Document Number
06-19
Tax Type
Corporation Income Tax
Description
Foreign source income subtraction technical fees incidental to licensing contracts
Topic
Assessment
Subtractions and Exclusions
Date Issued
02-07-2006

February 7, 2006




Re: § 58.1-1821 Application: Corporate Income Tax

Dear *****:

This will reply to your letter in which you seek correction of the corporate income tax assessments issued to your client, ***** (the "Taxpayer") for the taxable years ended December 31, 1998 and 1999. I apologize for the delay in responding to your appeal.

FACTS


The Taxpayer was audited by the Department for the taxable years at issue and numerous adjustments were made. One of the adjustments made by the auditor was to eliminate the foreign source income subtraction claimed by the Taxpayer. The auditor determined that the Taxpayer had included in foreign source income ("FSI") technical fees that were not incidental to the rental of real property or the licensing of intangible assets. The Taxpayer appeals the disallowance of the FSI subtractions.

DETERMINATION


Foreign Source Technical Fees

Virginia Code § 58.1-302 defines foreign source income, in pertinent part, as:
    • Rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property, including rents, royalties, or fees for the use of or the privilege of using without the United States any patents, copy rights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like properties.

Pursuant to the Department's long-standing policy, the words "technical fees from property located or services performed" cannot be taken out of their context to create a subtraction for income earned from the performance of services outside the United States for any service that can be characterized as of a technical nature. See Public Document ("P.D.") 86-209 (11/3/86). In order to qualify for the Virginia FSI subtraction, "technical fees" must be incidental to a contract relating to the rental of real property or the licensing of a patent or other like property outside the United States. See P. D. 91-57 (3/29/91).

In the instant case, the Taxpayer has provided copies of contracts pertaining to technology and trademark licenses outside of the United States. These contracts specify that the customers purchase a license to use software created by the Taxpayer. The Taxpayer then takes this software and modifies and installs it. It provides the licensee with various technical information and services that include development, integration, training and testing. All of the contracts are different and provide the licensee with differing levels of technical information and services.

In P.D. 91-57, the Commissioner held that software and operating systems are classified as intangible property for income tax purposes, regardless of whether they are custom or application software. As such, the software in this case produced by the Taxpayer and modified to meet the needs of the Taxpayer's customers is intangible property for income tax purposes.

The services specified in these contracts were necessary in order for the technology to be usable and for the foreign licensee to implement the Taxpayer's technology. Without these services, the license would have been worthless. All information was provided to assist the licensee in using the technology to produce and sell tangible personal property. Conversely, the Taxpayer would not have performed these services if there had not been an underlying agreement protecting its intellectual property rights. The consideration paid for these services, to the extent those services were performed outside the United States, clearly qualifies as "technical fees" incidental to the licensing of intangible property and is properly included as a Virginia FSI subtraction.

CONCLUSION


The documentation provided indicates that the Taxpayer correctly included in its foreign source income subtraction technical fees incidental to licensing contracts for services performed without the United States. Based on this determination, the audit has been revised (see enclosure). The refund of corporate income tax for the 1998 taxable year will be applied to the revised assessment for the 1999 taxable year, and an updated bill will be issued to the Taxpayer for the balance due pursuant to the enclosed schedule.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
                • Sincerely,


                    • Kenneth W. Thorson
                      Tax Commissioner




AR/53868B


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46