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On Nov. 7, 2018, the Ohio Supreme Court upheld the Ohio Board of Tax Appeals (BTA) decision in Willoughby Hills Development and Distribution, Inc. v. Testa, Slip Opinion No. 2018-Ohio-4488. This decision provides taxpayers with further guidance on the agency exemption from the Commercial Activity Tax (CAT). Ohio found that the taxpayer, Willoughby Hills Development and Distribution, Inc. (โ€œWHDDโ€), was not entitled to claim an agency exemption under the CAT for receipts generated as a distributor of Sunoco motor fuels.

The Agency Exemption

Ohio employs a gross receipts tax, referred to as the CAT, which โ€œis leviedโ€ฆon each person with taxable gross receipts for the privilege of doing business in the stateโ€ according to R.C. 5751.02(A). Unlike an income tax, the CAT has very few adjustments to the tax base of gross revenues. One important reduction is the so-called โ€œagency exemptionโ€ which excludes receipts received โ€œby an agent on behalf of another in excess of the agentโ€™s commission, fee or other remunerationโ€ under R.C. 5751.01(F)(2)(I). The term โ€œagentโ€ is further defined by the statute as โ€œa person authorized by another person to act on its behalf to undertake a transaction for the otherโ€ in R.C. 5751.01(P).

Look to the Contract Language

The Courtโ€™s analysis in this case centered on the factors determining whether WHDD met the definition of โ€œagent.โ€ The Court reiterated that the first place to look for support in establishing an agency relationship is the language of the contract. The fact that the contract between Sunoco and WHDD included a section labeling WHDD as an โ€œindependent contractorโ€ which was โ€œnot authorized to act as an agentโ€ weighed negatively against the taxpayerโ€™s argument. Such provision was deemed to be โ€œhardly โ€˜an expression of intent by the principal that the agent to act on behalf of the principal.โ€™โ€ The contract language also indicated that WHDD did not have any authority over Sunoco to bind Sunoco to its actions as an agent. Moreover, the contract provided that Sunoco was selling the gasoline to WHDD, and WHDD was purchasing the gasoline from Sunoco. There was no reference to WHDD selling the gasoline on behalf of Sunoco as its agent.

While the Court noted that it will look beyond the plain language of a contract to establish a true agency relationship, the taxpayer โ€œhas not pointed to anything in the recordโ€ that demonstrated evidence of Sunocoโ€™s approval of WHDD to act on its behalf. Thus, it is important to have evidence of the agency relationship, particularly evidence establishing authority to act on behalf of the principal. Best practice dictates this evidence should be supported by not only the agent but also through corroboration from the principal.

Focus on the Sales Transaction

While WHDD sought to argue that it had agency-like responsibilities – such as the responsibility to protect the intellectual property and goodwill of Sunoco – the Court stated these responsibilities had nothing to do with the sale of the gasoline which produced the receipts in question. The Court stated if WHDD was to benefit from the agency exclusion, its right to the exclusion โ€œmust turn on its acts of purchasing and selling gasoline, not on its responsibilities associated with managing and protecting Sunocoโ€™s intangible assets.โ€

Importance of Authority

The contract between WHDD and Sunoco expressly provided that WHDD โ€œis not authorizedโ€ฆto make any commitments or incur any expense or obligations of any kind on behalf of [Sunoco] unless Sunoco gives its approval.โ€ The Court noted this โ€œprovision as a departure from โ€˜one of the most important featuresโ€™ of an agency relationship.โ€ This approval requirement was a key factor in determining that the taxpayer did not have โ€œactual authorityโ€ in representing Sunoco as to the sales of gasoline to retailers.

Court Declined to Apply Control Test

The Court declined to employ the control test โ€œunder these circumstances.โ€ The control test has been commonly used by courts to establish an agency relationship between parties, particularly in non-tax areas such as tort law. WHDD argued that Sunoco exercises control over it with respect to its involvement in different credit- and debit-card programs, which are made part of its supplier agreement. The Court instead focused on the holding in Cincinnati Golf Management, Inc. v. Testa, a sales-and-use tax case, which applied the actual authority test discussed above. The Courtโ€™s reliance on a sales-and-use tax case may be an indication of the Courtโ€™s willingness to give credence to jurisprudence under other taxes when deciding CAT cases.

Interestingly, neither WHDD nor the Commissioner argued that the administrative rule covering the agency exemption applied. See Ohio Adm. Code 5703-29-13. Since neither party argued for the rule, the Court said it did not consider it. One must wonder if the application of the rule could have impact on future cases, as the rule expressly adopts the control test (โ€œThe supreme court of Ohio has held that an agency relationship โ€˜exists only when one party exercises the right of control over the actions of another, and those actions are directed toward the attainment of an objective which the former seeksโ€™โ€).

Conclusion

Taxpayers should evaluate Ohioโ€™s decision in Willoughby Hills if they intend to rely upon the agency exemption from the CAT. Taxpayers may wish to take steps to carefully negotiate contract language and business arrangements with suppliers and customers to ensure that the factors of the agency relationship are met.

For more information, contact any member of Frost Brown Toddโ€™sย Tax Practice.