September 27, 2019
Re: Appeal of Final Local Determination
Taxpayer: *****
Locality: *****
Business, Professional and Occupational License (BPOL) tax
Dear *****:
This final state determination is issued upon the application for correction filed by you on behalf of ***** (the “Taxpayer”), with the Department of Taxation. You seek a reconsideration of Public Document (P.D.) 18-168 (9/26/2018) requesting a refund of Business, Professional and Occupational License (BPOL) taxes paid by the Taxpayer to ***** (the “City”) for the 2011 through 2013 tax years.
The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL tax assessment is deemed prima facie correct, i.e., the local assessment will stand unless the taxpayer proves that it is incorrect.
The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site.
FACTS
Because the City’s final determination in response to P.D. 18-168 failed to clearly indicate that its computations were made in accordance with P.D. 17-93 (6/9/2017), the Department remanded the case back to the City in order for it to reconsider its calculations. The City determined the Taxpayer’s out-of-state deduction by multiplying the direct labor percentage by the total gross receipts in states in which a customer was located. It sitused these gross receipts to the City. The City then multiplied the gross receipts sitused to the other states by the direct labor percentage to calculate the out-of-state deduction. The Taxpayer appeals, contending that it was entitled to claim a deduction for all gross receipts attributable to a business that was sitused to states in which it filed an income or income-like tax return.
ANALYSIS
Out-of-State Deduction
Virginia Code § 58.1-3732 B 2 provides a deduction from gross receipts otherwise taxable for any receipts “attributable to business conducted in another state or foreign country in which the taxpayer . . . is liable for an income or other tax based upon income.” Title 23 of the Virginia Administrative Code (VAC) 10-500-80 A 2 further explains that a taxpayer must be liable for an income or an income-like tax in the other state and file a return in that state to take advantage of the deduction.
Pursuant to P.D. 13-170 (9/13/2013), a taxpayer that has a definite place of business in Virginia and does business in other states in which it is liable for an income or income like tax, and files a return in those states, and situses its gross receipts using direct labor is allowed to claim the out-of-state deduction for the receipts derived from customers located in those states.
The City’s methodology for calculating the out-of-state deduction is incorrect. Multiplying the gross receipts sitused out-of-state by the direct labor fraction merely gives a reasonable estimate of the deduction. This method is acceptable when using payroll apportionment because it is impossible or impractical to determine which definite place of business gross receipts would be attributed under the general rule. See Virginia Code § 58.1-3703.1 A 3 b. In this case, both the City and the Taxpayer agreed that gross receipts could be sitused between definite places of business under the general statutory method in Virginia Code § 58.1-3703.1 A 3 a (4) by a direct labor method.
When direct labor is applied, specifically identified receipts tied to individual transactions or contracts are sitused to a definite place of business based on the amount of time the services are performed. Under such circumstances, all gross receipts attributable to business conducted (i.e., performing a contract) for a customer located outside Virginia may be eligible for the out-of-state deduction if the business was subject to an income or income-like tax in that state and filed a return in such state. See P.D. 01-5 (1/4/2001), P.D. 05-1 (1/18/2005), and P.D. 05-53 (4/8/2005).
The City used amounts provided by the Taxpayer to situs gross receipts to the definite place of business located within the locality. Its computation, however, goes on to apply the same direct labor percentage to the sitused gross receipts to determine the amount eligible for the out-of-state deduction.
Using a percentage to estimate an out-of-state deduction is inconsistent with gross receipts that have been sitused under the general method. If receipts can be specifically identified for purposes of situsing, they must be specifically identifiable for the out-of-state deduction.
In cases where gross receipts are identifiable to individual contracts, the business would also have the responsibility to situs such receipts to the specific location where business was conducted for the customer. When a customer has multiple locations, the price of the contract may have to be separated based on which of the customer’s locations the business provided services. Thus, under a direct labor method, the location of the customer for which the services were performed, not the customer’s billing address, is used to determine whether receipts are eligible for the out-of-state deduction.
The Taxpayer’s method of calculating the out-of-state deduction is also incorrect. For contracts performed for customers in other states, either partially or fully served by its Virginia office, the Taxpayer attributed no gross receipts to the City. Essentially the Taxpayer claimed the out-of-deduction before situsing the gross receipts. Gross receipts must first be sitused before the out-of-state deduction can be claimed. See P.D. 09-146 (10/8/2009).
In order to determine the out-of-state deduction pursuant to Virginia Code § 58.1-3732 B 2 when gross receipts are sitused using direct labor, receipts must first be assigned or sitused to a definite place of business. Then, from those assigned receipts to a definite place of business within a Virginia locality, a business may deduct receipts attributable to business conducted in another state in which it filed an income tax return and income tax was paid. For services, gross receipts, otherwise eligible, must be attributable to business conducted at or on behalf of a customer’s facility located in another state or foreign country.
Example
Business A, a multistate service provider, generates $1,000,000 from each of five projects for customers in Virginia, State A, State B, State C and State D. Employees at its Virginia definite place of business conduct a portion of the projects for each customer. They perform 70% on behalf its customer in Virginia, 12% for State A customer, 20% for State B customer, 5% for State C customer and 10% for State D customer. The Virginia customer has facilities both within and without Virginia. 10% of the time Business A’s employees spent on the Virginia customer’s project benefited Virginia’s facility in State C.
Business A files an income tax return in every state where their customers are located except for State A. The project for State D customer was performed for both in its State D office and its facility in Virginia. Half of the time Business A’s employees spent on the State D project was conducted for State D’s Virginia facility. Business A situses its gross receipts using the direct labor method. The calculation of the out-of-state deduction would be as follows:
|
Project Location |
Gross Receipts Per Project |
Direct labor % - VA |
Gross Receipts sitused to Virginia |
Contract % at VA Facility |
Gross Receipts Eligible for Deduction |
Taxable Gross Receipts |
|
Virginia |
$1,000,000 |
70% |
$700,000 |
10% |
$70,000 |
|
|
State A |
$1,000,000 |
12% |
$120,000 |
|
$0 |
|
|
State B |
$1,000,000 |
20% |
$200,000 |
|
$200,000 |
|
|
State C |
$1,000,000 |
5% |
$50,000 |
|
$50,000 |
|
|
State D |
$1,000,000 |
10% |
$100,000 |
50% |
$50,000 |
|
|
Total |
|
|
$1,170,000 |
|
$370,000 |
$800,000 |
Business A would be eligible for an out-of-state deduction for a portion of the gross receipts sitused to Virginia, even though the contract was performed for a Virginia customer, because a portion of the project was performed at a State C facility. Likewise, because a portion of the State D’s project was performed for its Virginia facility, only a portion of the gross receipts would be eligible for the out-of-state deduction. No gross receipts for business conducted in State A would be eligible for the out-of-state deduction because Business A did not file an income or income like tax return in that state.
DETERMINATION
In light of the analysis above, I am remanding this case back to the City in order for it to recalculate the Taxpayer’s out-of-state deduction for the 2011 through 2013 tax years in accordance with this determination. The City must then issue another final local determination letter reflecting its calculations. If the Taxpayer disagrees with the City’s determination, it may appeal to the Department pursuant to Virginia Code § 58.1-3703.1.
If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/2025.B