Department of Finance and Administration

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1 STATE OF ARKANSAS Department of Finance and Administration REVENUE LEGAL COUNSEL Post Office Box 1272, Room 2380 Little Rock, Arkansas Phone: (501) Fax: (501) August 4, 2017 RE: Principal-agent Relationship - Purchases Made on Behalf of Tax Exempt Entity Opinion No Dear, This is in response to your letter dated, July 12, 2017, seeking the issuance of a legal opinion from the Arkansas Department of Finance and Administration (DFA). Your letter requests on behalf of and ( ) and relating to a construction project on the that DFA confirm that the Agency Language (Exhibit A ) is sufficient to create the legal relationship of principal-agent between and its contractors (and subcontractors) as agents of, and that, as such, purchases of personal property and materials for the Project made by those contractors (and subcontractors) under and pursuant to the contracts will be treated as purchases made directly b H, subject to the exemption from application of the Gross Receipts Tax pursuant to Ark. Code Ann , and Compensating Use Tax pursuant to Ark. Code Ann (2). In support of your request for legal opinion, you set out the following facts for consideration: 1. Facts. is a traditional children s home based organization and although it has expanded to include additional services, it is neither a hospital nor a sanitarium. was founded as an orphanage as many such homes were at the end of the 19 th century. As such it served orphans and other children who needed a place to live outside of their home for periods of time. Over many decades, the services evolved to meet the needs of the communities served and eventually to include statewide services. These programs, and the services to be provided in the Project upon completion, however, will not provide hospital services. As licensing standards were developed, came to be under the licensing standards for children s homes and orphanages.

2 The modern entity which addresses these licenses in the Arkansas Child Welfare Review Board. This body licenses children s homes, foster care providers and adoption placement services. The CWARB is not authorized to license or regulate hospitals. Hospitals are generally under the control of the Arkansas Department of Health. The new facility will be accredited by the Joint Commission on Accreditation of Health Care Organizations. While JCAHO does also accredit hospitals, is only reviewed under the behavioral health standards and is not considered a hospital by JCAHO. Hospitals general provide medical and surgical care over a broad base of services. Service provided in the Project will deal only with a narrow focus addressing behaviors of children and adolescents. The activities in the new facility will also be reviewed by the office of Long-Term Care for Arkansas, but again this is a review of the Medicaid behavioral health standards and does not consider traditional convalescent, medical recovery or other hospital-like care. Even though the title of the reviewer is titles Long-term care, the program to be administered in the new facility is in fact a 3-4 month program designed to allow children to move back to a lower level of care (return home, or go to a group home or foster care), as soon as possible. The classification of the Project for fire prevention (Arkansas Fire Prevention Code) is I-1 and hospitals are classified as I-2 for Medicare purposes, the facility will be a psychiatric residential treatment facility which is defined as a non-hospital facility. and - Certification/Certificational Compliance/Downloads/WhatisaPRTF.gov. The services provided by the facility do not fit any definition of the traditional definition for those institutions described as sanitariums which have traditionally provided long term care for conditions like tuberculosis. At the time these institutions were named Sanitariums or Sanitoriums, tuberculosis, chronic mental illness or insanity and other similar situations required quite extended, possibly permanent stays in a facility. programs have nothing that resembles this level of care. s activities in the new facility focus on a relatively short term basis that will thereafter be addressed with outpatient clinical care. In fact it is uncertain that a true sanitarium still exists within the state of Arkansas, as most, if not all, of them have been closed or abandoned for many years. 2. Law and Discussion. Arkansas Code Annotated section provides All sales to all orphans homes in this state, or children s homes, which are not operated for profit and whether operated by a church, religious organization, or other benevolent charitable association shall be exempt from the gross receipts or gross proceeds tax, commonly referred to as the sales tax. Neither Section (21)(A) or (B) applies since s new facility is neither a hospital nor a sanitarium.

