FSM 2 Intrm. 061-066

The Federated States of Micronesia Income Tax Law confirms that it is the nature of the services performed and the person performing the services, rather than the stated identity of the contracting party, which determines the tax treatment for the compensation under the contract. It is of no import that the contractor was identified as a corporation rather than as an individual when the contract makes clear that the primary services to be rendered were those of an individual and the corporation was merely a name under which the individual conducted business. Heston v. FSM, 2 FSM Intrm. 61, 64 (Pon. 1985).

A taxpayer who held the high public office of Chief of Finance, whose contract gave him a wide degree of discretion in carrying out governmental powers; and who was not an outside consultant who could merely suggest or advise but was an integral part of the governmental operation is a governmental official, therefore an employee for purposes of the FSM Income Tax Law. Heston v. FSM, 2 FSM Intrm. 61, 65 (Pon. 1985).

Although plaintiff incurred expense in carrying out his obligations under contract, they were well below ten percent of the amount he received under the contract. Such expenditures are insufficient to alter plaintiff's status from an "employee" to a business under the FSM Income Tax Law. Heston v. FSM, 2 FSM Intrm. 61, 66 (Pon. 1985).

This is the second case in the past several months in which a party who has contracted with the State of Pohnpei to carry out the responsibilities of an important governmental office has sought to be taxed at the lower "business" rate rather than the rate applicable to "employees" under the Federated States of Micronesia Income Tax Law, 54 F.S.M.C. 111 et seq. 1

On February 1, 1984, the Pohnpei State Government 2 entered into a contract reciting that the government "has been experiencing various problems in the operation of the State Finance Office" and "desires to bring about the efficient and accurate operations of the State Finance Office and the implementation and operation" of a "new computerized accounting system." To accomplish this, the "contractor," identified as Pacific Financial Consultants, agreed to "assume authority over and responsibility for the operations of the Ponape State Finance Office for a one year period commencing February 1, 1984 and ending January 31, 1985." Pacific Financial Consultants agreed to provide the plaintiff here, William L. Heston, to serve in the capacity of Chief of Finance during that year, with Heston "to assume such responsibilities and perform such duties as are provided by law and governmental policy."

In addition to the normal powers of a Chief of Finance, Heston was given the extraordinary authority to review the existing staff of the State Finance Office and select seven employees who would be permitted to continue. The government agreed to support Heston's selection by either reassigning or terminating the other employees.

He also was given substantial powers over the seven who remained. Although the contract specifically confirmed that these seven would be "entitled to all employee benefits applicable to State Government employees," authority of the contractor to "approve or disapprove" all the employees' "requests for annual, sick or administrative leave" was also confirmed, subject to approval of the Director of the Department of Administration.

The contract provided for compensation in the amount of $100,000 plus housing 3 for Heston during the year of the contract. There was no provision for sick leave or annual leave or other fringe benefits and Heston paid his own moving expenses to come to Pohnpei.

the seven State Finance employees to be selected by Heston. Any overtime payments beyond ten percent of the base pay of each employee were to be the responsibility of the contractor, to be deducted from the $100,000 payable under the contract. There is no indication that overtime payments exceeded the ten percent ceiling and the contractor apparently did not incur any expenses under that particular provision.

Heston testified that he did incur some personal expenses in carrying out his work under the contract. These included some $900 for renovation of the State Finance Office, $1600 for accounting consultant services and $500 for secretarial assistance in Guam. In addition, he points out that his personal car was used from time to time for office purposes without reimbursement to him.

Perhaps the most marked departure from standard government practice was that after the one year period ended, Heston voluntarily worked an additional month, without added compensation, to assure satisfactory completion of the contract work.

It is of no import that the "contractor" here was identified as Pacific Financial Consultants rather than as William L. Heston himself. The contract makes clear that the primary services to be rendered were those of Heston as Chief of Finance. The contract does not contemplate services by anybody other than Heston.

There is no suggestion that Pacific Financial Consultants had resources other than the services of Heston himself which might be employed in carrying out the obligations of the contractor. Although Heston testified that Pacific Financial Consultants is licensed to do business in the Northern Mariana Islands, it is not licensed in Pohnpei and has no assets and no employees here. In short, in Pohnpei, Pacific Financial Consultants is Heston. Appropriately enough therefore, Heston signed the contract, under the heading "contractor," both individually and on behalf of Pacific Financial Consultants. The contract then was an agreement by Heston that he would perform certain services in exchange for payments aggregating $100,000 to be made to him.

