Internal Policy Directive 2003-3
September 30, 2003
Internal Policy Directive 2003-3
GENERAL SALES AND USE TAX ACTS:
FOOD SERVICE ESTABLISHMENT EMPLOYEE MEALS
LEGAL POLICY ISSUE
- How are Michigan sales and use taxes applied to meals furnished to employees of food service establishments?
- Are meals provided free of charge or at a reduced rate to workers in a food service establishment who are not employees of the food service establishment subject to Michigan sales and use taxes?
- Who is an employee and who is an employer?
LEGAL POLICY DETERMINATION
- Prior to October 1, 2001 meals furnished to employees were subject to Michigan sales tax and measured by either the reduced amount charged the employee or the cost of providing a free meal to employees.
After September 30, 2001 meals furnished free or at a reduced price during work hours to employees of food service establishments licensed by the Michigan Department of Agriculture are exempt from Michigan sales and use taxes.
- Meals provided to workers in a food service establishment who are not employees of the food service establishment are subject to Michigan sales tax.
- The determination of who is an employee is a very fact specific determination. The Department will follow well established IRS tests to determine when an employee/employer relationship is between.
Sales and use tax statutes were amended effective October 1, 2001 to exempt employee meals under certain circumstances. Use Tax Act Section 4d (MCL 205.94d) and General Sales Tax Act Section 4g (MCL 205.54g) were amended in part to provide that "prepared food intended for immediate consumption provided during work hours for free or at a reduced rate to employees of food service establishments licensed by the Michigan department of agriculture" are not subject to tax.
The amendments established four criteria for exemption. They are: 1) the food must be provided during work hours, 2) the food must be provided for free or at a reduced rate, 3) to employees, and 4) of food service establishments licensed by the Michigan department of agriculture.
Criteria number "1" is self explanatory. Criteria number "2" precludes food sold to employees at regular prices from the exemption. Criteria number "3" requires that the food be provided to employees, which is a term undefined in the sales and use tax acts, therefore the department must establish guidelines to determine who is an employee. Criteria number "4" is a bright line test evidenced by the existence of a license issued by the department of agriculture to operate as a food service establishment.
As noted above, the sales and use tax acts do not contain a definition of the word employee. Generally, in the absence of a statutory definition the department will look to dictionary definitions. Websters New World Dictionary, Third College Edition, defines "employee" as "a person hired by another, or by a business firm, etc., to work for wages or salary". "Employer" is also defined to be "one who employs; esp., a person, business firm, etc. that hires one or more persons to work for wages or salary." Black's Law Dictionary, Sixth Edition, generally defines "employee" to be "[a] person in the service of another under any contract of hire, express or implied, oral or written, where the employer has the power or right to control and direct the employee in the material details of how the work is to be performed."
At best these dictionary definitions require a facts and circumstances analysis. The essential question can be stated as who has the contractual power or right to control and direct the employee in the material details of how the work is to be performed. The department's experience in this area derives from administration of other state "Revenue Act" taxes. In the interests of consistency and in the absence of conflict, the department will adopt its policies developed in the administration of these other taxes and apply them to the sales and use tax determination that is the subject of this document.
Both the Single Business Tax Act and the Income Tax Act of 1967 define the term "employee" by reference to Section 3401(c) of the Internal Revenue Code (IRC). IRC Sections 3401(c) and (d) effectively define the employer and employer relationship to generally be dependent on the party for whom service as an employee is performed, with exceptions under certain conditions based on who has control of the payment of wages.
Internal Revenue Service (IRS) Regulation 31.3401(c) provides added guidance on who is to be determined to be an employee. Generally Regulation 31.3401(c) requires a determination of the relationship of employer and employee and examines whether the right to control and direct exists. Subdivision (d) of Regulation 31.3401(c) states "[w]hether the relationship of employer and employee exists will in doubtful cases be determined upon an examination of the particular facts of each case."
The IRS has issued Revenue Ruling 87-41 (Ruling) which provides an aid to making doubtful case employee and employer determinations under common law rules. The Ruling has a context of contrasting employees from independent contractors. The common law rules expressed are in the form of twenty factors or elements used to determine whether sufficient control exists. The factors are only guides. They may prove useful, however, in determining who the parties are in an employer and employee relationship despite the employee/independent contractor context. The question is not whether the worker is an independent contractor, but rather what party exercises contractual control of the employee by the factors described in the Ruling. The "test" is intended to be utilized in a manner that does not require all factors to be present to reach a determination of the existence of an employer and employee relationship.
Example 1: All workers at Burger Heaven, a fast food franchise restaurant licensed by the Michigan department of agriculture, are considered by the restaurant to be employees of a related employee leasing company. Upon review of employment contracts between the employee leasing company and the Burger Heaven workers, a factual determination is made that the employer-employee relationship exists between Burger Heaven and the workers, not the employee leasing company and the workers. After September 30, 2001 the sales and use tax exemption would apply to meals provided to Burger Heaven workers provided they are given for free or a reduced rate during working hours.
Example 2: Happy Holidays Inn, a local hotel and banquet facility with a hotel restaurant licensed by the Michigan department of agriculture, considers themselves to be the employer of all hotel staff including hotel restaurant workers. Upon a review of employment contracts between Happy Holiday Management Company and Happy Holidays Inn restaurant workers, a factual determination is made that the employer-employee relationship exists between Happy Holiday Management Company and the restaurant workers, not between Happy Holidays Inn and the restaurant workers. Since the restaurant workers are not employees of a food service establishment licensed by the Michigan department of agriculture, all meals provided to employees would be subject to sales tax for periods before and after October 1, 2001.
The twenty common law factors from IRS Revenue Ruling are:
- Instructions. A worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.
- Training. Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner.
- Integration. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
- Services Rendered Personally. If the services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.
- Hiring, Supervising, and Paying Assistants. If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.
- Continuing Relationship. A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.
- Set Hours of Work. The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.
- Full Time Required. If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
- Doing Work on Employer's Premises. If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.
- Order or Sequence Set. If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the person or persons for whom the services are performed. Often, because of the nature of an occupation, the person or persons for whom the services are performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so.
- Oral or Written Reports. A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control.
- Payment by Hour, Week, Month. Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
- Payment of Business and/or Traveling Expenses. If the person or persons for whom the services are performed ordinarily pay the worker's business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker's business activities.
- Furnishing of Tools and Materials. The fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.
- Significant Investment. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship. Special scrutiny is required with respect to certain types of facilities, such as home offices.
- Realization of Profit or Loss. A worker who can realize a profit or suffer a loss as a result of the worker's services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee. For example, if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risk to support treatment as an independent contractor.
- Working for More Than One firm at a Time. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
- Making Service Available to General Public. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
- Right to Discharge. The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
- Right to Terminate. If the worker has the right to end his or her relationship with the person for whom the services are performed at anytime he or she wishes without incurring liability, that factor indicates an employer-employee relationship.