06-27 | Virginia Tax

Tax Type

Corporation Income Tax

Description

Taxpayer failed to deduct management fees charged by Corporation B

Topic

Allocation and Apportionment

Records/Returns/Payments

Date Issued

03-20-2006

March 20, 2006

Re: § 58.1-1824 Protective Claim: Corporate Income Tax

Dear *****:

This will reply to your letter in which you request a refund of corporate income tax paid on behalf of ***** (the "Taxpayer") for the taxable years ended December 31, 2001 and 2002. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer is a Virginia corporation that is the subsidiary of ***** ("Corporation A"). Corporation A is a subsidiary of ***** ("Corporation B"). Both Corporation A and B are located outside Virginia and provide management services for the Taxpayer and other Corporation B subsidiaries. Corporation B charges Corporation A a fee for providing management services.

The Taxpayer timely filed corporate income tax returns for the 2001 and 2002 taxable years. The Taxpayer subsequently filed amended returns for the 2001 and 2002 taxable years, requesting a refund on the basis that the Taxpayer failed to deduct management fees charged by Corporation B. The Department denied the amended returns because it could not be determined whether the management fee expenses were properly reflected in the Taxpayer's income subject to Virginia tax. The Taxpayer contests the Department's actions.

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 gives the Department the authority to consolidate entities and make adjustments if an agreement between two or more affiliated corporations serves to distort a corporation's income earned from business done in Virginia. The Virginia Supreme Court upheld this authority in Commonwealth v. General Electric Corporation, 236 Va. 54, 372 S.E.2d 599 (1988). The Department will generally invoke this authority if the distortion of Virginia taxable income is created by shifting income to an affiliated corporation that lacks economic substance or is accomplished in a transaction not conducted at arm's length. As such, the Department will not accept an amended return if the adjustments distort Virginia taxable income.

In the instant case, you assert that Corporation A paid Corporation B for management services that Corporation B provided for the Taxpayer and other lowertiered subsidiaries. In addition, you state Corporation A paid for a number of specific expenditures that were directly related to the daily operations of the lower-tiered subsidiaries such as computer expenses, consulting fees, outside services, telephone, facility charges and training. The Taxpayer believes that these expenses should be allocated to the lower-tired subsidiaries. The expenses attributed to the Taxpayer were then marked up by 7.5%.

The Department has addressed the issue of management fees in Public Document ("P.D.") 97-132 (3/19/97). In this ruling, the Department recognized that the taxpayer would have had to engage either an outside firm to perform the essential corporate services or develop its own in-house capability. Because no intercompany profit was incorporated into the overall management fee charged by the parent, the Department allowed the deductions. The Department concluded that a cost reimbursement arrangement between related parties, without any intercompany profit, could not be characterized as one that distorts Virginia taxable income.

In P.D. 97-290 (6/26/97), however, the Department disallowed a profit percentage added to a management fee because the parent holding Corporation lacked independent economic substance and failed to provide any evidence to show that the profit element of the management fee reflected fair market value.

In the instant case, both Corporation A and Corporation B are operating companies incurring management and administrative expenses that they are allocating to the subsidiaries. The evidence provided demonstrates that the both Corporation A and Corporation B are proportionally allocating their expenses in accordance with P. D. 97-132.

The Taxpayer has not, however, provided any evidence that the 7.5% markup of the expenses reflects fair market value. As such, the Department will allow the Taxpayer's deduction of the apportioned expense, but will not allow the expense markup.

CONCLUSION

Based on the foregoing, the Taxpayer will be issued a refund for the 2001 and 2002 taxable years pursuant to the enclosed schedule. The Code of Virginia section and public documents cited are 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, please contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/54098B

Rulings of the Tax Commissioner