The Ohio sales tax on employment services is continuing to generate controversy. Originally imposed on Jan. 1, 1993, the sales tax on employment services is an important component of the state of Ohio budget that annually raises approximately $160 million in tax revenue. But the tax is controversial because it can be a heavy burden on businesses attempting to fill their labor needs, particularly in the tight labor market that we are currently experiencing.
Subject to certain exceptions, the tax is imposed on statutorily defined “employment services.” Ohio law, namely R.C. 5739.01(JJ), defines employment services to require three components:
- Supplying personnel on a temporary or long-term basis.
- The personnel must perform work or labor under the “supervision or control of another.”
- The personnel must receive their wages, salary, or other compensation from the provider of the services.
Contractors and subcontractors have long been excluded from the tax through express statutory language contained in R.C. 5739.01(JJ)(1). The Ohio Supreme Court’s recent decision in Seaton Corp. v. Testa goes a bit further through its interpretation of the second prong of the definition of employment services, on “supervision or control,” to exclude “on-site management” from the tax as well.
On-Site Management Not Taxable
In the Seaton Corp. case, the staffing company, Seaton, agreed to “furnish, manage and supervise” workers for a pet food manufacturing line run by Kal Kan Foods, Inc. According to the Ohio Supreme Court, Seaton “scheduled its workers, made their job assignments, and monitored their work production.” In addition, “Seaton’s responsibilities included worker orientation, worker-performance management, worker coaching and counseling, interacting with workers on a daily basis, processing time cards and payroll, and enforcing workplace rules.”
“Kal-Kan supervisors had no work-related interactions with Seaton workers on the job floor, unless a Seaton worker was committing a safety violation.”
The Supreme Court rejected the state tax commissioner’s attempt to impose the tax because Seaton maintained control over the workers. First, the court rejected the tax commissioner’s position that Kal Kan necessarily controlled Seaton’s workers by maintaining control over its own manufacturing process where they worked. The court focused on which business controlled “workers’ schedules and workplace assignments” rather than control of the overall process. The court ruled that Seaton maintained control over these aspects of the workers’ assignments and therefore taxable employment services were not present.
Second, the court rejected the tax commissioner’s argument that excluding Seaton’s workers from the tax, in effect, flipped the “supervision or control of another” requirement on its head. The tax commissioner argued that taxable employment services are present because Kal Kan has some “supervision or control” over the workers and its own process; there is no requirement for Kal Kan to have exclusive supervision or control over the workers in all respects. Because Kal Kan maintained control over its own manufacturing line, for example to resolve problems with workers as they arose, the tax commissioner argued that Kal Kan therefore had supervision or control over the workers to establish taxable services under Ohio law.
Third, the court rejected the tax commissioner’s assertion that excluding Seaton’s services from the tax would render the aforementioned contractor exclusion meaningless. Ohio law excludes contractors from the tax by excluding the following from the definition of employment services: “Acting as a contractor or subcontractor, where the personnel performing the work are not under the direct control of the purchaser.” The court rejected the tax commissioner’s argument that there would have been no need for the Ohio General Assembly to enact this language if, by definition, contractor services and “on-site management” services were not taxable services in the first place.
Implications & Opportunities
The employment services tax in Ohio could turn in large part on how the incoming tax commissioner administers the tax going forward, whoever that may be. The General Assembly is not likely to abandon the tax any time soon, because the tax revenue that it generates helps balance the state budget. As an executive agency, the Tax Department likewise has an interest in raising revenue for essential government services. Taxpayers should therefore tread carefully when taking aggressive positions as to whether staffing services are taxable or not.
At the same time, the Seaton Corp. case and another case decided in 2017, Accel, Inc. v. Testa, highlight tax savings opportunities for the employment services tax. In certain situations, Seaton’s “on-site management” model could achieve major tax savings. However, companies must carefully follow the court’s guidance and, perhaps more importantly, take into account non-tax business considerations as to whether the model works for them. The Accel, Inc. case addresses another statutory exclusion from the tax for permanent workers, but again, companies must carefully follow their business practices and contractual arrangements to achieve tax savings.