Tax Type
Corporation Income Tax
Description
Consolidated Virginia corporate income tax return
Topic
Appropriateness of Audit Methodology
Computation of Income
Computation of Tax
Returns and Payments
Date Issued
05-02-2002
May 2, 2002
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you request a refund of corporate income tax and interest paid by ***** (the "Taxpayer") and affiliates as a result of an audit assessment for the taxable years ended December 31, 1997 and 1998. I apologize for the delay in the department's response.
FACTS
The Taxpayer and its affiliates filed a consolidated Virginia corporate income tax return for the 1997 and 1998 taxable years. Under audit, the department removed the Taxpayer from the consolidated return on the basis that it lacked nexus with Virginia.
The Taxpayer contends that it directed its business into Virginia and had sufficient business activities within Virginia to be subject to Virginia income tax. In addition, the Taxpayer asserts that the department failed to include the consolidated LIFO reserve in an affiliate's ("Company A") property factor for 1997 taxable years and did not recognize a revised apportionment factor on the Taxpayer's amended 1998 Virginia corporate income tax return for Company A. Finally, the Taxpayer avers that the department failed to include sales in the apportionment factor of another affiliate ("Company B").
DETERMINATION
Consolidated Return- Excluded Affiliate
Pursuant to Code of Virginia § 58.1-442, an affiliated group of corporations may elect to file a consolidated Virginia income tax return. Title 23 of the Virginia Administrative Code ("VAC") 10-120-322 provides that a corporation cannot be included in a consolidated return if it is exempt from Virginia income tax under Code of Virginia § 58.1-401, exempt from Virginia income tax under Public Law (P.L.) 86-272, not affiliated as defined by § 58.1-302 of the Code of Virginia, not subject to Virginia income tax if separate returns were to be filed, or using different taxable years.
Generally, corporations organized under Virginia law and foreign corporations having income from Virginia sources are subject to Virginia tax. A corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. See Public Document ("P.D.") 92-238 (11/16/92).
In this case, the Taxpayer had reported no property or payroll in the Virginia apportionment factor for the taxable years under audit. The Taxpayer's only source of income with any connection with Virginia are license fees resulting from technology license agreements with two unrelated parties located in Virginia. The department's auditor found that the Taxpayer would not have a positive sales factor under Code of Virginia § 58.1-416, resulting in no positive apportionment factors. Accordingly, the auditor determined that the Taxpayer did not have nexus with Virginia and should not be included in the consolidated return of the affiliated group.
The Taxpayer argues that because it is registered with the State Corporation Commission in Virginia it is required to file a return under 23 VAC 10-120-310, thus making the Taxpayer subject to Virginia income tax. Further, the Taxpayer asserts that according to the department's ruling in P.D. 88-58 (4/5/88) a portion of the license fees should be considered income from Virginia sources. This income would be attributed outside Virginia for the purposes of determining the Virginia sales factor.
Pursuant to 23 VAC 10-120-310, every corporation organized under the laws of Virginia, every corporation having income from Virginia sources, and every foreign corporation registered with the State Corporation Commission for the privilege of doing business in Virginia is required to file a return with the department. A return is required even if a corporation has no income from Virginia sources and no Virginia income tax is due. In P.D. 94-368, (12/12/94), a corporation that was registered to do business in Virginia but had not done so was found not to be subject to tax in Virginia and was, therefore, ineligible to be included in a consolidated Virginia return. As such, a filing requirement does not subject a corporation to the Virginia income tax.
Further, Code of Virginia § 58.1-400 imposes income tax "on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources." Thus, every corporation, whether incorporated in Virginia or elsewhere, having Virginia taxable income is subject to the Virginia income tax. Because the tax is imposed on the income of the corporation and not the corporation itself, a corporation, whether incorporated in Virginia or elsewhere, having no Virginia taxable income will not be subject to the tax. See P.D. 99-34 (3/24/99).
According to the information provided, the Taxpayer has no property or payroll in Virginia. In addition, the apportionment of the sale of other than tangible personal property is based on the "cost of performance" of such sale. See Code of Virginia § 58.1-416. Because the unit of employees that supports the licensing agreements is based at the Taxpayer's headquarters outside Virginia, all the sales are deemed to be outside of Virginia for purposes of determining the Taxpayer's sales factor. Accordingly, the Taxpayer had no positive apportionment factor in Virginia for the 1997 and 1998 taxable years. As a result, the Taxpayer had no income subject to Virginia tax.
In conclusion, although the technology license agreements with the unrelated parties in Virginia resulted in income from Virginia sources, the Taxpayer cannot be included in the consolidated return of the Virginia affiliated group for the years at issue because it would not be subject to Virginia income tax if separate returns were to be filed in accordance with 23 VAC 10-120-322. Accordingly, the auditor properly removed the Taxpayer from the consolidated return for the 1997 and 1998 taxable years.
Property Factor - Inventory
Company A maintained inventory on a first-in first-out basis ("FIFO") for accounting purposes. However, it reports inventory on a last-in last-out ("LIFO") basis for federal income tax purposes. In determining its property factor, Company A reported inventory for both the numerator and the denominator on a FIFO basis.
The auditor reduced inventory in the denominator of the property factor to reflect the LIFO valuation to match the value used in the federal income tax return but was provided no information concerning Virginia inventory under the LIFO method. The Taxpayer contends that the Virginia inventories should be adjusted to reflect LIFO values so that inventories within Virginia and inventories everywhere are on a comparable basis.
Pursuant to 23 VAC 10-120-170(B)(2), the inventories included in the property factor must be valued in accordance with the valuation method used on the federal income tax return. Therefore, the auditor correctly adjusted the denominator to reflect the LIFO inventory valuation. Although the numerator of the property factor should have been adjusted to reflect the LIFO method at the time of the audit, information as to the LIFO value of the inventory was not provided resulting in no adjustment of the inventory in Virginia. The Taxpayer has now provided information showing Company A's LIFO value of inventory in Virginia for the taxable years at issue. The audit has been adjusted accordingly.
Sales Factor
The auditor included the payroll and property factors of Company B in the consolidated apportionment factor, but failed to include Company B's sales in the consolidated apportionment factor for the 1998 taxable year. A review of the audit indicates that the sales were omitted in error. Accordingly, the audit has been adjusted to include Company B's sales in the consolidated sales factor.
Conclusion
The assessments issued to the Taxpayer for the 1997 and 1998 taxable years have been adjusted pursuant to the enclosed schedules. These schedules reflect the property factor changes pursuant to the 1998 amended return. A refund as shown on the enclosed schedule will be issued to the Taxpayer.
Copies of the Code of Virginia, regulations and public documents cited are available online in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
AR/33716B
Rulings of the Tax Commissioner