05/16/2013 by Attorney Geoffrey G. Hemphill
Authored by attorney Geoffrey G. Hemphill
There are many reasons to use a joint venture to bid on a construction project. One potential negative consequence seen recently is the threat of paying the business license tax twice. And as Seinfeld taught us, double dipping is bad and should be avoided.
The Virginia Business Professional and Occupational License (BPOL) tax is imposed on a contractor at approximately 0.16% of its gross receipts. The BPOL tax is administered by each city or county. If a contractor works on a project in Norfolk (for example) and receives over $25,000 for that job, Norfolk can impose the BPOL tax, regardless of whether the contractor has a “place of business” (office) in Norfolk.
The general rule in the prime contractor/subcontractor relationship is that both prime and sub pay a full BPOL tax on their gross receipts without deduction. For example, assume the prime receives $5,000,000 from the client. The prime then pays its subcontractor $3,000,000. Under current law, the prime is subject to BPOL tax on the $5,000,000 ($8,000 in tax) and the subcontractor is subject to BPOL tax on the $3,000,000 ($4,800 in tax). The prime may not deduct amounts paid to the subcontractor for BPOL purposes. Thus, the same money is effectively taxed twice.
The increasing use of joint ventures in construction projects has given rise to some confusion about how BPOL taxes are applied. Contractors want to avoid the situation in which the city imposes a tax at the JV level and then another tax on the same money after it has passed through to the JV contractors. That is double dipping and it is bad.
The problem is that we have seen different treatment of this situation by various cities. Also, each JV arrangement is different.
One argument used as a basis for avoiding the tax at the JV level is to claim that the JV has no “place of business” in the first place. But when corporate attributes are given to the JV: such as an office, employees or filing tax returns with a separate FEIN, it looks more like a “definite place of business” subject to taxation. Also, the Virginia code does not require a definite place of business for contracts over $25,000 – if the job is worth that much, the city can tax it.
Alternatively, the law provides an exemption from BPOL tax when a corporation or limited liability company transacts with its subsidiary or a sister company. The language of the Code, however, does not extend that exemption to unincorporated joint ventures, so the JV must be formed as a limited liability company or corporation. Many JVs are reluctant to establish limited liability companies if the JV must have a contractor’s license.
An argument that has worked is the appeal to the “agency” theory. Under VA Dept. of Taxation rulings, the BPOL tax is not assessed against funds that pass through the account of an agent. To be an agent, (1) there must be contractual relationships between the customer and the JV, and between the JV and the contractors; (2) the JV cannot comingle funds, but must have a separate account used to pass through funds paid under the contract to the contractors; (3) the JV cannot deduct distributions to JV contractors as costs on its federal tax return – it must pass them through to the contractors.
Most JVs that are truly pass-through vehicles used to secure contracts can meet the agency definition with careful planning. The more the JV looks like a prime/sub arrangement, however, the more likely it will be subject to double dipping.
When considering a joint venture contractors should analyze the business license treatment. It is sometimes wise to proactively engage the city or locality to obtain assurances that the joint venture is not subject to the BPOL tax.
These articles are meant to bring awareness to these topics and are not intended to be used as legal advice.