Tax Type
Corporation Income Tax
Description
Virginia Nexus
Topic
Collection of Delinquent Tax
Corporate Distributions and Adjustments
Date Issued
11-24-2004
November 24, 2004
Re: § 58.1-1821 Application: Corporate Income Tax
Dear **********:
This will reply to the letter in which you seek correction of the corporation income tax assessment issued to ***** (the "Taxpayer") and affiliates for the taxable year ended December 31, 1993. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is incorporated and located in ***** ("State A"). It is subject to Virginia corporate income tax and files a separate return for Virginia income tax purposes. The Taxpayer wholly owns ***** ("Corporation A"), which, in turn, wholly owned ***** ***** ("Corporation B") during the taxable year at issue.
In 1993, Corporation A issued a loan to Corporation B, which paid interest on the loan to Corporation A. As a result of an audit by the Department, the auditor consolidated the taxable income of the Taxpayer and Corporation A, and assessed additional tax and interest. The auditor's position is that the Corporation A lacked economic substance because it had no employees or tangible assets, and consequently, the interest paid by Corporation B would flow through to the Taxpayer.
The Taxpayer appeals the assessment and argues that the auditor's assumption that the interest paid by Corporation B would flow through to the Taxpayer if Corporation A did not exist is incorrect. The Taxpayer also relies on the fact that neither Corporation A nor Corporation B had nexus with Virginia.
The Department sent an information request to the Taxpayer in order to gather sufficient documentation to address the Taxpayer's appeal. The Taxpayer has not responded to the Department's request.
DETERMINATION
Consolidation of the Taxpayer and Corporation A
Although Virginia utilizes federal taxable income as the starting point in computing Virginia taxable income and generally respects the corporate structure of taxpayers, Va. Code § 58.1-446 provides, in pertinent part:
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- When any corporation liable to taxation under this chapter by agreement or otherwise conducts the business of such corporation in such manner as either directly or indirectly to benefit the members or stockholders of the corporation .... by either buying or selling its products or the goods or commodities in which it deals at more or less than a fair price which might be obtained therefor, or when such a corporation . . . acquires and disposes of the products, goods or commodities of another corporation in such manner as to create a loss or improper taxable income, and such other corporation . . . is controlled by the corporation liable to taxation under this chapter, the Department . . . may for the purpose determine the amount which shall be deemed to be the Virginia taxable income of the business of such corporation for the taxable year.
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- In case it appears to the Department that any arrangements exist in such a manner as improperly to reflect the business done or the Virginia taxable income earned from business done in this Commonwealth, the Department may, in such manner as it may determine, equitably adjust the tax. [Emphasis added.]
The Virginia Supreme Court's opinion in Commonwealth v. General Electric Company, 236 Va. 54 (1988), upheld the Department's authority to adjust equitably the tax of a corporation pursuant to Va. Code § 58.1-446 (or its predecessor) where two commonly-owned corporations structure an arrangement in such a manner as to improperly, inaccurately, or incorrectly reflect the business done in Virginia or the Virginia taxable income. Generally, the Department will exercise its authority if it finds that a transaction, or a party to a transaction, lacks economic substance or transactions between the parties are not at arm's length.
Title 23 of the Virginia Administrative Code (VAC) 10-120-361 sets forth the factors considered by the Department in deciding whether transactions create an improper reflection of Virginia taxable income. The regulation also lists examples of transactions deemed not to cause a distortion of the participants' income from business done in Virginia. The "safe harbor" transaction relating to intercompany loans under Title 23 VAC 10-120-361(E) is as follows:
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- 3. Lending Transactions. In an intragroup lending transaction, the lending party must be a discrete, separate business enterprise with its own employees, office space, and books and records. Funds must be loaned at a fair market value interest rate, with collateral, payments, and credit standing substantially similar to those which the borrower could obtain from an unrelated lending institution.
According to Title 23 VAC 10-120-360, the term "arm's length" means "a charge for goods or services such that the price structure of intragroup transactions is substantially equivalent to the price structure of transactions between unrelated taxpayers, each acting in its own best interest." In accordance with this definition, the Department will look beyond the "fair market" price of the transaction and into the structure and nature of a transaction in comparison with transactions between unrelated parties in determining if an improper reflection of Virginia taxable income has occurred. Also, the Department will appraise the economic substance of the entity receiving the income in considering whether each party is acting in its own best interest.
You contend that Corporation A exists, that it loaned money to Corporation B under an arm's length arrangement and appropriately charged interest. The Taxpayer provided no evidence at the time of its appeal to support its assertion that the Department's adjustments were invalid.
The Department has the authority to investigate any books and records of a taxpayer in order to ascertain the proper tax liability. See Va. Code § 58.1-219. Further, Va. Code § 58.1-205 1 provides that in any proceeding relating to the interpretation of the tax laws of Virginia, any assessment of a tax by the Department is deemed prima facie correct. As such, the burden of proof is on the Taxpayer to show that the transactions with Corporation A did not improperly reflect the Virginia taxable income of the Taxpayer. The Department requested that the Taxpayer provide information to substantiate the loan arrangement between Corporation A and Corporation B. Inasmuch as the Taxpayer has not provided the requested information, the auditor's adjustment consolidating the income of Corporation A with the Taxpayer is upheld.
A copy of the Department's information request is enclosed. I will allow the Taxpayer one final opportunity to furnish the information necessary to support its position. Please complete the information request and return it to: Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attention: *****. If complete documentation is not provided within 30 days from the date of this letter, I will have no choice but to uphold the Department's assessment of tax and interest issued to the Taxpayer for the taxable year ended December 31, 1993, as shown on the enclosed schedule.
If the Taxpayer cannot produce the requested documentation, it should remit its payment for the total outstanding balance within 30 days from the date of this letter to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attention: *****. Failure to remit full payment within the 30 day period may result in the imposition of additional interest and an additional 20% penalty on the tax due under the terms of Virginia's recent Amnesty. See the enclosure entitled "Important Payment Information." If you have any questions concerning payment of the assessment, you may contact ***** at *****.
The Code of Virginia sections and regulations cited, and 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 questions regarding this determination, you may contact ***** at *****.
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- Sincerely,
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Kenneth W. Thorson- Tax Commissioner
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AR/13830B
Rulings of the Tax Commissioner