City can’t tax work done out of town

The long arm of the local tax collector in Virginia does not extend to a contractor’s business at its out of town offices, the Supreme Court of Virginia held this month in the first appellate case interpreting a 1996 state tax code revision.

In a decision welcomed by contractors and businesses generally, the court held that the city of Lynchburg could not tax a construction company’s activities in other communities where the company had temporary offices.

The case rejects a common practice used by many jurisdictions, lawyers said. Those cities and counties likely will be writing tax refund checks just like Lynchburg will have to do after this decision, they said.

Lynchburg’s case for taxing those out of town offices, the court ruled, “ignores the clear legislative intent underlying the General Assembly’s 1996 revision of the business license tax laws.” Writing for the court, Senior Justice Charles S. Russell said, “That revision relies strongly on the importance of a ‘definite place of business’ in determining the taxable status of gross receipts.”

The taxpayer in question is English Construction Company, Inc., a third-generation family-owned business based in Lynchburg.

City auditors claimed English owed more than $115,000 in back taxes for a four-year period.

The tax bill was based on gross receipts from English’s construction projects outside of Lynchburg. In each out-of-town project, English had set up a temporary office – such as a construction trailer at the building site – that stayed in place for at least 30 days. At these particular construction sites, the local governments did not impose any gross receipts tax. Lynchburg sought to step into that gap by taxing English’s out of town activities.

English paid the city’s tax bill and sought a refund in the courts. Circuit Judge Mosby G. Perrow III ordered the city to pay back the disputed taxes. The city appealed.

At the Supreme Court, both sides gained backing from statewide organizations. A collection of local government groups filed an amicus brief in support of the city. The Virginia Chamber of Commerce argued for English’s position.

The case required harmonizing two statutes. One, Virginia Code § 58.1-3703.1, provides for taxing a contractor’s gross receipts at the “definite place of business” where his services are performed or, if there is no such place, at the home office. The other statute, § 58.1-3715, allows a locality to tax a contractor’s revenue if the contractor does more than $25,000 in business in that locality. The contractor would get an equivalent deduction on taxes paid at the home office.

Lynchburg pointed to the second statute and argued that, by implication, if a foreign locality could have taxed the business – but chose not to – then Lynchburg was authorized to collect the tax instead.

The city’s reasoning was undone by a 2001 decision where the court declared that tax statutes would be strictly construed and not “extended by implication.”

Moreover, the court held, Lynchburg’s position was inconsistent with the importance of the “definite place of business” as the nexus for taxation under the 1996 revision.

Richmond lawyer William L.S. Rowe, who co-authored the amicus brief on behalf of the Virginia Chamber of Commerce, said the decision “confirmed, in essence, that what a locality can tax is activity in and through offices in that locality.”

The court’s invocation of that broad basis of the tax code revision is reassuring for all state businesses, Rowe said. Nevertheless, he said, the direct impact of the Lynchburg decision will be felt only by construction companies who set up branch offices for their out of town jobs.

Rowe chuckled as he dismissed the notion that the decision might give rise to construction sites with flimsy, sham business offices. First of all, he noted, there are few localities that pass up the opportunity to tax business activity within their borders.

Secondly, he said, contractors are not likely to pay for an unneeded temporary office just to save a few bucks on a tax bill.

The city and its allies argued that a large majority of Virginia localities collected taxes in the same manner as Lynchburg – taxing business income of local companies even though it was earned outside the local boundaries.

Colonial Heights attorney Debra L. Mallory, co-author of the amicus brief filed by local government groups, said she was surprised the court failed to mention that so many localities were taxing contractors the same way Lynchburg did. “They deserve an explanation of how did they – apparently – so badly interpret this. It’s not telling me why we were wrong.”

Roanoke lawyer Frank K. Friedman, who argued the case for English Construction, said it should not matter what localities actually were doing.

“A lot of localities just didn’t make any changes after the new legislation came into place,” he said. “The test is not what people are doing, the test is what does the act say. I think the court got it right.”

Friedman said the decision affirms that the 1996 tax reforms were intended to limit the tax collector’s reach – in most cases – to local activity.

“As I understood it, that was part of the legislative compromise that was made in 1996 and effective in 1997,” Friedman said. “This is a local tax. The contractors are already paying an income tax. You’re not supposed to be able to get every penny. You’re supposed to get what’s logically traced to your locality.”

Friedman’s partner, Roanoke tax lawyer Neil V. Birkhoff, argued the case in the circuit court. He sees the result as affirmation of the policy of strict construction of tax statutes. The Supreme Court opinion, he said, shows the court “will not tolerate taxing power by implication.”

For English Construction, the decision means a refund of more than $185,000 from the city. Other cities will be forking over similar refunds, according to Lynchburg City Attorney Walter Erwin.