Document Number
06-76
Tax Type
Corporation Income Tax
Description
Corporation commercially domiciled; Nexus
Topic
Corporate Distributions and Adjustments
Nexus
Date Issued
08-23-2006


August 23, 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, 2001 and 2002. I apologize for the delay in responding to your appeal.

FACTS


The Taxpayer is the parent corporation of an affiliated group (the "Group") that files a consolidated Virginia corporate income tax return. The Department audited the Group and made a number of adjustments to the returns filed for the taxable years at issue. ***** ("Corporation A"), ***** ("Corporation B"), ***** ("Corporation C") and ***** ("Corporation D") were removed from the consolidated return. The Department's auditor determined that the corporations at issue lacked nexus with Virginia and did not have income from Virginia sources. The Taxpayer contests the adjustments, asserting that these companies had nexus with Virginia for the taxable years at issue and were properly included in the Group's consolidated return.

DETERMINATION


Consolidated Virginia corporate income tax return

Pursuant to Va. Code § 58.1-442, an affiliated group of corporations may elect to file a consolidated Virginia income tax return. Title 23 of the Virginia Administrative Code ("VAC") 10-120-322 provides that a corporation cannot be included in a Virginia consolidated return if it is exempt from Virginia income tax under Va. Code § 58.1-401, exempt from Virginia income tax under Public Law (P.L.) 86-272, not affiliated as defined under Va. Code § 58.1-302, not subject to Virginia income tax if separate returns were to be filed, or using different taxable years. Public Law 86-272, codified at 15 U.S.C.A. §§ 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.

Income from Virginia sources

Virginia Code § 58.1-400 imposes income tax "on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources." Generally, a corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. The existence of positive Virginia apportionment factors clearly establishes income from Virginia sources.

Under certain conditions, a corporation may have income from Virginia sources resulting from a positive apportionment factor, but not be subject to tax by virtue of the protections afforded under P.L. 86-272. Further, corporations that do not have a positive apportionment factor are not considered to be subject to Virginia income tax if separate returns are filed.

Corporation A

Corporation A, headquartered in ***** ("State A"), reported positive sales and payroll factors in Virginia. The auditor found that Corporation A had reported no salaries and wages to the Virginia Employment Commission (VEC). Without any property or payroll in Virginia, the auditor concluded that Corporation A failed to conduct sufficient activities within Virginia to create nexus.

The Taxpayer asserts that the chief financial officer of Corporation A lived and worked in Virginia. The information provided indicates that the chief financial officer was also employed by the Taxpayer. The chief financial officer's wages were in fact included in the Taxpayer's filings with VEC. Based on the evidence provided, the officer's activities in Virginia exceed the protection afforded under P.L. 86-272 and were not de minimis in relation to Corporation A's overall activities. Accordingly, Corporation A had nexus with Virginia for the taxable years at issue.

The Department's long-standing policy prohibits wages paid by a parent corporation from being included in the payroll factor of a subsidiary, despite bookkeeping allocations by the parent corporation to the subsidiary for a portion of the expense. See P. D. 90-17 (1/11/90). As such, wages paid by the Taxpayer to employees of Corporation A were incorrectly included in Corporation A's Virginia payroll factor.

The Taxpayer argues that the Department has adjusted the payroll factor when wages have been incorrectly reported to VEC. See P.D. 94-46 (3/10/1994). The Department presumes that wages reported to VEC are includible in the numerator of the factor. In P.D. 94-46, however, the evidence showed that salaries and wages for employees that worked outside of Virginia were reported to VEC. When such an error is made, it is incumbent upon the Department to attribute payroll correctly among the states.

In the Taxpayer's case, there is no issue regarding the correct reporting method. The officer's salary was correctly reported to VEC based on the structure of the Group and the rules governing VEC. The Taxpayer indicates that it has amended its VEC filings to report the chief financial officer's salary under Corporation A. Copies of the amended returns have been provided. In addition, the Taxpayer has not shown that the amended returns were accepted by VEC and the taxes due for the amended returns were paid and accepted by VEC. Further, Corporation A reported no Virginia withholding for any employees in Virginia. Accordingly, there is insufficient evidence to find that Corporation A had a positive payroll factor for the 2001 and 2002 taxable years.

Corporation A also reported a positive sales factor. According to the documentation provided, Corporation A had no customers in Virginia for the taxable years at issue. For the 2001 taxable year, the numerator of the sales factor includes only interest income. For 2002, Corporation A reported interest income and a loss from the sale of an intangible asset in the numerator of the sales factor.

Under Title 23 VAC 10-120-210 D, interest is included in the numerator of the sales factor when a greater proportion of the income producing activity is performed in Virginia. Corporation A is headquartered outside Virginia. The Department has found that costs of record keeping, collection and other income producing activities associated with generating interest income usually occurs at the principal location of a business. In this case, despite the fact that the chief financial officer worked in Virginia, Corporation A had no property in Virginia and no other significant activities occurring in Virginia. Accordingly, it is unlikely that Corporation A incurred any costs in Virginia associated with producing the interest income. Therefore, the interest income must be attributed to State A for the 2001 and 2002 taxable years.

Pursuant to Va. Code § 58.1-302, only the net gain from the sale or disposition of intangible property is included in the sales factor. As such, the loss reported in the numerator of the sales factor by Corporation A must be removed from both the numerator and denominator of the sales factor.

