Tax Type
Corporation Income Tax
Description
Corporations not doing business in VA and not connected with taxpayer's business
Topic
Appropriateness of Audit Methodology
Assessment
Date Issued
10-05-2006
October 5, 2006
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 appeal.
FACTS
The Taxpayer is an out-of-state corporation that files a separate Virginia corporate income tax return. In 1980, the Taxpayer entered into negotiations with an unrelated third party to acquire a controlling interest in ***** ("Corporation A"), which operated a local processing facility in ***** ("State A"). Corporation A had no other operations.
In 1981, the Taxpayer formed ***** ("Corporation B") to hold the stock of Corporation A and finance its operations. The Taxpayer contributed cash and marketable securities to Corporation B. The Taxpayer owned 80% of Corporation B and Corporation A owned the remaining 20%. In December 1981, Corporation B purchased 95% of the stock of Corporation A from an unrelated third party.
In 1982, the Taxpayer began planning a larger manufacturing facility on property adjacent to Corporation A's facility in State A. A locality in State A built the manufacturing facility and funded it by selling bonds to Corporation B. Corporation B borrowed funds from Corporation A in order to purchase the bonds.
The Department audited the Taxpayer for the 1993 taxable year. The Department's auditor determined that Corporation B lacked economic substance and the interest it accrued should be considered income of the Taxpayer. The auditor consolidated the taxable income of the Taxpayer and Corporation B and assessed additional tax and interest.
The Taxpayer appeals the audit assessment, contending that neither Corporation B and Corporation A do business in Virginia and the arrangement between the two corporations is not connected with the business activities of the Taxpayer. In addition, the Taxpayer contests the auditor's assumption that the interest would have been reported on the books of the Taxpayer if it were not for Corporation B.
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 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, 372 S.E.2d 599 (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.
In the instant case, neither Corporation A nor Corporation B operated in Virginia or were subject to Virginia income tax. The arrangement, therefore, was not conducted in such a manner as to reflect improperly, inaccurately, or incorrectly business done in Virginia.
In addition, while the Taxpayer did perform minimal administrative services for Corporation A and Corporation B, these expenses were not sufficient to create an improper reflection of the Taxpayer's income from Virginia sources. As such, the arrangement between Corporation A and Corporation B does not affect a Virginia taxpayer. Accordingly, the additional Virginia income tax and interest assessed against the Taxpayer for the taxable year ended December 31, 1993 has been abated.
The Code of Virginia section cited is available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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Janie E. Bowen
Tax Commissioner
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AR/54545B
Rulings of the Tax Commissioner