Document Number
05-30
Tax Type
Corporation Income Tax
Description
Retroactive permission to change filing methods
Topic
Accounting Periods and Methods
Date Issued
03-10-2005

March 10, 2005


Re: § 58.1-1821 Application: Corporate Income Tax


Dear *****:

This will respond to your letter in which you seek correction of the corporate income tax assessments issued to ***** (collectively, the "Taxpayers") for the taxable years ended March 30, 1992 and 1993. I apologize for the delay in responding to your letter.

FACTS

The Taxpayers are members of an affiliated group that filed a consolidated federal return for the years at issue. Prior to the 1990 taxable year, the Taxpayers filed Virginia corporation income tax returns on a separate company basis. Subsequently, the Taxpayers began filing a consolidated Virginia income tax return that included other affiliated corporations. Several of these affiliated corporations did not have nexus with Virginia.

For the 1991 and 1992 taxable years, the Taxpayers continued to file as part of a consolidated Virginia corporate income tax return that included several other members of the federal affiliated group. The Department's auditor disallowed the return on the grounds that permission to file a consolidated return had not been granted. Consequently, the auditor computed the Virginia corporate income tax liability of the Taxpayers on a separate company basis, resulting in assessments of additional tax.


You request that the Department grant permission for the Taxpayers to file Virginia corporate income tax returns on a consolidated basis. If the Department denies this request, you ask that the Department consolidate the Taxpayers, pursuant to Va. Code § 58.1-445, with the other members that joined the 1990 consolidated return. In the alternative, the Taxpayers assert the interest incurred by their common parent (the "Parent") should be allocated to the Taxpayers in accordance with Va. Code § 58.1-446.

DETERMINATION


Permission to file a Consolidated Return

The Department previously addressed this issue with regard to the Taxpayers in Public Document ("P.D.") 96-365 (12/09/96). Virginia Code § 58.1-442 allows corporations to elect to file returns as separate, combined or consolidated entities regardless of how the corporations file their federal income tax returns. Title 23 of the Virginia Administrative Code ("VAC") 10-120-320 provides that in the first year two or more members of an affiliated group of corporations are required to file Virginia returns, the group may elect to file separate returns, a combined return or a consolidated return. All returns for subsequent years must be filed on the same basis unless permission to change is granted by the Department.

In the instant case, two members of the affiliated group filed separate Virginia corporate income tax returns prior to the 1990 taxable year. A third affiliate, incorporated in 1989, also filed a separate Virginia return for the 1989 taxable year. Because permission to file a consolidated return was neither requested nor granted, the election to file separate returns was still in effect for the 1991 and 1992 taxable years. The auditor, therefore, properly disallowed the consolidated return and computed the Virginia tax liability of the Taxpayers on a separate company basis.

If the Department were to grant the Taxpayers' request to accept the consolidated return as filed, such action would effectively grant retroactive permission to change filing methods. Generally, the Department will not grant permission to change to or from the consolidated filing method, because such a change would affect the allocation and apportionment factors and possibly distort the reporting of the business done in Virginia.

You contend that reporting on a separate company basis distorts Virginia income because it does not allow for the allocation of expenses associated with the performance of services on behalf of the Taxpayers by the Parent. This result is not because of the Taxpayers' election to file separate returns; rather, it is because of the inability of the controlled group to allocate those expenses in the manner permitted under the Internal Revenue Code.

You further state that because the affiliated group engages in a unitary business, it would have immense difficulty allocating expenses among related corporations. This difficulty does not, however, constitute an extraordinary circumstance sufficient to warrant granting permission to change to filing on a consolidated basis. Accordingly, permission to file a consolidated return is denied.


Consolidation of Accounts

In the alternative, you request that the Department consolidate the accounts of the Taxpayers with the Parent and other members of the federal consolidated group pursuant to Va. Code § 58.1-445. The purpose of Va. Code § 58.1-445 is to assure that items of income, gain, profit, deduction and capital are properly distributed or apportioned among taxpayers who may be taxable at different rates, by different methods, or by different states. Title 23 VAC 10-120-350 provides that consolidation is appropriate in situations in which federal taxable income is accurately stated, but the income from Virginia sources taxable by Virginia is inaccurately stated.