3 As described above, operates a nonprofit children s homes in. Thus, satisfies all of the requirements for application of the gross receipts tax exemption described above. The issue for determination in connection with this request is whether the agency relationship created between and its contractor support application of the exemption to purchases by its contractor as s purchasing agent. The 1954 case of Kern-Limerick, Inc. v. Scurlock addresses a similar issue. That case involved application of the Arkansas Gross Receipts Tax to equipment purchased by a contractor in connection with the construction of a navel ammunition depot pursuant to a contract with the Naval Department. The construction contract between the contractor and the U.S. Government (the Government ) specifically provided that the contractor would act as the purchasing agent of the Government in connection with the work and that the Government would be directly liable to vendors for the purchase price. This agency power was subject to various approval requirements as set forth in the contract. In addition, the contract specifically required that title to all purchased materials and equipment pass directly from the vendor to the Government, without vesting in the contractor. Similar provisions were expressly made applicable to subcontractor working on the job. Kern-Limerick, as seller of the equipment in question, paid the gross receipts tax under protest and filed a refund action, in which the Government intervened. The Arkansas Supreme Court held against Kern-Limerick on the basis that the Government could not delegate its purchasing power to a third-party contractor. Based on the language of the contract between the Government and the third-party contractor, the United States Supreme Court reversed, holding that the purchases by the contractor as agent of the Government were effectively sales to the Government that were immune from state taxation. In support of its holding, the Supreme Court cited the delegation of contracting authority to the contractor by explicitly naming the contractor as the Government s purchasing agent, language obligating the Government to the selling vendor for the amount of the purchase price, and the fact that title to the property purchased vested immediately and directly in the Government without passing through the hands of the contractor. May v. McCastlain involved a federal situation addressed by ACA (21). The contractor in that case was hired to install air conditioning equipment at the University Medical Center in Little Rock, now know as UAMS. The equipment was purchased directly by the contractor and installed pursuant to the contract. The State Commissioner of Revenue determined that the equipment was taxable as property consumed by the contractor in the performance of its contract with the state. The trial court found that, under the terms of the contract, the contractor was not an agent of the Medical Center but was the ultimate consumer of all machinery and goods used in the performance of the contract.

4 The May case involved the predecessor of the exemption statute at issue in this request. On appeal to the State Supreme Court, the contactor argued that the intent of the exemption was to exempt sales to a contractor (as the consumer) when it is conduction business with an otherwise exempt hospital. The contractor also argued that it was acting in the capacity of an agent of the tax-exempt institution, purchasing materials and property on its behalf. The Court noted that it was required to construe tax exemption statutes strictly and by their plain language. On the basis, the Court held that the wording of the exemption statute required that the sale be made directly to the hospital to be exempt. In response to the contractor s argument that it was acting as an agent of the Medical Center, the Court specifically distinguished the facts of the May case from those involved in Kern-Limerick in which the agency relationship was expressly created by the terms of the written agreement. A different result was required in May, according to the Court, relying on the form of the contract rather than its economic effect. The Court determined that the contractor was not expressly made an agent for the purchase of materials as in Kern-Limerick, and refused to imply an agency relationship where one was not expressly created by the terms of the contract. It is important to note that in May the Court did not find that a contractor could never obtain the benefit of the exemption when acting as agent of an exempt institution but, simply, that the contract between the Medical Center and the contractor did not create a valid principal-agent relationship. In 1982 the Supreme Court of the United States decided the case of U.S. v. New Mexico. This case involved contracts between the U.S. Government (the Government ) and three independent contractors to manage certain government owned atomic laboratories located in New Mexico. The management contracts provided that title to all personal property purchased by the contractors would pass from the vendor directly to the Government. Nevertheless, the contractors placed orders with suppliers in their own names and identified themselves as the purchaser. Under special procedures described in the contracts, the contractors were allowed to draw upon a Government created account to pay creditors and employees for all services/materials provided. These contracts initially did not refer to the contractors as agents of the government, but were subsequently modified to provide that each contactor would act as an agent of the government for certain purposes. Following application of New Mexico s excise tax to purchases made by the contractors, the Government initiated an action for declaratory judgment seeking that funds advanced, property purchased, and the use of Government property by the contactors, was not subject to the State tax. In finding in favor of the Government, the District Court determined that the contractors were acting as procurement agents of the Government in performing services pursuant to the contracts. The Court noted that the Government maintained control over the procurement systems, method of payment and other operations under the contracts. Thus, the Court determined that a true agency relationship existed. As such, the

