Court: Court of Appeals of Washington; August 15, 1988; Washington; State Appellate Court
Rho Company, Inc. appeals the Board of Tax Appeals' denial of its petition for a refund of B. O taxes. Rho operates in the contract personnel sector, connecting skilled individuals, primarily engineers, with clients needing temporary assistance. The process involves clients requesting contract personnel, for which Rho provides resumes from its files or advertises for candidates if necessary. Rho does not interview candidates but facilitates salary negotiations between the client and personnel, including arrangements for travel expenses and per diem, which are determined by the client. Rho charges a percentage markup on the direct wages of personnel, covering its service fees and related costs such as social security and unemployment insurance.
Contracts between Rho and clients establish that personnel are Rho's employees, not the client's, and personnel sign agreements with Rho. Once assigned to a client, personnel work under the client's supervision, with the client managing their performance and employment duration. Any salary increases are negotiated directly with the client, and Rho has no further involvement post-placement. Following an audit from January 1, 1979, to December 3, 1983, the Department of Revenue assessed excise tax liabilities against Rho, determining that Rho's gross income was fully taxable, including wages and per diem costs. Rho contested this finding, leading to its appeal to the Board of Tax Appeals.
The Board held a formal hearing and determined that Rho was correctly taxed, rejecting Rho's claim of being a 'processor for hire' subject to a lower tax rate. Rho's appeal to the superior court was affirmed, leading to a critical issue regarding Rho's tax obligations under RCW 82.04.290 as a service business, specifically whether Rho could deduct payroll and per diem expenses. This issue is divided into two questions: the classification of contract personnel as Rho's employees versus those of Rho's clients, and whether payroll and per diem expenses qualify as deductible reimbursements under WAC 458-20-111.
Rho argues that the Board's decision was based solely on contract language, which Rho claims overlooks the substance of its business operations, asserting it functions merely as an agency that connects contract personnel to clients. Alternatively, Rho contends it qualifies as a 'processor for hire' under RCW 82.04.280. The Department of Revenue, supported by the Board and trial court, maintains that the essential nature of Rho's services involved establishing an employer/employee relationship with the contract personnel, necessitating that payments to them be included in gross income as defined by law.
The standard of review for Board hearings is based on RCW 34.04.130, focusing on errors of law, with agency findings of fact reviewed under the clearly erroneous or arbitrary and capricious standards. Business and occupation taxes are imposed on business activities defined under RCW 82.04.220, which includes any activities aimed at profit. Gross income encompasses all value derived from business transactions, as stipulated in RCW 82.04.080, and RCW 82.04.290 broadly applies to businesses rendering services. Relevant Department of Revenue rules, such as WAC 458-20-138 and -224, clarify the application of these statutes to specific service-oriented businesses.
Determining whether contract personnel were correctly classified as Rho's employees or those of Rho's clients hinges on whether Rho acted as an employer or merely as an agent for the clients. The case of Boise Cascade Corp. v. State provides guidance, where Boise Cascade contested a tax assessment by arguing that its contractor, S.W., was its agent rather than an independent contractor. Boise Cascade presented contractual language labeling S.W. as an 'agent' and evidence of its control over S.W.'s employees. However, the court found that the contract language alone was insufficient to establish an agency relationship, noting that S.W. maintained considerable autonomy, including handling its payroll and tax obligations. The court concluded that S.W. was not integrated into Boise Cascade to the extent that it became part of the company. The ruling emphasized that if Boise Cascade had directly managed labor relations, it would have strengthened its argument. The court indicated that the entity recognized as the employer by state and federal agencies is generally presumed to be the employer in fact, but this presumption is not absolute. Similarly, contractual language between Rho and its clients is not definitive but serves as evidence of intent, with a focus on substance over form. The principles of tort and agency law, while not always applicable in tax situations, underscore the importance of control in determining employer status. The right to control an employee's work correlates with liability for tax obligations arising from the employee's productivity.
The determination of the actual employer hinges on who exerts control over contract personnel, including who sets compensation and is liable for wages. Relevant case law, such as Wilbur-Ellis Co. v. Department of Rev., illustrates that an entity may act solely as an agent by managing transactions between a manufacturer and customer without assuming liability for payment, thus affecting tax implications. The question of control also influences whether payroll and per diem expenses qualify as deductible reimbursements under WAC 458-20-111. According to Christensen, O'Connor, Garrison, Havelka v. Department of Rev., a taxpayer's gross income can exclude customary reimbursements if the taxpayer does not provide the service and is not liable for payment. The Walthew, Warner, Keefe, Arron, Costello, Thompson v. Department of Rev. case further clarifies that advances made by a law firm for litigation costs were considered client liabilities, with the firm acting merely as an agent. The court emphasized that the definition of gross income under RCW 82.04.080 and RCW 82.04.090 focuses on compensation for services rendered. The Department of Revenue’s interpretation that all client reimbursements should be included in gross income contradicts the statutory intent to exclude pass-through reimbursements where the taxpayer has no liability beyond acting as an agent. The court affirmed that Rule 111's language aligns with the statute, supporting exclusions for advances without taxpayer liability. Although the Walthew ruling was informed by attorney regulations, its reasoning is not limited to that context.
The principles of agency law are critical in assessing the gross income of Rho's business. The Board failed to evaluate Rho's role as an agent for the client when it came to paying wages and expenses for contract personnel, overlooking the right of control regarding hiring, firing, and compensation. Instead of focusing on the substantive nature of the relationships, the Board analyzed only the contractual language. This oversight constitutes a legal error, thus necessitating a remand for further examination of these agency principles. If Rho is determined not to be the employer or not primarily responsible for compensation, the payments made would be considered non-taxable advances or reimbursements. Additionally, the Board must reassess Rho's status as a "processor for hire," ensuring a fair consideration of relevant activities and tax implications. The case is reversed and remanded to the Superior Court with instructions for the Board of Tax Appeals to conduct further proceedings aligned with these findings. The agreements with Boeing and Westinghouse clarify that Rho, as the seller, maintains independent contractor status while controlling its employees, who are not classified as employees of the buyers.
An agreement with Boeing specifies that the undersigned acknowledges their employment with Rho, clarifying they are not considered an employee of Boeing under any circumstances. Relevant to tax law, WAC 458-20-111 defines 'advance' as funds received from a client intended for paying costs or fees, while 'reimbursement' refers to funds received to repay the taxpayer for expenses incurred on the client’s behalf. Both terms apply only when the client is solely liable for the costs and the taxpayer has no personal liability beyond acting as an agent. Tax exclusions may apply to amounts received as reimbursements for advances, provided they are customary in the taxpayer's business. However, this does not include instances where clients advance payments for services or goods the taxpayer is to provide.
Additionally, the classification of a person as an employee under the State Employment Security Act or Federal Social Security Act does not automatically qualify them as an employee under the Revenue Act. Relevant case law includes Fisher v. Seattle, which addressed vicarious liability in workers' compensation, and Washington Sav-Mor Oil Co. v. State Tax Commission, which examined corporate veil principles in tax liability. The courts have consistently rejected applying corporate law concepts, such as piercing the corporate veil, to tax law. In Boise Cascade Corp. v. State, the distinction between agent and independent contractor for tax purposes differs from tort or contract considerations. Moreover, tax deductions must be narrowly interpreted, with the taxpayer bearing the burden of proof for entitlement, as established in Browning v. Department of Revenue and UPS, Inc. v. Department of Revenue.