The regulation also permits a taxpayer to request permission to consolidate accounts of related trades or businesses. The process requires the taxpayer to file returns using their elected method and then file an amended return using the proposed consolidation. The taxpayer must attach an explanation of the nature and cause of the distortion of income from Virginia sources and an explanation of why the consolidation of accounts is necessary. If the Department finds that the consolidation of accounts is necessary, the tax is adjusted accordingly.

In this case, the Department finds that it would be inappropriate to use the provisions of Va. Code § 58.1-445. The Taxpayers failed to follow the procedures prescribed in the regulation. In addition, the federal taxable income of each of the Taxpayers is accurately stated, and there is no inaccurate reflection of the income from Virginia sources taxable by Virginia.

The Taxpayers argue that, because they are part of an affiliated group engaged in a unitary business that inherently makes allocation of shared expenses difficult, the Department is obliged to accept the consolidated return as filed. A review of the consolidated return filed and the auditor's work papers reveals that several members of the affiliated group had insufficient business activity within Virginia to render any of the apportionment factors positive. Virginia Code § 58.1-445 is limited to businesses that are owned or controlled directly or indirectly by the same interests and are subject to Virginia income tax. As such, a consolidated return under this statute could not include the members of the affiliated group that had insufficient business activity within Virginia to generate a positive apportionment factor.

Furthermore, you offer no evidence to show that the consolidation of the Taxpayers is necessary to reflect Virginia taxable income accurately, other than their unitary relationship to entities that are not subject to Virginia income tax. Consolidating the accounts as requested would circumvent the Department's long-standing policy regarding the corporate filing status election and the circumstances in which permission to change status is allowed. Accordingly, your request must be denied.


Allocation of Interest Expense

As part of its operations, the Parent provides administration, oversight, and almost all of the financing for its subsidiaries. Because of this arrangement, the Parent has a large interest deduction, but little income to offset the deduction. The interest is not allocated for federal income tax purposes. You assert that the Taxpayers should be allowed a deduction for a portion of the interest expense paid by the Parent for the taxable years under audit.

Under Va. Code § 58.1-446, the Department has the authority to adjust equitably the tax of a taxpayer when it finds that two of more 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 of the taxpayer.

The Department has addressed the issue of allocating interest expense in P.D. 97-132 (3/19/97) and P.D. 02-127 (10/06/02). In P.D. 97-132, the interest expense allocation was allowed only on loans on the books of an affiliate that directly, benefited the taxpayer. In P.D. 02-127, the interest incurred by a common parent corporation did not meet this criterion.

For management purposes, the interest accrued and paid by the Parent is allocated among members of its affiliated group. The Taxpayers have provided an explanation as to how interest is allocated from the Parent. The allocation process amounts to a complicated computation that essentially apportions interest expense to the affiliates. The Department does not consider interest that is apportioned from the Parent to the Taxpayers to be the result of debt that directly benefited the Taxpayers. Therefore, the allocation of interest expense from the Parent to the Taxpayers is not allowed.

CONCLUSION

The Department's assessments issued to the Taxpayers for the taxable years ended March 30, 1992 and 1993 are upheld. Updated bills, with interest accrued to date, will be mailed shortly to the Taxpayers. No further interest or penalties will accrue provided the outstanding assessment is paid within 30 days from the date of the updated bill. Failure to submit full payment within this 30-day period may also result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's recent Amnesty. See the enclosure entitled, "Important Payment Information."

The Taxpayers should remit payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.

While you request a conference in your letter, your request is declined because the Department's policy is well established in the regulations and prior rulings on point.

The Code of Virginia sections, regulations and public documents 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.virginia.gov. If you have any questions concerning this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
                • Sincerely,


                • Kenneth W. Thorson
                  Tax Commissioner





AR/29515O


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46