Tax Type
Corporation Income Tax
Description
Domestic and Foreign Corporations
Topic
Taxpayers
Date Issued
06-30-1999
June 30, 1999
Re: Sec. 58.1-1821 Application: Corporate Income Tax
Dear***
This will reply to your letter in which you make an application for the correction of an adjustment to the foreign source income subtraction for ***** (the "Taxpayer') for the taxable years ended December 31, 1991 and 1992. I apologize for the delayed response.
FACTS
The Taxpayer claimed a foreign source income subtraction on its 1991 and 1992 Virginia corporate income tax returns. These returns were audited and a number of adjustments were made. One of the adjustments was to recompute the foreign source income subtraction using amounts reported on the Taxpayer's consolidated federal Form 1118 (Foreign Tax Credit - Corporations) for the 1991 and 1992 taxable years. Because apportioned expenses exceeded the eligible Virginia foreign source income, the subtractions were disallowed.
The Taxpayer contests this adjustment because the consolidated Forms 1118 is inappropriate for computing amounts for a separate entity. Further, the Taxpayer disagrees with the auditor's calculation because it assumes that all expenses related to the income subject to are reported on Schedule F of the Forms 1118. The Taxpayer contends that the denominator used to apportion the remaining expenses should include all sources of foreign source income to which the expenses are apportioned. The Taxpayer has proposed an alternate computation that would more accurately reflect the apportioned expenses related to the foreign source income.
DETERMINATION
It has been the department's long standing policy that the computation of the Virginia subtraction for foreign source income (considering expenses related to the income) be determined in accordance with Internal Revenue Code (I.R.C.) Sec.861 through Sec.863. See Public Document (P.D.) 91-229 (9/30/91), copy enclosed. Virginia law requires the use of the federal sourcing rules of IRC Sec.861 et seq. whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and regardless of what expenses would be under generally accepted accounting principles.
The purpose of Form 1118 is to compute the limitation on the amount of foreign taxes which can be claimed as a credit against federal tax liability. When the procedures of the IRC Sec.861 et seq. are used to complete Form 1118, the information reported on this form is considered useful and presumed correct and accurate. Although expenses related to foreign source income was computed on a consolidated basis, the Taxpayer separately stated income and related expenses for each affiliate on the consolidated Form 1118. Such information is an appropriate starting point for computing the foreign source income subtraction allowed on the Taxpayer's Virginia return.
All of the deductions were reported as not definitely allocable on the Forms 1118. The auditor used the total deductions reported by the Taxpayer on Form 1118 as the starting point for computing the expenses related to Virginia foreign source income.
Expenses that are definitely allocable to a particular type of foreign source income are allocable to such income. Expenses that are not definitely allocable to any class of foreign source income are apportioned among all types of foreign source income. In P.D. 91-229, the department ruled that the proper method of computing nonallocable expenses attributable to foreign source income is to multiply the total nonallocable deductions by a ratio, the numerator of which is the total foreign source gross income eligible for the Virginia subtraction and the denominator of which is total gross income from without the United States ("U.S.').
The Taxpayer claims that the foreign source income reported on Schedule F of Form 1118 pursuant to IRC Sec.863(b) was incorrectly removed from the denominator of the ratio used to determine the amount of not definitely allocable expenses used to offset foreign source income qualifying for the Virginia subtraction. In computing the foreign source income subtraction, the auditor removed foreign source income attributed to the U.S. pursuant to IRC Sec.863(b). However, this domestic portion had already been removed from the gross foreign source income reported for the Taxpayer for the 1991 and 1992 taxable years. As a result, no IRC Sec.863(b) income was included in the computation.
IRC Sec.863(b) prescribes the method for sourcing taxable income when of gross income derived from sources partly within and partly without the United States. Under this method, taxable income is determined by deducting expenses, losses, or other deductions properly apportioned or allocated under the Treasury Regulations to IRC Sec.861 et. seq. After taxable income is determined, it is apportioned between United States and foreign sources by formula.
To correctly apportion the nonallocable expenses, the Taxpayer asserts that the denominator of the ratio should include all sources of foreign income including both foreign and domestic portions of IRC Sec.863(b) income. The department disagrees. P.D. 91-229 states that the denominator is total gross income from without the United States. Further, the Taxpayer has not shown that the portion of the expenses attributable to U.S. source IRC Sec.863(b) income is included in total deductions reported on Form 1118. As such, the denominator should only reflect total gross income from without the U.S.
The audit has been adjusted to include the foreign portion of the IRC Sec.863(b) income in the denominator of the expense apportionment ratio (see attached schedules). However, total not definitely allocable expenses still exceed gross foreign source income. As a result, foreign source income eligible for the Virginia subtraction less related expenses results in an amount less than $0. As such, the Taxpayer is not eligible to receive a foreign source income subtraction for the 1991 and 1992 taxable years.
Accordingly, the audit adjustments for the 1991 and 1992 taxable years are upheld. However, if the Taxpayer can show what amount, if any, of expenses related to U.S. source IRC Sec.863(b) income is included in the amounts reported on the 1991 and 1992 Forms 1118, an adjustment will be made to remove those expenses related to Virginia foreign source income. If such information is not provided within 30 days of this letter, this case will be considered closed. Please send any documentation to ***** at Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218. If you have any questions, please contact ***** at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10555G
Re: Sec. 58.1-1821 Application: Corporate Income Tax
Dear***
This will reply to your letter in which you make an application for the correction of an adjustment to the foreign source income subtraction for ***** (the "Taxpayer') for the taxable years ended December 31, 1991 and 1992. I apologize for the delayed response.
