03-78 | Virginia Tax

Tax Type

Corporation Income Tax

Description

Sale of Contracts, Interest and Royalties

Topic

Computation of Tax

Taxpayers' Remedies

Date Issued

11-03-2003

November 3, 2003

Re: § 58.1-1821 Application: Corporation Income Tax

Dear **********************:

This will reply to your letter in which you seek correction of the corporation income tax assessment issued to************ (the "Taxpayer') for the taxable year ended December 31, 1993.

FACTS

The Taxpayer has its corporate headquarters in Virginia. In February 1993, the Taxpayer sold a manufacturing division located outside Virginia to an unrelated third party located in another state ("State A"). The sale included intangible assets in the form of manufacturing contracts. For income apportionment purposes, the Taxpayer included the proceeds from the sale of the contracts in the denominator of its sales factor only. In addition, the Taxpayer attributed certain interest and royalty income outside Virginia in its sales factor for the 1993 taxable year.

Under audit, the Department included the proceeds from the sale of the contracts, interest, and royalty income in the numerator of the Virginia sales factor and assessed additional tax and interest. The Taxpayer contends that the income-producing activity with regard to these items occurred outside Virginia and, therefore, should not be included in the numerator of the Taxpayer's sales factor.

DETERMINATION

Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are in the Commonwealth if:

1. The income-producing activity is performed in the Commonwealth; or

2. The income-producing activity is performed both in and outside the Commonwealth and a greater proportion of the income-producing activity is performed in the Commonwealth than in any other state, based on costs of performance.

Pursuant to Title 23 of the Virginia Administrative Code ("VAC") 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. "Income producing activity" is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned.

As a general rule, receipts resulting from intangible personal property, such as gains, interest, and royalties, are attributed to the state where a corporation is commercially domiciled. This rule is based on the assumption that the greater portion of the costs directly performed by a corporation, including administration and protection of the asset, investment analysis and decisions, accounting and record keeping, and tax compliance are usually performed at the corporation's headquarters.

Sale of Contracts

In this case, the Taxpayer asserts that the greater proportion of the costs directly associated with the sale of the manufacturing division, including the manufacturing contracts, were incurred outside Virginia. The Taxpayer has submitted evidence concerning costs directly incurred in selling the manufacturing division. The evidence demonstrates that the majority of the negotiation process occurred in State A and that the data for the sale was gathered in the division's facilities in another state ("State B"). The due diligence process for the sale was coordinated by employees located in State B. Presentations on the progress of the negotiations were given to the Taxpayer's Board of Directors in Virginia.

An unrelated law firm and investment bank conducted a fairness opinion on the sale. The fairness opinion was reviewed by the Taxpayer's legal, tax, benefits and treasury employees in both Virginia and State B. The final sign-off on the sales agreement was given by Virginia employees.

The sale closed in March 1993 in State A. All documents, including the master sales agreement, were executed in State A. The determination of the final balance sheet, working capital adjustment, determination of the gain, and all other final accounting functions were completed in State B.

Although the Taxpayer's employees in Virginia provided certain approval and oversight for the sale, the evidence indicates that the greater portion of the costs of the activities performed by the Taxpayer for the purpose of producing the sale was incurred outside Virginia. As such, pursuant to Va. Code § 58.1-416, the sale of the manufacturing division, including the manufacturing contracts, is not attributable to Virginia. Accordingly, proceeds from the sale of the contracts will be removed from the numerator of the sales factor.

Interest

With regard to the interest income, the Taxpayer contends several divisions outside Virginia generated the interest income. The Taxpayer has provided a schedule from its federal return showing this income is attributed to different divisions located in other states; however, the Taxpayer has not provided sufficient evidence to show that the greater portion of costs directly performed by the Taxpayer in producing this interest income occurred away from its commercial domicile in Virginia. Accordingly, the interest income was properly included in the numerator of the sales factor by the auditor.

Royalties

The Taxpayer contends that the royalty income was derived from patents associated with the division that was sold during 1993 and, therefore, was received outside Virginia. The Taxpayer has provided a schedule from its federal return that shows that this income is attributed to State B. The Taxpayer, however, has not provided sufficient evidence to show that the greater portion of costs directly performed by the Taxpayer in the licensing of patents was conducted away from its commercial domicile in Virginia. Therefore, the royalty income was properly included in the numerator of the sales factor by the auditor.

CONCLUSION

The assessment has been adjusted pursuant to the enclosed schedule. A refund will be issued shortly. Copies of the Code of Virginia and the regulation cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department's web site located at www.tax.state.va.us. If you have any further questions, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/45121B

Rulings of the Tax Commissioner