5 purchases were immune from state taxation. On appeal, the U.S. Court of Appeals for the 10 th Circuit reversed this determination and held that the governmentcontractor relationship did not raise to the level such to make the contractors instrumentalities of the United States. In upholding the various State taxes on appeal, the U.S. Supreme Court held that the contractor must actually stand in the Government s shoes in order to claim immunity from taxation. In acknowledging the complexity of determining agency in the sales tax context, the Court distinguished its facts from Kern- Limerick, a case heavily relied on by the United States. In doing so, the Court focused on the following factors: (1) the contractor made purchases in its own name, which the contract obligated them to do; (2) vendors were not informed that the Government was the only party with an independent interest in the purchase (as in Kern-Limerick); (3) the contractors were not required to obtain the Government s prior authorization for purchases: and (4) the Government disclaimed any formal intention to appoint the contractors as purchasing agents. The Court concluded that the facts demonstrated that the contractor were substantially independent of the Government. It should be noted that New Mexico has been distinguished by other courts based on its facts, and that the case did not overrule the holding of Kern-Limerick but was merely a distinguishable factual scenario. The New Mexico Court focused the substantial part of its analysis on the imprecision of prior applications of the Supremacy Clause of the Constitution rather than agency principles. In this regard, the Court noted that a private party would not be immune from taxation under the Supremacy Clause unless it actually stood in the Government s shoes. The Court confirmed that, in the sales tax area, it is arguable that a third party could be so closely related to the government in the procurement function, so as to make sales to that party the same as sales to the government. Despite the Court s lengthy analysis of the nuances of the Supremacy Clause, the Court s ultimate decision appeared to rest on the absence of factors demonstrating a true agency relationship as in Kern-Limerick. Based on the authorities cited above, it is position of the parties requesting this ruling, that the exemption provided by Ark. Code Ann would apply to purchases made by s contractors in connection with the Project provided that the contracts between such parties create the legal relationship of principalagent (at least with respect to the purchasing/procurement function). Under Arkansas law, an agent is a person authorized by another to act on his behalf. The principal-agent relationship may be created simply by the principal s indication that the agent is to act on his behalf, provided the agent acts or agrees to act on behalf of the principal and subject to the principal s control. A person may simultaneously act as an independent contractor in certain respects and as an agent for other purposes.

6 In the construction contract ( Contract ) between and, the contractors will typically be independent from in connection with the performance of construction services. As such, will not generally bear any responsibility for debts or obligations incurred by its contractor, nor will it directly control the manner and method in which services are performed. With respect to the procurement of property and materials necessary in connection with the Project, however, the Contracts contain language sufficient to create the principal-agent relationship with its contractors for purchases made on s behalf (the Proposed Contract Language ): The specific language from the Contracts relating to the agency of the contractors ( Agency Language ) is attached hereto as Exhibit A. We have obtained the transcript of Parker v. Kern-Limerick, Inc., 223 Ark. 464; 266 S.W. 2d 298 (1954) and the Agency Language is largely extracted from the contracts for construction which were exhibits to that case. Question Presented for Legal Opinion: and request a legal opinion from DFA that the agency language contained in Exhibit A to your letter is sufficient to create the legal relationship of principal-agent between and its contractors and sub-contractors such that purchases of personal property, materials and services for the Project made by those contractors and subcontractors pursuant to the contracts will be treated as purchases by entitled to the sales and use tax exemption under Ark. Code Ann and Ark. Code Ann (2). Response: DFA agrees that the language contained in Exhibit A to your letter creates the legal relationship of principal-agent between and its contractors and subcontractors for the purpose of purchasing tangible personal property and services. Consequently, as more fully explained below, purchases made by the contractors or subcontractors pursuant to the contractual language contained in Exhibit A will be entitled exemption from Arkansas sales and use tax as provided by Ark. Code Ann and Ark. Code Ann (2). As you point out, Ark. Code Ann provides a sales tax exemption and states: All sales to all orphans homes in this state, or children s homes, which are not operated for profit and whether operated by a church, religious organization, or other benevolent charitable association shall be exempt from the gross receipts or gross proceeds tax, commonly referred to as the sales tax. In addition, Ark. Code Ann (2) provides that sales of property or services that are exempt by law from the sales tax are also exempt from the Arkansas Use Tax.

