Tax Type
Corporation Income Tax
Description
Nexus; Distortion of Virginia income
Topic
Appropriateness of Audit Methodology
Assessment
Computation of Tax
Date Issued
08-31-2004
August 31, 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 assessments issued to ***** (the "Taxpayer") for taxable years ended July 31, 1994 through 1996. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer, a technology services company based in ******* ("State A"), was audited for the taxable years at issue. ***** ("Corporation A"), a wholly owned subsidiary of the Taxpayer, was a mail order supply company that also had its office in State A. The Taxpayer filed a separate Virginia corporate income tax return. Corporation A did not file a Virginia corporate income tax return.
During the audit, the Department inquired about a large intercompany receivable reported by Corporation A. The Taxpayer failed to respond to two letters sent by the Department's auditors requesting additional information regarding the substance of Corporation A and the intercompany transactions between the Taxpayer and Corporation A. Because no response was received, the auditors used the information available and consolidated the taxable income of the Taxpayer and Corporation A. As a result, the Taxpayer was assessed additional tax and interest.
The Taxpayer contested the consolidation with Corporation A on the basis that: (1) Corporation A lacked nexus with Virginia; (2) Corporation A should not have been consolidated under Va. Code § 58.1-446 or Internal Revenue Code § 482; and (3) Corporation A and the Taxpayer do not have an agency relationship with each other.
DETERMINATION
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 therefore, 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 reflect improperly, inaccurately, or incorrectly 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 Taxpayer contends that Corporation A lacked nexus with Virginia and that consolidating the Taxpayer with Corporation A subjects Corporation A to Virginia income tax. Further, the Taxpayer argues that it cannot be consolidated with Corporation A because it lacks an agency relationship with Corporation A.
Absent the creation of the arrangement, Corporation A's income could have been included in the Taxpayer's taxable income apportioned and taxed in Virginia. The federal tax laws affecting corporate transfers and consolidated returns allow this action to be taken without adverse federal tax consequences, even where the transactions are not performed at arm's length. Under these circumstances, Va. Code § 58.1-446 authorizes the Department to deem income of an affiliate to be Virginia income even if the affiliate does not have nexus.
The Taxpayer also contends that the intercompany transactions between the Taxpayer and Corporation A do not distort Virginia income under Va. Code § 58.1-446 or Internal Revenue Code § 482. At the time of the audit, the auditors made two separate written requests to the Taxpayer to provide information to substantiate interactions between the Taxpayer's and Corporation A's Virginia and federal income tax returns. The Department also mailed an information request subsequent to the Taxpayer's appeal. The Taxpayer has refused to provide the requested information or any documentation to substantiate its claim.
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 provides that in any proceeding relating to the interpretation of the tax laws of Virginia, an "assessment of a tax by the Department shall be 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. Because the Taxpayer has not provided the requested information, the auditors' adjustments to consolidate the income of Corporation A with the Taxpayer are upheld.
Accordingly, I uphold the Department's assessment of tax and interest issued to the Taxpayer for the taxable years ended July 31, 1994, 1995 and 1996. The Taxpayer should remit its payment for the outstanding tax and updated interest as shown on the enclosed schedule to: Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 1880, Richmond, Virginia 23218-1880, Attention: *****. Payment should be made within 30 days from the date of this letter to avoid the accrual of additional interest and the imposition of a 20% Amnesty penalty. See the enclosure entitled "Important Payment Information."
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
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- Tax Commissioner
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- Kenneth W. Thorson
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AR/21156B
Rulings of the Tax Commissioner