Tax Type
Corporation Income Tax
Description
Taxpayer claims that the statutory method is unconstitutional or inapplicable.
Topic
Allocation and Apportionment
Date Issued
08-16-2006
August 16, 2006
Re: Request for Ruling: Corporate Income Tax
Dear *******************:
This will reply to your letter in which you request an alternative method of allocation and apportionment on behalf of you client (the "Taxpayer").
FACTS
The Taxpayer is a Virginia based corporation engaged in the design, implementation, and management of technology systems. It provides remote network support services from operation centers located in ***** (State A), ***** (State B), and Virginia. The Taxpayer also provides on-site support services at customer facilities. In addition, the Taxpayer has facilities in ***** (State C) and Virginia that provide support for the whole network. In some cases, support services are provided on-site at the customer's location.
The Taxpayer functions primarily as a subcontractor for an unrelated third party. This third party contracts to provide the hardware, software, and related technology equipment. Under these contracts, the Taxpayer provides all design, configuration, and installation services (including both hardware and software installation) and systems management on behalf of the unrelated third party.
The Taxpayer files its Virginia corporate income tax return using the standard three-factor apportionment formula. Sales of other than tangible personal property are attributed based on "cost of performance" in accordance with Title 23 of the Virginia Administrative Code (VAC) 10-120-230. Because the greatest percentage of "income producing activity" occurs in Virginia as compared to any other state, the Taxpayer sources all of its receipts to Virginia. Not all of the Taxpayer's income producing activities, however, are conducted in Virginia.
You represent that the other states for which the Taxpayer is required to file income tax returns either require receipts to be attributed based of the time worked or sourced based on the customer's location. The Taxpayer believes it is unreasonable for Virginia to require them to attribute 100% of its service receipts to Virginia when it is also required to include the same receipts, or a portion thereof, in the numerator of the sales factor of other states.
The Taxpayer requests permission to use an alternative method of sourcing receipts for the Virginia sales factor. The alternative method proposed by the Taxpayer would attribute sales based on the amount of time spent at each location where services are performed.
RULING
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.
An apportionment formula used as an approximation of a corporation's income reasonably related to the activities conducted within a taxing state will only be disturbed when the taxpayer has proved by "clear and cogent evidence" that the income attributed to the state is in fact "out of all reasonable proportion to the business transacted . . . in that state," Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123, 135 (1931), or has "led to a grossly distorted result," Norfolk & Western R. Co. v. Missouri State Tax Commission, 390 U.S. 317, 326 (1968).
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 within the time prescribed for filing amended returns claiming refunds. The amended return must include a statement of why the statutory method is inapplicable or inequitable and an explanation of the proposed method of allocation and apportionment. The Department will not grant an alternative method of allocation and apportionment unless it determines that: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer's situation; 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 VAC 10-120-280.
In the context of a ruling request, without the opportunity to examine the records underlying the claim, a corporation cannot demonstrate that Virginia's factor formula produces an unreasonable or distorted result. Further, even assuming the existence of double taxation, a corporation's argument that Virginia's statutory method (rather than another state's method) causes an unconstitutional result will not be accepted without documentation revealing the sources of the corporation's profits. This cannot be done until after a corporation has fully accounted and prepared its financial statements after the close of a taxable period. Consequently, it is impractical for the Department to issue an advanced ruling with regard to allocation and apportionment. The procedures set forth under Title 23 VAC 10-120-280 were designed for this purpose.
The Taxpayer asserts that using Virginia's statutory apportionment method is inequitable because 100% of its sales are attributed to Virginia. According to the Taxpayer, only about 25% of its cost of performance (primarily payroll) is done in Virginia. As a result, the Taxpayer estimates that the cumulative state sales factor exceeds 160%. As such, the Taxpayer asserts that it is paying income tax on more than 100% of its income.
The Taxpayer is not requesting an alternative method of either the property or payroll factors. As such, the Taxpayer's concern with the sales portion of its apportionment formula is tempered by these other factors.
The fact that Virginia taxable income is greater under the statutory method than an alternative method does not constitute "extraordinary circumstances" sufficient to justify permission to use an alternative method. See Department of Taxation v. Lucky Stores, Inc., 217 Va. 121 (1976). Further, even though other states prescribe a different method for attributing sales of other than tangible personal property within and without their jurisdiction, Virginia's statutory formula can still reasonably apportion a corporation's income to its activities conducted within Virginia.
CONCLUSION
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. Based on the facts presented, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer. Furthermore, the Taxpayer's request is not in accordance with the procedure for requesting an alternative method of allocation and apportionment outlined in Title 23 VAC 10-120-280. Based on the foregoing, I must deny the Taxpayer's request to use an alternative method of sourcing receipts for the Virginia sales factor.
The Code of Virginia and regulation sections cited, along with other reference documents, 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 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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- Janie E. Bowen
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AR/1-826164547
Rulings of the Tax Commissioner