7 Pursuant to Arkansas Gross Receipts Rule GR-31, certain specified organizations or groups have been exempted by state law from sales and use tax when they purchase tangible personal property or taxable services. Sellers of tangible personal property or taxable services to these specified organizations are not required by law to collect the sales or use tax upon sales to those organizations. Rule GR-31(B)(9) identifies orphans homes or children homes located in Arkansas which are not operated for profit and which are operated by a church, religious organization or other benevolent, charitable association as one of those specified organizations exempt from sales or use tax on their purchases. To be exempt under the reasoning you propose, must first qualify for the sales and use tax exemption for purchases by nonprofit orphans homes or children s homes. Your letter explains that will perform activities in the newly constructed facility that assist clients with behavioral changes as well as treating mental health conditions on a short-term basis. You explain that the programs of are administered as a 3 to 4 month program designed to allow children to ultimately move back to a lower level of care by returning to their home or by moving to a group home or foster care. Neither the Arkansas Gross Receipts Tax Act nor the Gross Receipts Tax Rules promulgated by DFA define the terms orphans home or children s homes. In addition, a search of the Arkansas Code failed to identify a definition of those terms elsewhere in state law. The Arkansas Supreme Court has explained that in construing a statute, in the absence of any indication of a different legislative intent, words should be given their ordinary and usual accepted meaning in common language. Phillip s Petroleum v. Heath, 254 Ark. 847, 497 S.W.2d 30 (1973). Applying this test to the residential care facility operated by, we conclude that MCH comes within the intended scope of a children s home as that term is used in Ark. Code Ann Your letter also indicates that operate on a nonprofit basis. Consequently, operates a nonprofit children s home and purchases by for use in the operation of that facility will qualify for the sales and use tax exemption provided by Ark. Code Ann Ordinarily, when a contractor purchases materials to perform a contract, the contractor is considered to be the consumer of the materials and is responsible for paying tax on the purchase regardless of whether the contractor is acting on behalf of a contractee for which the purchase would be non-taxable. However, as you point out, in Kern-Limerick, Inc. v. Scurlock, 347 U.S. 110 (1954), the Supreme Court held that under certain circumstances, a contractor may act as an agent for the exempt taxpayer so that the purchase may be considered to be an exempt transaction. However, as the Supreme Court noted in United States v. New Mexico, 455 U.S. 720 (1982), Kern- Limerick involved a case where the entity serving as a federal procurement agent was so closely associated with the Government, and so lacked an independent role in the purchases, as to make the sale in both a real and a symbolic sense a sale to the United States, even though the purchasing agent has not otherwise been incorporated into the Government structure. Id. at 742. In New Mexico, the Court found it insufficient that the Government maintained control over the contractor s procurement systems, property management and disposal practices, methods of operational costs, and other operations under the contracts. Id. at 729. Likewise, it was insufficient that the title of the purchased property passed directly to the government. The New Mexico Court noted that in Kern-Limerick the contractor identified itself as a federal procurement agent and

