07-57 | Virginia Tax

Tax Type

Corporation Income Tax

Description

A proportion of the income producing activities clearly occurs in another state

Topic

Allocation and Apportionment

Taxable Transactions

Taxability of Persons and Transactions

Date Issued

05-10-2007

May 10, 2007

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 assessment issued to ***** (the "Taxpayer") for the taxable year ended March 31, 2003.

FACTS

The Taxpayer is a corporation headquartered in Virginia. The Taxpayer's data support center is located in ***** ("State A"). It also has a number of sales support and marketing field offices throughout the country.

The Taxpayer obtains data about motor vehicles (the "property") from various sources and compiles histories of this property for sale to dealers and consumers of the property. After the Taxpayer receives the data, it is verified, reformatted, cleansed, and compiled into histories. Customers are charged a flat fee to access this information via the Internet.

In determining its apportionment formula for Virginia corporation income tax purposes, the Taxpayer attributed all its sales to State A based on the cost of performance. Under audit, the Department adjusted some of the Taxpayers costs, resulting in 100% of the sales being attributed to Virginia in the sales factor. As a result, the Department issued an assessment for additional corporate income tax and interest. The Taxpayer contests the auditor's adjustments, asserting that a majority of its costs for each transaction should be allocated to State A.

DETERMINATION

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.

In General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S.E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Va. Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining "cost of performance" and "income producing activity" in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.

In response to the General Motors decision, the Department issued Tax Bulletin 05-3 (4/18/05). The bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department's adoption of policies in response to the General Motors decision. Because the Department administers Va. Code § 58.1-416 in a manner similar to Va. Code § 58.1-418, taxpayers with sales other than tangible personal property may also elect to file returns prepared in accordance with Title 23 VAC 10-120-230 pending the adoption of policies in response to the General Motors decision.

Currently, the Taxpayer's only product is the reports generated from its database. The reports are available exclusively via the Internet. Customers may purchase individual reports or get unlimited reports through a subscription. In either case, the costs of producing each report are approximately the same.

The auditor removed database and software costs from the Taxpayer's computation of the costs of performance. The auditor determined that his allocation did not correspond to the Taxpayer's allocation of electronic data processing equipment between State A and the headquarters in Virginia.

The Taxpayer has provided the Department a detailed breakdown of its costs. For the taxable year at issue, the Taxpayer has elected to follow Title 23 VAC 10-120230 in preparing its return for the taxable year at issue. A review of these documents demonstrates that the Taxpayer incurs substantial costs to obtain data for its database at its information technology center located in State A. When the database and software costs are included in the computation of the sales factor, the greater proportion of the income producing activities clearly occurs in State A.

As such, the Taxpayer properly reported no sales in the numerator of the sales factor on its original return for the taxable year ended March 31, 2003. Accordingly, the audit assessment of additional corporate income tax and interest for the taxable year ended March 31, 2003 has been abated.

The Code of Virginia section and regulation cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website you have any questions regarding this determination, please contact ***** the Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Janie E. Bowen
        Tax Commissioner

AR/56917B

Rulings of the Tax Commissioner