Tax Type
Corporation Income Tax
Description
A distribution center in Virginia would not, by itself, create nexus for the Taxpayers
Topic
Allocation and Apportionment
Subtractions and Exclusions
Date Issued
03-22-2006
March 22, 2006
RE: Request for Ruling: Corporate Income Tax
Dear *****:
This will reply to your letter in which you request a ruling concerning the proposed activities of a distribution center located with Virginia.
FACTS
***** ("C1"), ***** ("C2"), and ***** ("C3") (collectively, the "Taxpayers") are engaged in the manufacture and sale of healthcare and consumer products. The Taxpayers are located outside Virginia. According to the ruling request, only C2 is subject to Virginia income tax and files a separate Virginia income tax return.
The Taxpayers are members of a larger conglomeration of corporations (the "Group"). In addition to C2, a number of other members of the Group file separate corporate income tax returns in Virginia.
The Taxpayers are planning to restructure their supply chain management in the area of sales, logistics, and distribution. To this end, the Taxpayers' sales representatives and logistics departments for one of its regions would be transferred to ***** ("C4"), a single member limited liability company owned by C1. As part of the restructuring, C4 would elect to be taxed as a corporation for federal income tax purposes.
Under the restructuring, C4 would buy products from the Taxpayers and sell to third-party customers. The Taxpayers would invoice C4 for its purchases of inventory reflecting arm's length terms, conditions, and pricing.
C4 would sell and distribute its products to its customers at market prices. The sales representatives employed by C4 would handle the accounts formerly served by the Taxpayers. C4's logistics and distribution personnel would be responsible for the logistics and distribution associated with its inventory. C4 would retain risk of ownership and loss associated with its inventory and arrange for transportation of its products to destinations both within and without Virginia.
C4 currently owns and manages a distribution center in ***** ("State A"). C4 is considering establishing a new distribution center in Virginia to replace the State A distribution center. In order to fully evaluate this move, the Taxpayers have requested rulings concerning nexus, the sales factor, and an alternative method of apportionment.
RULING
Nexus
Public Law ("P.L.") 86-272, codified at 15 U.S.C. §§ 381-384, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. The Department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992). The Department has a long-established policy of narrowly interpreting the provisions of P.L. 86-272.
As noted above, C2 currently has nexus with Virginia. The Taxpayers assert that neither C1 nor C3 conduct activities within Virginia beyond those permitted under P.L. 86-272. At issue is whether the presence of C4's distribution center in Virginia would create corporate income tax nexus for the Taxpayers.
According to the request, C4 would be purchasing products from the Taxpayers and selling and shipping its own inventory. The Taxpayers would not own inventory in Virginia other than when it is in the process of being shipped to C4. C4 would not be an affiliated representative or an independent contractor acting on behalf of the Taxpayers in Virginia. Accordingly, the activities of C4 would not create corporate income tax nexus for C1 and C3.
Sales Factor
The Taxpayers request that their sales made to C4 and shipped to the distribution center in Virginia be treated as transfers made as part of the transportation process because C4 is not the ultimate recipient of the sale of product by the Taxpayers. Under this scenario, the Taxpayers' sales to C4 would not be included in the numerator of the sales factor. Instead, the Taxpayers numerator would be the sum of sales directly made and transported by the Taxpayers to third party customers in Virginia and C4's Virginia sales of products manufactured by each of the Taxpayers. Such a ruling would apply immediately to C2, and to the remaining Taxpayers only if their activities exceed the protection afforded under P.L. 86-272.
The Taxpayers cite previous rulings by the Department that a sale of product is not included in the Virginia receipts factor numerator as a Virginia sale when an initial delivery of product within Virginia is for transportation purposes and the seller of the product knows the ultimate recipient of the product is located outside of Virginia. See Public Document (P.D.) 91-248 (10/8/1991) and P.D. 95-24 (2/13/1995).
These rulings state that the determinative factor is not the mode of transportation because the standard imposed by the statute merely stipulates that the good be subject to some form of transportation. Instead, the Department weighs more heavily the fact that the original seller of product had knowledge that the ultimate destination of the good was outside Virginia.
The Taxpayers scenario, however, is clearly distinguishable from the Department's previous determinations. In the previous rulings, the taxpayer delivered goods to independent carrier or the customer for the purposes of transportation in connection with a single sales transaction.
In this case, the Taxpayers sell the product to C4 and deliver the products to the distribution center. As such, the Taxpayers are not delivering inventory to C4 for transportation purposes. Instead, the products have been delivered to a customer's facility pursuant to a sales transaction. This makes C4 the ultimate recipient of sales made by the Taxpayers. Therefore, if such products are delivered to a C4's distribution center in Virginia, the sales would be included in the Taxpayers' numerator of the Virginia sales factor. C4's subsequent sales of goods to unrelated third party customers has no bearing on the transactions between the Taxpayers and C4.
