Tax Type
Corporation Income Tax
Description
Disallowed Deduction and Sales Factor Issues
Topic
Corporate Distributions and Adjustments
Date Issued
10-30-2001
October 30, 2001
RE: § 58.1-1821 Application: Corporate Income Taxation
Dear *****
This will reply to your letter in which you seek correction of the corporate income tax assessments issued to ***** (the "Taxpayer") for the taxable years ended September 30, 1997 through 1999.
FACTS
Under audit, the department disallowed a portion of a deduction for a worthless stock of a wholly-owned subsidiary ("Subsidiary A"). In addition, the auditor removed income that the Taxpayer classified as "other income" from the denominator of its sales factor.
You contend that the Taxpayer's forgiveness of Subsidiary A's debt and payment of its expenses were properly treated as a contribution of capital to Subsidiary A and should be included in the value of the worthless stock. You also contend that the income removed from the denominator of the sales factor resulted from receipts that meet the definition of sales pursuant to Code of Virginia § 58.1-302.
DETERMINATION
Worthless Securities Deduction
The Taxpayer took a federal income tax deduction for worthless stock for the taxable years ended September 30, 1998 and 1999. The worthless stock deduction occurred when Subsidiary A became insolvent.
The computation of Virginia taxable income for a separate return begins with federal taxable income. Therefore, Virginia relies on the amount and character of each item reported on the federal return and supporting schedules. In this case, the auditor questioned the character of the portion of the worthless stock deduction reported as a capitalized intercompany account for the taxable year ended September 30, 1998, and capital contributions made during the taxable year ended September 30, 1999. The auditor reasoned that Internal Revenue Code ("IRC") § 165 would not permit the stepped-up basis in the value of the worthless stock resulting from these adjustments.
IRC § 165(g) provides that a security that becomes worthless will be treated as a sale or exchange of a capital asset on the last day of the taxable year unless the security is held by an affiliated taxpayer that is a domestic corporation. Under Treasury Regulation § 1.165-5(d), a taxpayer that owns a worthless security in a subsidiary is allowed an ordinary loss for purposes of the worthless securities deduction.
A shareholder who forgives a debt owed by the corporation is considered to have made a contribution to capital. See Noll's Food Co. v. Commissioner, 23 TCM 456 (1964) and Lidgerwood Manufacturing Company v. Commissioner, 22 TC 1152 (1954), copies enclosed. In addition, the payment of the expenses and liabilities of a subsidiary by a parent after the subsidiary ceases operations is treated as a capital contribution. See Revenue Ruling 67-411, 67-2 CB 124, copy enclosed.
According to the Taxpayer, the capitalized intercompany account was an intercompany loan treated as a contribution to capital pursuant to federal case law, and capital contributions resulted from payments by the Taxpayer for expenses and liabilities of the dissolved subsidiary. As there is no question as to the amount of the deductions, and additional capital contributions as characterized by the Taxpayer are permitted for federal income tax purposes, the worthless stock deductions as originally reported will be allowed.
Other Income in Sales Factor
In addition, for the taxable years at issue, the department's auditor removed items reported as "other income" on the federal return from the denominator of the sales factor. The Taxpayer contends that these items belong in the sales factor.
Code of Virginia § 58.1-302 defines the term "sales" as the gross receipts of the corporation from all sources (except dividends, which are allocated), whether or not such gross receipts are generally considered sales. The sales factor includes all gross receipts included in Virginia taxable income and connected with the conduct of the taxpayer's trade or business within the United States. The department has previously ruled that receipts of an unknown or unspecified nature may not be included in the denominator of the sales factor. See P.D. 92-45 (4/27/92), copy enclosed.
The Taxpayer has provided evidence that the "other income" was derived from advertising, production and media services. This income constitutes receipts within the meaning of Title 23 VAC 10-120-210. Accordingly, these items will be included in the sales factor for the taxable years ended September 30, 1997 through 1999.
The assessments for the taxable years ended September 30, 1997 through 1999 have been adjusted pursuant to the enclosed schedules. Please remit payment of the amounts due to at the Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 1880, Richmond, Virginia 23218-1880. If you have any questions regarding this determination, you may contact ***** at *****.
Sincerely
Danny M. Payne
Tax Commissioner
AR/34843B
Rulings of the Tax Commissioner