Tax Type
Corporation Income Tax
Description
Foreign source income
Topic
Computation of Income
Date Issued
09-30-1991
September 30, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear******************
This will reply to Your letter of April 19, 1991, in which you seek correction of assessments of corporation income taxes for**************** (the "Taxpayer").
FACTS
The taxpayer was audited and numerous adjustments were made, resulting in the assessment of additional tax. You object to four of the adjustments. The issues you raise will be addressed separately.
DETERMINATION
Foreign source income expenses: On its Virginia returns, the taxpayer included in its subtractions amounts representing foreign source income. The auditor recomputed the foreign source income and applied a 5% expense factor to each type of income (rent, royalties and interest). You contend that the auditor's method of applying expenses is inappropriate, and you have supplied backup schedules for federal Form 1118 showing the "actual" expenses related to the foreign source income.
Previous rulings of the department require the Virginia subtraction for foreign source income to be reduced by expenses, determined in accordance with Internal Revenue Code (IRC) §861 et seq. P.D. 86-154 (8/14/86) (copy enclosed). Virginia law requires use of IRC §861 et seq. whether or not the taxpayer believes certain expenses have any connection to income from foreign sources and regardless of what the expenses would be under generally accepted accounting principles. The regulations under §861 et seq. provide that expenses not definitely allocable are to be apportioned ratably among the statutory groupings of gross income and the residual grouping.
A review of your computation of the foreign source income subtraction reveals that it is not totally consistent with IRC §861 et seq. Your computations include only the "definitely allocable" expenses shown on Form 1118. You failed to include a ratable portion of the expenses which are not definitely allocable.
The proper method of computing nonallocable expenses attributable to foreign source income is to multiply the total nonallocable expenses by a ratio, the numerator of which is total Virginia foreign source income and the denominator of which is total income from without the United States per federal Form 1118. Dividends and gross-up income qualify for subtractions under separate provisions of the Code of Virginia; therefore, they are not subtracted again as foreign source income, nor are they included in the numerator of the ratio. However, such income must be included in the denominator of the ratio, to the extent included on Form 1118. Allocable expenses, if any, should be applied to the category of income to which they belong.
The auditor applied a 5% expense factor to foreign source income because expense information was not available at the time of the audit. You have supplied backup information detailing the amount of allocable and nonallocable expenses as shown on federal Form 1118. Expenses relating to foreign source income will be computed in a manner consistent with the principles set forth above, and the audit report will be adjusted accordingly.
Apportionment of capital gains: The taxpayer included in allocable income capital gains from the sale of stock of two corporations. The auditor included the capital gains in apportionable income. You maintain that the gains should be allocated to the state of the taxpayer's commercial domicile, citing the Virginia Supreme Court decision in Corning Glass Works, Inc. v. Virginia Department of Taxation.
The department is currently in litigation involving the unitary business principle. This case may or may not have relevance to your factual situation. You may wish to file a protective claim for refund pursuant to Va. Code §58.1-1824 and request that the department hold it without action pending a final decision in Virginia Department of Taxation v. Corning, Inc., Docket No. 90-1852, in the United States Supreme Court. This procedure will allow the department to investigate and ascertain the pertinent facts and apply the relevant principles, if any, of the final decision to the facts of your protective claim.
Gross receipts in the sales factor: In computing the sales factor, the taxpayer included gross receipts from investments that generated interest income. The auditor removed the gross receipts from the sales factor and included only the interest income.
A review of the audit report indicates that the investment gross receipts were from certificates of deposit and short-term loans; the amounts included in the sales factor were principal amounts from these investments. The department has previously ruled that proceeds from certificates of deposit are not included in the sales factor. P.D. 89-155 (5/11/89) (copy enclosed). Furthermore, the repayment of funds lent to a borrower is not a "gross receipt" for purposes of the sales factor. P.D. 91-212 (9/6/91) (Copy enclosed).
Therefore, the auditor properly excluded the gross receipts, representing principal amounts from certificates of deposits and short-term loans, from the sales factor.
Revised sales factor: You state that after its 1988 Virginia return was filed, the taxpayer discovered an error was made in determining Virginia sales. You have provided a copy of an internal memo outlining the revision to substantiate your claim.
The auditors had no record of a correcting entry; consequently, they failed to include the information in their audit report. The memo indicates that the sales in question were attributed to other states. The department will accept your information showing reduced Virginia sales for 1988 and will recompute the sales factor accordingly.
The audit report will be revised to reflect foreign source income expenses based on the backup information received and the revised 1988 Virginia sales figure per the taxpayer's internal memo. In all other respects, the assessment is correct. The additional tax and interest due from the assessments have been collected from the taxpayer's 1989 overpayment. Therefore, a refund will be issued based on the above adjustments.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner