Management Fees: Structuring Agreements to Minimize of Sales and Use Tax
Connecticut is one of many States that impose sales and use tax on a variety of services and transfers of tangible property. Herein we shall be addressing the applicability of Connecticut sales and use tax on business management services and specifically the risks that may befall unwary healthcare providers. Many multiple-facility providers, and even one-off-facility providers, are structured with a single management company, which offers various types of services to a number of facilities; usually with each facility housed in a dedicated limited liability company or corporation.
Generally, when the ownership of the “facilities” (herein used interchangeably with “holding entity of the facility”) is identical to that of the management company, there is no need to charge sales tax on the provision of these management and related services. This exemption is justified by the fact that given their common ownership, the various facilities and management services technically could be incorporated within a single entity, which would clearly avoid the application of sales tax on any intra-company services, and further that these operations have been separated primarily for legal liability purposes. However, when the ownership is not identical, some, or all of the management services provided by the management company may be subject to sales and/or use tax, which for many providers is unexpected or foreseen.
First, let’s define what types of activities comprise business management services. Basically, most forms of business analysis, management, management consulting and public relations constitute business management services and are subject to Connecticut sales tax. However, these services do not include services customarily rendered by attorneys, accountants and actuaries, when such professionals are acting within the scope of their professions. Also excluded are marketing, investment, investment banking, engineering, insurance and auditing services. More importantly, a management service, whether business analysis, management or management consulting, must be related to the recipients’ core business activities in order to be taxable. Core business activities are those activities directly related to the recipient’s sales of goods or services, its capital structure or budgeting, or its short-range, long-range or strategic planning. This includes core human resources activities, which is not ongoing administration of payroll and benefits plans and core business activities which does not include internal mailroom and delivery operations, buildings and grounds maintenance, insurance management or shareholder relations.
Otherwise taxable services are exempt from sales tax when rendered between business entities and their 100% subsidiaries. For example, one entity (either the service provider or recipient) must own a 100% controlling interest in the other. This exemption applies when the services are rendered between two entities that have the same owner. Corporations, partnerships, trusts, estates, limited partnerships, limited liability companies, non-stock corporations and sole proprietorships are the business entities that apply to the common ownership exceptions. The attribution and constructive ownership of stock rules of the federal tax code are used to determine if an entity or an individual has a controlling 100% interest in both entities. For example, an individual is considered as owning any stock that is owned, directly or indirectly, by or for his “family.” “Family,” in this regard includes parents, grandparents, brothers, sisters, spouse, children and grandchildren. For example, if a management company is 100% owned by the parents and an operating entity is 100% owned by their children, both the parents and children are deemed to own 100% of both the management company and the operating entity and the sales tax exemption would apply to management services provided in this context.
Additionally, when the service provider and recipient are not owned 100% by the same controlling interest, then the management services would be subject to Connecticut Sales Tax. In this situation, in order to prevent the application of sales and use tax on services that would not necessarily be taxable, except for the fact that they were bundles with taxable services, it is beneficial to separate the taxable management services from the non-taxable services; such as payroll administration or grounds maintenance. When invoiced with the proper level of detail, including exact company name, amount and description, the reimbursement of non-taxable services not included in a bundled management fee should not generate Connecticut Sales Tax – as long as the reimbursement is exact and not based upon an allocation or estimate.
This outcome is based upon a general principle of Connecticut Sales and Use taxation that applies to instances where taxable and nontaxable services are bundled or combined for billing and/or accounting purposes as one service under a management fee arrangement, the entire combination of the services are subject to sales and use tax. For example, if a management fee of $100 comprises $10 of taxable business management services and $90 of non-taxable payroll administration services, then the entire $100 is subject to Connecticut Sales and Use tax.
Sales tax is a major source of revenue for the State of Connecticut and the State’s audit activity has increased in recent years due the lack of other tax revenue and general economic conditions. As audits are becoming ever more common, it is important to properly analyze and document the ownership structure in order to determine the taxability of the various services provided by the management entity. If the controlling interest exemption cannot be achieved, then taxable management services should be segregated from non-taxable (or reimbursable) services to avoid tainting the entire group of services.
Our sales and use professionals at Marcum LLP are available to provide assistance in these matters. Please feel free to contact your local health care team representative for more information.