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 In addition, they do not pick up damaged or out-of-date merchandise or make adjustments for those products.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

RESPONSE LETTER

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

^^