Tax Type
Corporation Income Tax
Description
Adjustments to the foreign source income subtraction and the property factor
Topic
Accounting Periods and Methods
Appropriateness of Audit Methodology
Date Issued
11-15-2002
November 15, 2002
Re: §58.1-1821 Application: Corporate Income Tax
Dear***********
This will reply to your letter in which you seek correction of the corporate income
tax assessment issued to ********(the "Taxpayer") for the taxable years ended May 31, 1998 and 1999. I apologize for the delay in the department's response.
FACTS
The Taxpayer was audited for taxable years at issue and a number of adjustments were made that resulted in an assessment of additional corporate income tax. The Taxpayer is contesting adjustments to the foreign source income subtraction and the property factor. These issues will be addressed separately below.
DETERMINATION
Foreign Source Income Related Expenses
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 ("IRC") § 861 through § 863. Virginia law requires the use of the federal sourcing rules of IRC § 861 et seq. whether or not a 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. Title 23 of the Virginia Administrative Code ("VAC") 10-120-20 provides: "[The] federal procedure in Treasury Reg. § 1.861-8 is applied to allocate and apportion expenses to income derived from U.S. and foreign sources."
The purpose of Form 1118 is to compute the limitation on the amount of foreign taxes that can be claimed as a credit against federal tax liability. When the procedures of the IRC § 861 et seq. are used to complete Form 1118, the information reported on this form is considered useful and presumed correct and accurate. Such information is an appropriate starting point for computing the foreign source income subtraction allowed on the Taxpayer's Virginia return.
Previous rulings of the department require the subtraction for foreign source income to be reduced by expenses, determined in accordance with IRC § 861 et seq. See Public Document (P.D.) 91-229 (9/30/91). Therefore, in accordance with the Treasury Regulations under IRC § 861, expenses that are not definitely allocable are apportioned ratably among the statutory groupings of gross income and the residual groupings.
In P.D. 91-229, the department ruled that the proper method of computing nonallocable expenses attributable to foreign source income is to multiply total nonallocable expenses by a ratio, the numerator of which is gross Virginia foreign source income and the denominator of which is gross income from without the United States per the Form 1118. Items which qualify for separate subtractions under other provisions of Chapter 3 of Title 58.1 of the Code of Virginia, such as IRC § 78 gross-up, Subpart F income, and dividends from corporations in which the taxpaying corporation owns 50% or more of the voting stock are not subtracted again as foreign source income.
The information that the Taxpayer has provided regarding its related foreign source income expenses has been reviewed and the subtraction has been adjusted in accordance with department policy.
Foreign Source Dividends
Code of Virginia § 58.1-302 includes dividends, other than dividends derived from sources within the United States ("U.S."). Accordingly, dividends earned from without the U.S. are foreign source income for purposes of the subtraction.
A review of the federal return for the taxable year ended May 31, 1998, indicates that the Taxpayer received foreign source dividends from corporations in which it owned 50% or more of the voting stock for the taxable year ended May 31, 1998. These dividends are also eligible for a subtraction pursuant to Code of Virginia § 58.1-402(C)(8).
The department has previously ruled in P.D. 93-152 (7/23/93) that, because such dividends are subject to a separate subtraction, they are not required to be included in the foreign source income subtraction. However, expenses related to these dividends are calculated in the same manner as other foreign source income. See P.D. 94-24 (2/18/94). Accordingly, the foreign dividends received from 50% or more owned corporations net of related expenses will be removed from the foreign source income subtractions and allowed as a separate subtraction.
Property Factor
Code of Virginia § 58.1-409 provides that:
The property factor is a fraction, the numerator of which is the average value of the corporation's real and tangible personal property owned and used or rented and used in the Commonwealth during the taxable year and the denominator of which is the average value of all the corporation's real and tangible personal property owned and used or rented and used during the taxable year and located everywhere, to the extent that such property is used to produce Virginia taxable income and is effectively connected with the conduct of a trade or business within the United States and income therefrom is includable in federal taxable income.
Under 23 VAC 10-120-170(B), property owned by a corporation is generally valued at its basis for federal income tax purposes at the time of acquisition and including any subsequent capital additions and improvements or partial dispositions by reason of sale, exchange, or abandonment.
The denominator reported on the Taxpayer's Virginia returns exceeds the amount of assets reported on the federal return information. The auditor was unable to reconcile the differences and adjusted the property factor based on the Taxpayer's trial balance for its federal return. The Taxpayer contends that the trial balance reflects the book basis rather than the tax basis of its assets. The Taxpayer avers that this adjustment is inaccurate to determine the value of property for purposes of the apportionment factor.
In reviewing the information provided, neither the Taxpayer's reported denominator nor the auditor's denominator reflect the amount reported on the Taxpayer's federal proforma returns from which federal taxable income was reported on the Virginia income tax returns. It appears that the asset amounts reported on Schedule L of the proforma returns most closely reflects the value of the assets used to determine the Taxpayer's federal taxable income reported to Virginia. Accordingly, the denominator of the property factor will be adjusted to reflect the amounts reported on the federal proforma returns.
By letter dated July 1, 2002, the department requested information reconciling the property reported in the numerator for the property factor to the information reported on the profroma returns. No information has been provided. Therefore, no adjustment to the numerator can be made.
The assessments for taxable years ended May 31, 1998 and 1999 have been adjusted according to the enclosed schedules. Please remit payment of the amount due to the Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 1880, Richmond, Virginia 23218-1880, Attention: Payment must be made within 30 days from the date of this letter to avoid the accrual of additional interest.
The Code sections, regulations, and public documents cited are available online
in the Tax Policy Library section of the department's web site, located at www.tax.state.va.us. If you have any questions regarding this determination, you may contact *************at***********.
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- Sincerely,
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- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
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AR/39745B
Rulings of the Tax Commissioner