Tax Type
Corporation Income Tax
Description
Does parent and Guarantor have nexus for income tax purposes; Sales Factor
Topic
Nexus
Date Issued
07-19-2007
July 19, 2007
Re: Request for Ruling: Corporate Income Tax
Dear *****:
This will reply to your letter in which you request a ruling as to whether certain related companies have nexus with Virginia for income tax purposes and how to apportion guaranteed lease fees.
FACTS
A parent corporation (the "Parent") owns a group of corporations (the "Group") that in turn own entities that own retail stores and a distribution center located in Virginia. The Group includes an operating company (O) that performs administrative functions on behalf of members of the Group. The Group also included a corporation (G) primarily engaged in providing lease guarantees. G merged with O in 2005. The Parent, O, and G are all located in another state (State A).
Third parties that lease property to the Group require a guarantor for the teases. The Parent and O also guarantee leases on behalf of the Group. In exchange for guaranteeing the leases, members of the Group pay guarantee fees to the Parent, O and G. The Parent, O, and G source these fees to their state of commercial domicile.
In addition to guaranteeing leases on behalf of the Group, the Parent is the primary financial intermediary between the Group and third parties. Specifically, the Parent manages all of the borrowing and lending for the Group and executes other financial instruments on behalf of the Group.
O is responsible for much of the administrative and general management functions of the Group. O performed all of the Group's activities related to the leasing of the property. In regard to the lease guarantees, O acted as an agent for the Parent and G. O has nexus with Virginia for Virginia income tax purposes.
You request a ruling that addresses three questions: (1) Whether the parent and Guarantor have nexus for income tax purposes; (2) If the Parent and G have nexus with Virginia, whether they are required to source the lease guarantee fees into the numerator of their sales factor; and (3) Whether O is required to source the lease guarantee fees into the numerator of its sales factor.
RULING
Nexus
Public Law (P.L.) 86-272, codified at 15 U.S.C.A. §§ 381-384, prohibits Virginia from imposing a net income tax on a foreign corporation when its only contact with Virginia constitutes solicitation of sales. This same protection has been extended by the United States Supreme Court to include activities that are ancillary to solicitation or de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214 (1992). Although P.L 86-272 applies to tangible property, the Department's policy has been to extend the "solicitation test" of P.L. 86-272 to situations involving the sales of services.
The Department has a long established policy of narrowly interpreting the provisions of P.L. 86-272. A taxpayer that engages in activities that exceed the protection provided by P.L. 86-272 would be subject to the Virginia corporate income tax. Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G, however, exempts activities that are de minimis in nature. Pursuant to Wrigley, all nonancillary activities are examined to determine if, when considered together, they create more than a de minimis connection to the Commonwealth.
Based on the facts presented, neither the Parent nor G has employees or property located in Virginia. All the Parent's and G's business activities occur outside of Virginia. Because no activities performed by the Parent and G occur within Virginia, other than de minimis activities, it appears neither the Parent nor G has nexus with Virginia for income tax purposes.
Apportionment
Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are in the Commonwealth if:
- 1. The income-producing activity is performed in the Commonwealth; or
- 2. The income-producing activity is performed both in and outside the Commonwealth and a greater proportion of the income-producing activity is performed in the Commonwealth than in any other state, based on costs of performance.
Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. "Income producing activity" is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.
The income producing activities that generate the guarantee lease fees are approval for providing a lease guarantee, the negotiation of its terms and its execution. These activities occur at the Group's out-of-state headquarters. As such, the lease guarantee fees would not be reported in the numerator of O's Virginia sales factor, but would be included in the denominator only.
Intercompany Transactions
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 § 58.1-4.46. 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.
Based on the information provided, the guarantee payments resemble management fees. The Department has addressed the issue of management fees in Public Document (P.D.) 97-132 (3/19/1997). 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 (6/26/1997), 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.
No information has been provided with regard to the intercompany profits of the guarantee fees. However, 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.
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 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 ruling, please contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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- Janie E. Bowen
Tax Commissioner
- Janie E. Bowen
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AR/1-592718941B
Rulings of the Tax Commissioner