FACTS
The Taxpayer claimed a foreign source income subtraction on its 1991 and 1992 Virginia corporate income tax returns. These returns were audited and a number of adjustments were made. One of the adjustments was to recompute the foreign source income subtraction using amounts reported on the Taxpayer's consolidated federal Form 1118 (Foreign Tax Credit - Corporations) for the 1991 and 1992 taxable years. Because apportioned expenses exceeded the eligible Virginia foreign source income, the subtractions were disallowed.
The Taxpayer contests this adjustment because the consolidated Forms 1118 is inappropriate for computing amounts for a separate entity. Further, the Taxpayer disagrees with the auditor's calculation because it assumes that all expenses related to the income subject to are reported on Schedule F of the Forms 1118. The Taxpayer contends that the denominator used to apportion the remaining expenses should include all sources of foreign source income to which the expenses are apportioned. The Taxpayer has proposed an alternate computation that would more accurately reflect the apportioned expenses related to the foreign source income.
DETERMINATION
It has been the department's long standing policy that the computation of the Virginia subtraction for foreign source income (considering expenses related to the income) be determined in accordance with Internal Revenue Code (I.R.C.) Sec.861 through Sec.863. See Public Document (P.D.) 91-229 (9/30/91), copy enclosed. Virginia law requires the use of the federal sourcing rules of IRC Sec.861 et seq. whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and regardless of what expenses would be under generally accepted accounting principles.
The purpose of Form 1118 is to compute the limitation on the amount of foreign taxes which can be claimed as a credit against federal tax liability. When the procedures of the IRC Sec.861 et seq. are used to complete Form 1118, the information reported on this form is considered useful and presumed correct and accurate. Although expenses related to foreign source income was computed on a consolidated basis, the Taxpayer separately stated income and related expenses for each affiliate on the consolidated Form 1118. Such information is an appropriate starting point for computing the foreign source income subtraction allowed on the Taxpayer's Virginia return.
All of the deductions were reported as not definitely allocable on the Forms 1118. The auditor used the total deductions reported by the Taxpayer on Form 1118 as the starting point for computing the expenses related to Virginia foreign source income.
Expenses that are definitely allocable to a particular type of foreign source income are allocable to such income. Expenses that are not definitely allocable to any class of foreign source income are apportioned among all types of foreign source income. In P.D. 91-229, the department ruled that the proper method of computing nonallocable expenses attributable to foreign source income is to multiply the total nonallocable deductions by a ratio, the numerator of which is the total foreign source gross income eligible for the Virginia subtraction and the denominator of which is total gross income from without the United States ("U.S.').
The Taxpayer claims that the foreign source income reported on Schedule F of Form 1118 pursuant to IRC Sec.863(b) was incorrectly removed from the denominator of the ratio used to determine the amount of not definitely allocable expenses used to offset foreign source income qualifying for the Virginia subtraction. In computing the foreign source income subtraction, the auditor removed foreign source income attributed to the U.S. pursuant to IRC Sec.863(b). However, this domestic portion had already been removed from the gross foreign source income reported for the Taxpayer for the 1991 and 1992 taxable years. As a result, no IRC Sec.863(b) income was included in the computation.
IRC Sec.863(b) prescribes the method for sourcing taxable income when of gross income derived from sources partly within and partly without the United States. Under this method, taxable income is determined by deducting expenses, losses, or other deductions properly apportioned or allocated under the Treasury Regulations to IRC Sec.861 et. seq. After taxable income is determined, it is apportioned between United States and foreign sources by formula.
To correctly apportion the nonallocable expenses, the Taxpayer asserts that the denominator of the ratio should include all sources of foreign income including both foreign and domestic portions of IRC Sec.863(b) income. The department disagrees. P.D. 91-229 states that the denominator is total gross income from without the United States. Further, the Taxpayer has not shown that the portion of the expenses attributable to U.S. source IRC Sec.863(b) income is included in total deductions reported on Form 1118. As such, the denominator should only reflect total gross income from without the U.S.
The audit has been adjusted to include the foreign portion of the IRC Sec.863(b) income in the denominator of the expense apportionment ratio (see attached schedules). However, total not definitely allocable expenses still exceed gross foreign source income. As a result, foreign source income eligible for the Virginia subtraction less related expenses results in an amount less than $0. As such, the Taxpayer is not eligible to receive a foreign source income subtraction for the 1991 and 1992 taxable years.
Accordingly, the audit adjustments for the 1991 and 1992 taxable years are upheld. However, if the Taxpayer can show what amount, if any, of expenses related to U.S. source IRC Sec.863(b) income is included in the amounts reported on the 1991 and 1992 Forms 1118, an adjustment will be made to remove those expenses related to Virginia foreign source income. If such information is not provided within 30 days of this letter, this case will be considered closed. Please send any documentation to ***** at Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218. If you have any questions, please contact ***** at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10555G
Rulings of the Tax Commissioner