8 when it made purchases title passed directly to the Government; the purchase orders themselves declared that the purchase was made by the Government and that the United States was liable on the sale. The Court emphasized that each transaction required specific Government approval. Id. at 742. In order to qualify for an exemption on a purchase made through a purchasing agent, the exempt taxpayer must be the actual purchaser of the materials by contract and in fact. Each exempt purchase and use must be made in the name of and subject to the approval and control of the exempt taxpayer. If the methods described in Exhibit A are fully implemented, then adequate approval and control procedures will be in place to satisfy this requirement. Each purchase must also conform to the laws and regulations governing such purchases by the exempt taxpayer. Therefore, where is the actual purchaser, and the contractor, subcontractor, or subsubcontractor is the purchasing agent, consistent with Articles 3 and 4 of the contracts as detailed in Exhibit A to your letter and strictly following Kern-Limerick as interpreted by U.S. v. New Mexico, the materials for the construction of the Project will be tax exempt. This opinion is based upon my understanding of the facts as set out in your inquiry and as current law and rules apply to those facts. Any changes in the facts or law could result in a different opinion. You may rely on this opinion for three years pursuant to Arkansas Gross Receipts Tax Rules GR-75(B). Sincerely, John H. Theis, Attorney Arkansas Department of Finance and Administration Office of Revenue Legal Counsel

9 Exhibit A Excerpt from the Supplementary Conditions to AIA Document A General Conditions of the Contract for Construction Psychiatric Residential Treatment Facility Article Owner s Agent for Procurement, Arkansas Notwithstanding the foregoing or any other provisions of this contract, Contractor shall act as Owner s agent in the purchase of materials used in the construction of the project Except where provisions are otherwise made by the Owner, the Contractor shall furnish all materials, articles, supplies and equipment required for the execution of the work under this contract. The Contractor shall act as the purchasing agent of the Owner in effecting such procurement and the Owner shall be directly liable to the vendors for the purchase price. The exercise of this agency is subject to the obtaining of approval in the instances and in manner required by the provisions of this contract. The Contractor shall negotiate and administer all such purchases and shall advance all payments therefor unless the Owner shall otherwise direct Title to all such materials, articles, supplies and equipment, the cost of which is reimbursable to the Contractor hereunder, shall pass directly from the vendor to the Owner without vesting in the Contractor and such title (except as to property to which the Owner has obtained title to at an earlier date) shall vest in the Owner at the time payment is made therefor by the Owner or by the Contractor or upon delivery thereof to the Owner or the Contractor, whichever of said events shall first occur. This provision for passage of the title shall not relieve the Contractor of any of its duties or obligations under this contract or constitute any waiver of the Owner s right of absolute fulfillment of all the terms of this contract Each subcontract entered into by Contractor and any sub-subcontract entered into by a subcontractor of Contractor shall, unless otherwise directed by the Owner, provide that: (i) the subcontractor and any sub-subcontractors shall act as the purchasing agent of the Owner to the extent and with the same authority granted to Contractor in Article in regard to such action by the Contractor and (ii) title to purchases for which the subcontractor and sub-subcontractor is entitled to reimbursement shall pass to the Owner in the same manner as that specified in Article in regard to purchases for the cost of which the Contractor is entitled to reimbursement A-1

10 Each purchase order shall be issued under the Owner s letterhead in one of the following formats: By its agent, or By its agent, and its agent, (Subcontractor) or and its agent, (Subcontractor) and its agent, (Sub-subcontractor) The Contractor, Subcontractor or Sub-subcontractor as agent for the Owner shall sign each purchase order No purchase in excess of $10,000 shall be made hereunder without the prior written approval of the Owner, except that the Owner may, in its discretion, either reduce the limitation on the amount of any purchase which may be made without such prior approval or authorize the Contractor to make purchases in amounts not in excess of $50,000 for any one purchase without obtaining such prior approval No subcontract or purchase order in excess of the limitations shall be entered into by the Contractor without prior written approval of the Owner. Article 3.6 Taxes Subject to the provisions of the Arkansas Department of Finance and Administration Sales Tax Opinion Number [ ] and Article 3.4.4, the purchase of supplies and materials for the construction of the qualifying facility and any ancillary work in support of the qualifying facility will be exempt from sales and use tax. The A-2

11 Contractor will indemnify and hold the Owner harmless from any sales and use tax liability due to the Contractor s failure to comply with all the provisions of the sales tax opinion and Article A-3