By removing the payroll and sales from the numerator of the sales factor, Corporation A lacks a positive apportionment factor with Virginia. Without a positive apportionment factor, Corporation A is not considered to have income from Virginia sources and would have no income subject to Virginia tax for the taxable years at issue. Accordingly, the auditor correctly removed Corporation A from the consolidated Virginia income tax return for the 2001 and 2002 taxable years.

Corporation B

Corporation B holds investments in foreign subsidiaries. The auditor removed Corporation B from the Virginia consolidated return because it reported no positive apportionment factors. The Taxpayer contends that Corporation B reported salaries for federal income tax purposes, and Virginia is the only place of business to report the incurred salary expense.

Under Title 23 VAC 10-120-140, the commercial domicile of a corporation is defined as the location of the principal office where "the business affairs of the corporation are normally directed or managed." This is usually a corporation's headquarters. The regulation goes on to state:
    • If the corporation has no office then the commercial domicile may be where the officers, directors and shareholders regularly meet or where the principal officer or majority shareholder/officer conducts the affairs of the corporation, depending upon the facts and circumstances.

Based on the evidence, Corporation B had no office, employees, or tangible assets. Corporation B's affairs are conducted primarily by officers employed by the Taxpayer and located at the Taxpayer's office in Virginia. Therefore, based on the facts and circumstances, Virginia is considered to be the commercial domicile of Corporation B, and it is subject to income tax in Virginia.

In general, a corporation that is commercially domiciled in Virginia will be subject to tax on its income and eligible to be included in a consolidated Virginia income tax return. See P.D. 05-90 (6/9/2005). Accordingly, Corporation B must be included in consolidated corporate income tax return filed by the Group for the 2001 and 2002 taxable years.

Corporation C

Corporation C is a Virginia Corporation engaged in managing investments in foreign subsidiaries. Corporation C was removed from the Virginia consolidated return for the taxable years at issue because the auditor determined that it lacked nexus with Virginia. The Taxpayer asserts all of Corporation C's officers were located in Virginia and a portion of the salaries reported by Corporation C for federal income tax purposes were incurred in Virginia.

In this case, the Taxpayer acknowledges that it is in the process of investigating its records to determine the amount, if any, of the salaries and wages that should be reported to the VEC under Corporation C. Likewise, Corporation C reported no Virginia withholding or any employees in Virginia. Accordingly, Corporation C will not be considered to have a positive payroll factor for the 2001 and 2002 taxable years.

The information provided also indicates that the Taxpayer charged Corporation C a management fee for the 2002 taxable year. The purchase of administrative and management services would not create a positive Virginia property, payroll or sales factor. See P. D. 99-34 (3/24/1999). Thus, even if the activities of the officers create nexus with Virginia, Corporation C must establish a positive apportionment factor in order to have income subject to Virginia tax.

For the taxable years at issue, Corporation C reported no property, payroll, or sales in the numerator of its apportionment factor. Meanwhile, Corporation C reported substantial receipts, payroll, and property from sources outside Virginia.

Without a positive apportionment factor, Corporation C is not considered to have income from Virginia sources and, therefore, would have no income subject to Virginia tax. Accordingly, even though Corporation C may have nexus with Virginia, the auditor correctly removed Corporation C from the consolidated Virginia income tax return for the 2001 and 2002 taxable years.

Corporation D

Corporation D manages an investment in a foreign corporation located in a foreign country. Corporation D's sole source of revenue for the 2001 and 2002 taxable years was interest income. The auditor determined that Corporation D did not have nexus with Virginia and removed the corporation from the consolidated return. The Taxpayer contends that Corporation D's only source of income is interest; therefore, Corporation D qualifies as a financial corporation for apportionment purposes. The Taxpayer further argues that because Corporation D's sole place of business is Virginia, it has a 100% apportionment factor and all of its interest income should be sourced to Virginia.

Corporation D had no office, employees, or tangible assets. Corporation D's affairs are conducted primarily by officers employed by the Taxpayer and located at the Taxpayer's office in Virginia. Based on Title 23 VAC 10-120-140, Corporation D would be considered to be commercially domiciled in Virginia and subject to income tax in Virginia.

Virginia Code § 58.1-418 requires financial corporations to apportion income based on cost of performance. Virginia Code § 58.1-418 defines a "financial corporation" as one that derives more than 70% of its gross income from (1) fees for financial services, (2) gross profits from securities trading, (3) interest, and (4) dividends to the extent included in Virginia taxable income. Title 23 VAC 10-120-250 defines the "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of obtaining gains or profit, except activities directly performed by the taxpayer for the ultimate purpose of obtaining allocable dividends.

Because all of its income resulted from interest, Corporation D is a financial corporation for the taxable years at issue. Pursuant to Va. Code § 58.1-442, affiliated corporations using different apportionment factors are permitted to file as a Virginia consolidated group. Accordingly, Corporation D must be included in the consolidated Virginia income tax returns for the 2001 and 2002 taxable years.

CONCLUSION


Based on the foregoing, the audit will be returned to the audit staff to adjust the assessments as noted above. After the auditor makes the appropriate adjustments, the Taxpayer will receive a revised bill. The Taxpayer should remit its payment for the outstanding balance as shown on the revised bill within 30 days from the date of the bill to avoid the accrual of additional interest.

The Code of Virginia sections, regulations 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,

                • Janie E. Bowen
                  Tax Commissioner



AR/54505B


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46