Tax Type
Corporation Income Tax
Description
Correction of Assessment
Topic
Collection of Tax
Date Issued
05-06-1999
May 6, 1999
Re: § 58.1-1821 Application: Corporate Income Tax
Dear****
This will reply to your letter in which you request a correction of an assessment of corporate income tax against ***** (the "Taxpayer') for the taxable years ended December 31, 1992 and 1993. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer's operations consist of leasing real estate and tangible personal property. The lease terms normally range from 20 to 40 years. Leases are funded primarily through nonrecourse financing obtained from various sources. Four of the Taxpayer's leases are leveraged leases. The Taxpayer provides no management services in regard to each lease.
The Taxpayer's only property located in Virginia is an office building. The Taxpayer currently leases this building under a 30 year leveraged lease agreement. The lease commenced in 1978 and the tenant has an option to purchase the building at the end of the fifteenth year and every five years thereafter. The Taxpayer does not provide any management services for the Virginia property.
On its original returns, for the taxable years ended December 31, 1992 and 1993, the Taxpayer had separately stated its income and/or loss from property located in Virginia and allocated all other income out of Virginia. On audit, the department adjusted the Taxpayer's returns to reflect the statutory method of allocation and apportionment pursuant to Code of Virginia § 58.1-406.
The Taxpayer has contested this adjustment and requested that to be allowed to use an alternative method of allocation pursuant to Code of Virginia § 58.1-421. Specifically, the Taxpayer would like to be allowed to separately report the income generated from the leasing of Virginia real property to Virginia and allocate all other rental income to the states where the property is located.
DETERMINATION
Alternative Method
The Code of Virginia does not provide for the allocation of income other than certain dividends. Accordingly, a taxpayer's entire federal taxable income, adjusted and modified as provided in Code of Virginia Secs.58.1-402 and 403, less dividends allocable to Code of Virginia § 58.1-407 is subject to apportionment. The policies which apply to requests for an alternative method of allocation and apportionment under Code of Virginia § 58.1-421 are well established. See Title 23 of the Virginia Administrative Code (VAC) 10-120-280, copy enclosed.
The Taxpayer contends that the property is so highly leveraged that the cost of the asset has less to do with the yield on the lease than prevailing interest rates. Thus, the statutorily required method of allocation and apportionment will operate to subject the Taxpayer to taxation on a greater portion of its Virginia taxable income than is reasonably attributable to its business within Virginia.
However, your claim that taxable income would be greater under the statutory method than under separate accounting does not justify permission to use an alternative method. See Department of Taxation v. Lucky Stores, Inc.. 117 Va. 121 (1976). The department's long standing policy is that the statutory method provides the most equitable means of determining a multistate corporation's income subject to taxation by Virginia. The department will only grant permission to use an alterative method of allocation and apportionment when a taxpayer can show, by clear and cogent evidence, that application of the statutory three factor formula provides an unconstitutional or inequitable result.
In this case, the department finds that application of the statutory three factor formula is "rationally related' to the Taxpayer's activities in Virginia. The mere fact that a Taxpayer's income is derived from a Virginia leveraged lease transaction does not render that finding invalid.
Pre-1981 Virginia Law
The Taxpayer contends that it should be allowed to allocate the lease income because the lease income was allocated under pre-1981 Virginia law. Prior to 1981, rental income was allocable to the state in which the property was located. The leveraged lease was transferred to the Taxpayer in 1989, but has been in effect since 1978.
As a result of the Virginia Supreme Court decision in Commonwealth v. Champion Int. Corp., 220 Va. 981 (1980), the 1981 General Assembly eliminated the distinction between business and nonbusiness income. As such all of a corporations income is subject to the statutory method of allocation and apportionment pursuant to Code of Virginia § 58.1-406.
Non Business Income
In addition, the Taxpayer argues that its ownership in the Virginia property is a nonunitary passive investment. In this particular matter, the Taxpayer must bear the heavy burden of demonstrating the imposition of Virginia's statute is a violation of the standards enunciated by the United States Supreme Court in Allied-Signal Inc. v. Director Division of Taxation, 112 S.Ct 2251 (1992). In Allied-Signal, the Court stated:
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- The existence of a unitary relation between payee and payor is one justification for apportionment, but not the only one. Hence, for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms a part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank.
- The existence of a unitary relation between payee and payor is one justification for apportionment, but not the only one. Hence, for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms a part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank.
The Taxpayer contends that there was no unitary relationship because it had no control or involvement in the operational activities of its lessees. However, the relationship between the Taxpayer and the lessee does not decide a unitary relationship. The determinative question is whether the Supreme Court's three factor test applies to the Taxpayer's control and involvement in its leases.
The business of the Taxpayer is the leasing of real estate and tangible personal property. The real estate at issue is owned and controlled by the Taxpayer and held in its inventory of property it is leasing. While the day to day operations may be handled by separate management, the Taxpayer ultimately controls the leasing operations of its real estate and tangible personal property. Thus, the department finds that the property in Virginia is a unitary part of the Taxpayer's business.
The next question is whether the leveraged leases serve an operational rather than a passive investment function. The Taxpayer's primary business activity is leasing real and tangible personal property. Clearly, the performance of a businesses' primary business activity is an operational activity, not a passive investment. The mere fact that the Taxpayer does not perform the day to day property management activities does not change the Taxpayer's role as lessor.
The Taxpayer cites Public Document (P.D.) 93-195 and P.D. 95-190 as evidence of the passive nature of its leasing activities. However, these determinations can be distinguished from the instant case. Both P.D. 93-195 and P.D. 95-190 allowed the allocation of income resulting from the capital gains derived from the sale of a minority interest in the stock of other corporations. In each case, the taxpayers clearly had no control of the companies whose stock they sold. In the instant case, the income is generated through the rental of real property fully owned and controlled by the Taxpayer.
Based upon the information provided, permission to use an alternative method of allocation and apportionment of the leveraged lease income is denied. The enclosed schedule shows the amount currently due. Please send your payment to Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218-1880 within 30 days to avoid the accrual of additional interest. If you have any questions about this determination, ***** can be contacted at (804) 367-0167.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/12072B
Rulings of the Tax Commissioner