Ohio Denies Commercial Activity Tax Exclusion for Reimbursed Expenses

By:  Tina M. Chunn, SALT Senior Manager

At a glance

• The main takeaway: Do your contracts with customers provide that they will reimburse you for the cost of products or services procured on their behalf? If so, depending on how your contracts are structured, those amounts may be subject to gross receipts taxes.  
• Assess the impact: Before entering into contracts with customers, it is important to either structure the contracts to meet any requirements for the exclusion of reimbursed expenses from gross receipts taxes or price the contracts accordingly to net the desired margin.
• Take the next step: Aprio’s State and Local Tax (SALT) team can review your transactions and ensure they are documented in accordance with each state’s tax requirements so that you obtain the desired tax outcome in the event of an audit. 

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The full story:

When a business incurs a cost for its customer’s benefit that will be passed along to that customer (without reduction or mark-up), there is no direct impact on the business’ income since the reimbursement by the customer is offset by the expense. However, in states that impose a tax on gross receipts (where expenses are not deductible), that reimbursement may be included as taxable revenue if not structured properly. This was the issue addressed by a recent Ohio Board of Tax Appeals decision.¹

A closer look at the case

Aramark Corporation (Aramark or the Taxpayer) is a food services, hospitality, facility services and uniform services company. These managed services are provided to businesses as well as educational, healthcare and government institutions. Aramark provides its services under two types of contracts with the difference between the two related to the allocation of the risk of profitability. 

The first is a profit and loss contract. This contract is performed independently of the client and the profit or loss is determined based on sales exceeding expenses (i.e., the price charged by Aramark to its customer exceeds its costs for those items).

The second is a management fee contract, whereby Aramark purchases food, supplies, and other items for its customers and is reimbursed by the customer for the cost of those items.  In addition, the customer pays Aramark a management services fee. 

The Taxpayer paid Ohio Commercial Activity Tax (CAT), a gross receipts tax, on all revenues from both types of contracts. It subsequently filed a refund claim to exclude amounts under its management fee contract that represented amounts reimbursed by its customers, arguing that it was acting as its customer’s agent. The state denied the claim on the grounds that the Taxpayer failed to establish that it acted as its customers’ agent. 

The ruling explained

The CAT is levied on a taxpayer’s gross receipts, which is defined as “the total amount realized by a person, without deduction for the cost of goods sold or other expenses incurred.”² Certain amounts are excluded from gross receipts, including “[p]roperty, money, and other amounts received or acquired by an agent on behalf of another in excess of the agent’s commission, fee, or other remuneration.”³ An “agent” is defined as “a person authorized by another person to act on its behalf to undertake a transaction for the other” and includes a “person retaining only a commission from a transaction with the other proceeds from the transaction being remitted to another person.”⁴

Under Ohio’s regulation,⁵ in “a principal-agent relationship, the agent has the legal authority to act on behalf of the principal, and generally the principal is bound by and is liable for those actions.” Regarding the agency exclusion for a person retaining only a commission, the regulation states that “the agency relationship should be explicitly stated in a contract that is available to the tax commissioner to inspect. Absent such proof, it will be presumed that no agency relationship exists and the person claiming the agency relationship will include the total amount received in its gross receipts.”

Upon review of Aramark’s contracts with its customers, it was found that no such agency authority was provided and in fact it was explicitly stated that the Taxpayer did not have the authority to bind its customers to reimburse these costs directly to the suppliers. The contracts further stated that nothing in the contract should be deemed to create an agency relationship; to the contrary, certain contracts stated that Aramark “will be an independent contractor, and shall retain control over its personnel, suppliers, contractors and agents.” As such, the Board of Tax Appeals ruled that the reimbursements received by Aramark from its customers were part of the Taxpayer’s costs of goods sold and are not excludable from gross receipts.

The bottom line

If a business is not able to exclude reimbursed costs from gross receipts, there can be a material impact on the business’ margin, particularly if margins are already tight. Therefore, when entering into contracts with customers, it is important to either structure those contracts to meet any requirements necessary for the exclusion of reimbursed expenses or price the contracts accordingly in order to net the desired margin. Aprio’s SALT Team has experience reviewing these types of issues, and we can assist to ensure that your transactions are documented in accordance with each state’s tax requirements so that you obtain the desired tax outcome in the event of an audit. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter. 

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¹ Aramark Corp. v. Harris, Ohio BTA Case No. 2019-2975, November 6, 2023.

² Ohio Rev. Code § 5751.01(F).

³ Ohio Rev. Code § 5751.01(F)(2)(l).

⁴ Ohio Rev. Code § 5751.01(N)(2). It should be noted that during the period at issue in the case, this definition was in paragraph P and that is how the opinion cites to the statute. For purposes of the citations in this article, we are using the current version of the statute.

⁵ Ohio Admin. Code Rule 5703-29-13.