Alternative Method
If the Department is unable to rule favorably with regard to the sales factor request, the Taxpayers request permission to use an alternative method of allocation and apportionment. If this request were to be granted, the Department would allow C2 to exclude sales made to C4 and shipped to the distribution center in Virginia from the numerator of its sales factor.
Under the requested alternative method, C2 would include in the sales factor numerator only those sales transported by C2 directly to third party customers in Virginia, plus C4's Virginia sales of products manufactured by C2. Further, the Taxpayers request the alternative method for other members of the Group should they have a similar relationship with C4 and their activities rise to a level that create a, taxable presence within the Commonwealth.
According to the information provided, C2's Virginia sales factor for the last several taxable years has been less than 3%. The remaining Taxpayers percentage of sales in Virginia is estimated to be similar to those of C2. Consequently, C4 expects to, transport approximately 2.5% of its sales to customers at Virginia locations. Such sales would be included in the numerator of the C4's Virginia sales factor.
At the same time, up to 50% of the Taxpayers' respective products are expected to be transported to C4's distribution center. Remaining products would be shipped to the other regional distribution centers located outside Virginia. The Taxpayers, therefore, assert that without an alternative method of allocation and apportionment, each of the Taxpayers' Virginia sales factor and overall apportionment factor, including the double weighted sales factor, would be well in excess of prior tax years.
The policies that apply to requests for an alternative method of allocation and apportionment under Va. Code § 58.1-421 are well established. In order for a taxpayer to request an alternative method of allocation and apportionment, the taxpayer must file the return using the statutory method and pay any tax due. Next, the taxpayer is required to file an amended return proposing an alternative method and request a refund. The Department will not grant an alternative method of allocation and apportionment unless it determines that: (1) the statutory method produces an unconstitutional result; or (2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state's method of apportionment. See Title 23 of the Virginia Administrative Code ("VAC") 10120-280.
The Taxpayers assert that using the statutory apportionment method is inequitable because sales to C4's distribution center in Virginia would cause the Taxpayers apportionment factor to increase dramatically.
The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair, 437 U.S. 279 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.
Further, as set forth in Title 23 VAC 10-120-280, a taxpayer must demonstrate that the use of an alternative method of allocation and apportionment is justified due to disparities being caused by Virginia's method rather that the methods employed by other states. In this instance, the Taxpayers are in the process of restructuring their operations. It stands to reason that when a business changes the way it operates, its apportionment factors will change. When a taxpayer builds a new factory in Virginia, its property and payroll factors change. Likewise, when a taxpayer gains a new customer in Virginia, its sales factor changes.
In this case, the Taxpayers would be selling to C4 (a new Virginia customer). This would denote a significant change to the Taxpayers' business done in Virginia. Thus, under apportionment theory, it would be appropriate to include the Taxpayers' sales made to C4 in the numerator of the Virginia sales factor.
Currently, this would only affect C2 because it is the only member of the Taxpayers subject to Virginia income tax. The remaining Taxpayers would only be subject to tax on their Virginia income if they engage in activities beyond those protected by P.L. 86-272.
The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. After considering the facts set forth, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayers, or that the circumstances would justify granting your request.
Intercompany Transactions
The Taxpayers indicate that sales to C4 would reflect arm's length terms, conditions, and pricing. It should be noted that the Department has the authority to adjust the taxable income of two or more corporations in accordance with Va. Code § 58.1-446. In the event that the Department finds that transactions between commonly owned businesses improperly reflects Virginia taxable income from business done in Virginia, the Department can, and if necessary will, seek remedies that may include consolidating the accounts of one or more of the corporations. See Title 23 VAC §§10-120-360 through 364.
Assuming that all transactions are, in fact, at arm's length terms, conditions, and pricing, the Department would unlikely to invoke Va. Code § 58.1-446. Because the application of Va. Code § 58.1-446 is highly dependent on the facts and circumstances, the Department cannot issue an advance ruling with respect to these transactions.
CONCLUSION
In conclusion, C4's distribution center in Virginia would not, by itself, create nexus for the Taxpayers and the Taxpayers' sales to C4's distribution center in Virginia would properly be included in the numerator of the sales factor. Further, based on the information provided, I find it unlikely that members of the Taxpayers having nexus with Virginia would be granted an alternative method of allocation and apportionment should an application be made pursuant to Title 23 VAC 10-120-280.
This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.
The Code of Virginia and regulation sections 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.policylibrary.tax.virginia.gov. If you have any questions about this ruling, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, 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/1-538612101O
Rulings of the Tax Commissioner