and not to replace existing employees or to fill a temporary or seasonal need.
Second, some level of evidence is necessary to establish the nature of the transaction between the parties in operation. The court recognized that in some cases, primary records may not be available and other evidence may have to be considered; however, where it is available, documents that demonstrate the parties are conducting themselves in a manner that is consistent with a permanent assignment as construed by the court. In this case, it was Bay’s refusal to provide that information that ultimately was fatal to its claim.