Tax Type
Corporation Income Tax
Description
Free website that connects individuals with common interests
Topic
Computation of Tax
Taxable Income
Date Issued
07-30-2008
July 30, 2008
Re: Ruling Request: Corporate Income Tax
Dear *****:
This will reply to your letter in which you request a ruling on behalf of your client (the "Taxpayer") concerning the proper method of allocating advertising receipts for purposes of computing the Virginia sales factor.
FACTS
The Taxpayer, headquartered in ***** (State A), operates a social networking website that connects friends, coworkers, neighbors, and individuals with common interests. Subscribers are not charged a fee for this service. Instead, the Taxpayer generates revenue through delivering relevant on-line advertisements to targeted subscribers.
Almost all the Taxpayer's employees administer and operate the business from its facility in State A. The Taxpayer also has sales representatives located in other states, but none in Virginia. The social networking website resides on servers, most of which are located in State A. Some of the servers are located in Virginia. Advertisements are loaded onto servers by employees in State A for delivery to subscribers. The Taxpayer requests a ruling regarding the proper method to allocate revenue for purposes of the Virginia sales factor.
RULING
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
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- 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 (VTB) 05-3 (4/18/2005). 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.
All the Taxpayer's operations, development, sales, and administration and most of its systems support activities occur outside Virginia. The Taxpayer also has a facility in Virginia where it houses approximately 25% of its servers that are maintained by up to 10 employees. Fees generated from advertising loaded and stored on the Virginia servers would be costs associated with income producing activities in Virginia. Fees generated from advertising loaded onto servers located in State A would not.
The question becomes whether the greater portion of the income producing activity for the fees from advertising stored on the Virginia servers occurred in Virginia or another state. First, the Taxpayer would have to determine the costs associated with loading and storing the advertising on the Virginia server for a given taxable year. The computation of such costs might include the percentage of space and time the advertising was on the Virginia servers. Costs in Virginia for a particular advertising fee would also include a portion of the costs for maintaining the social networking website on Virginia servers.
The costs occurring outside Virginia would include, but not be limited to, sales and marketing, development and operations of the social networking website, preparation and loading advertising data onto servers, and general administration of the business. These costs would have to be allocated among all of the advertisers in order to determine income producing activities occurring outside Virginia.
Because approximately 75% of the servers are located in State A, it appears unlikely that the greater portion of the income producing activities for the fees from advertising stored on the Virginia servers would occur in Virginia. However, depending on the amount of space and time a particular advertisement is on a Virginia server, and the fact that not all costs are incurred in Virginia and State A, it might be possible that the greater portion of the income producing activities for some of the fees could occur in Virginia.
Based on this ruling, the Taxpayer should develop a method for determining the income producing activities associated with revenue. Even if it is determined that none of the advertising fees should be included in the numerator of the Virginia sales factor at this time, the location of the income producing activities may change in the future as the business environment changes.
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 tax bulletin 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, you may contact ***** in the Office of Tax Policy, 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/1-2271562441.o
Rulings of the Tax Commissioner