Ohio Supreme Court Provides Guidance on Temporary Labor

State and Local Tax

By William Vohsing

Ohio has subjected temporary employment services to sales/use tax since 1993. (O.R.C. 5739.01(JJ)) What is clearly taxable is the provision of employment services on a seasonal basis or to replace a worker that is on vacation or sick. However, employment services are not subject to Ohio sales/use tax if the service provider “supplies personnel to a purchaser pursuant to a contract of at least one year between the service provider and the purchaser that specifies that each employee covered under the contract is assigned to the purchaser on a permanent basis.” (O.R.C. 5739.01(JJ)(3))

The permanent assignment exemption has been litigated numerous times. The result of this litigation has placed the burden of proving permanent assignment on the taxpayer. The courts have consistently ruled that providing a contract that simply states a time period of greater than one year is insufficient proof for the exemption. In fact, a written contract is not a requirement to meet the exemption. (Excel Temporaries v. Tracy, BTA No. 97-T-257 (October 30, 1998)) What is important is the actual performance of the parties in the contract.

In a recent case, the Ohio Supreme Court issued a decision against a taxpayer regarding the purchase of temporary employment labor. (Bay Mechanical & Electrical Corporation v. Testa, Slip Opinion 2012-Ohio-4312) At issue was whether Bay Mechanical was entitled to the permanent assignment exemption contained in O.R.C. 5739.01(JJ)(3).

Bay Mechanical was audited by the Ohio Department of Taxation for sale/use compliance. As part of that audit, certain employment service contracts were reviewed by the Department and deemed taxable. Bay Mechanical objected to the inclusion of the employment service contracts, claiming that these contracts were for a period of greater than one year. Bay Mechanical provided copies of the contracts to the Department that clearly showed that the agreements were for a period of at least one year. However, Bay Mechanical refused to supply copies of invoices or time cards that were requested by the Department’s agents. Because Bay Mechanical did not supply the additional documentation to the agents, or through the appeal process, Bay Mechanical did not prove that the performance of the contract matched the language of the contract.

The lesson for taxpayers from the Bay Mechanical decision is that a contract that contains language that complies with the statutory definition of permanent assignment is not sufficient proof of exemption. In order to prove that employees were assigned on a permanent basis, taxpayers will have to produce core documents such as invoices and time cards that correlate to the language of the contract.

An additional item of note is that the Ohio Department of Taxation has adopted what they refer to as “the one bad apple rule.” The exemption states that each employee must be assigned on a permanent basis. If it is determined that just one employee covered in a contract does not meet the permanency test, the entire contract (all employees) will be subject to tax. If a taxpayer knows that not all employees covered in an employment contract will be assigned on a permanent basis, separate contracts should be written for those permanently assigned and those employed on a temporary basis.

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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