The Federated States of Micronesia Income Tax Law also confirms that it is the nature of the services performed and the person performing the services, rather than the stated identity of the contracting party, which determine the tax treatment for the compensation under the contract. The terms "wages" and "salaries" are defined as including any "compensation paid

for ... personal services performed by an individual ... as an employee." 54 F.S.M.C. 112(11). 4 An "employee" is "any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee." 54 F.S.M.C. 112(3).

In Rauzi v. FSM, 2 FSM Intrm. at 1719, it was held that all governmental officials are employees of the government within the meaning of the Federated States of Micronesia Income Tax Law.

A crucial consideration here is that the plaintiff is not just a person who has been doing some work for the Pohnpei State Government. For the past year he has held the high public office of state prosecutor. This may be the most powerful office in our system of justice. Nix v. Ehmes, 1 FSM Intrm. 114 (Pon. 1982). The prosecutor invokes and implements the sovereign powers of the state in the justice system and is given a wide degree of discretion in so doing. Id. See also FSM v. Mudong, 1 FSM Intrm. 135 (Pon. 1982). The fact that he has been permitted to exercise those powers without supervision by an attorney and with relatively little supervision by anyone has made him an even more powerful public official.

The taxpayer here held the "high public office" of Chief of Finance. In the state hierarchy, Heston's Chief of Finance title is comparable to Rauzi's State prosecutor position. Both positions are immediately below department heads.

Heston too was given a "wide degree of discretion" in carrying out his powers. Although the Director of Administration retained the right to supervise Heston, the unmistakable thrust of the arrangement was that Heston was to act quickly to assume control, analyze the operation and make any changes he considered desirable.

Rauzi contended that he had even broader discretion than most state prosecutors because he was not supervised by an attorney. Heston too was given an extraordinarily strong mandate. For him, the quite substantial powers of the Chief of Finance were buttressed by authorization to remove all but seven of the staff from the State Finance Office.

It is especially significant that Heston, like Rauzi, was not an outside consultant who could merely suggest or advise, but was an integral part of the governmental operation. He served directly in the capacity of Chief of Finance, a position established pursuant to Pohnpei State law. See Pon. S.L. No. 1L-6-79, as amended, Section 1(3). Heston was given "full authority over the operations of the Finance Office and full responsibility for its operation." He specifically agreed to "abide by all laws, established Government policies and procedures applicable to the Finance Office function." His work was done within the physical confines of the State Finance Office.

There can be no doubt that Heston was acting as a governmental official in carrying out his responsibilities under the contract. Under the Rauzi analysis, he must therefore be regarded as an employee within the meaning of the Federated States of Micronesia Income Tax Law.

Heston incurred considerably more personal expense in order to carry out his obligations under the contract than did Rauzi. Still, Heston's expenditures were well below ten percent of the $100,000 he received under the contract. Such expenditures are insufficient to alter the conclusion that it is fair to regard Heston as an employee in this case.

In carrying out the terms of the contract, plaintiff William L. Heston assumed authority over and responsibility for the operations of the Pohnpei State Finance Office for a one year period." During that year he bore the title "Chief of Finance," a position established under Pohnpei State law. He was given the power to remove state employees from that government office and to supervise those who remained. He was in every sense a government official and therefore must be regarded as an employee under the Federated States of Micronesia Income Tax Law. Plaintiff's requests for relief are denied.

1. The tax for "businesses" is a gross revenue tax of $80 for the first $10,000 of revenue per year and three percent on all additional revenue. 54 F.S.M.C. 141. For "employees" the rate is six percent of the first $11,000 and ten percent of any additional wages and salaries. 54 F.S.M.C. 121. (Back to opinion)

2. The contract and other pertinent documents prepared prior to the November 8, 1984 effective date of the Pohnpei Constitution refer to the "Ponape" State Government. To avoid confusion, the state name specified by the Constitution, "Pohnpei," is used throughout this opinion. (Back to opinion)