Document Number
08-139
Tax Type
Corporation Income Tax
Description
Are two subsidiaries of a Virginia taxpayer are subject to Virginia corporate income tax
Topic
Computation of Tax
Federal Conformity
Nexus
Partnerships
Pass-Through Entities
Date Issued
07-30-2008


July 30, 2008





Re: Request for Ruling: Corporate Income Tax

Dear *****:

This will reply to your letter in which you inquire whether two subsidiaries of a Virginia taxpayer are subject to Virginia corporate income tax.

FACTS


Corporation A is a corporation not domiciled in Virginia, but subject to Virginia corporate income tax. It produces and sells tangible personal property (TPP) that it sells nationwide. It wholly owns Corporation B, which in turn wholly owns Corporation C. Corporation A generates accounts receivable from the sale of its TPP. It sells the receivables to Corporation B for a discount. Corporation B, in turn, sells the receivables to Corporation C.

Corporation A borrows money from banks that use the receivables owned by Corporation C as collateral. Corporation A services the receivables on behalf of Corporation C for an administrative fee. Receivable payments are typically sent electronically to a Corporation C collection account, but are occasionally sent to lock boxes located outside of Virginia.

Corporation A's collection officers occasionally travel to Virginia to service receivables. While in Virginia, Corporation A collection officers engage in sales promotion on behalf of Corporation A, the periodic review of existing customers' credit worthiness, and the discussion of delinquent accounts.

Corporation B has no employees, property, and the only income is the proceeds from the sale of the receivables. Corporation C has no employees or property other than the receivables and the lease of the lock boxes. Corporation C's only income is the proceeds from the gain from the collection of the receivables and the administrative fees paid by Corporation A. Corporation C is the lessee of the lock boxes. You request a ruling as to whether Corporation B and Corporation C are subject to Virginia corporate income tax.

RULING


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 establishes income from Virginia sources.

Public Law (P.L.) 86-272, as codified at 15 U.S.C. §§ 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. The Department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are 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.

However, a taxpayer that engages in activities that exceed the protection provided by P.L. 86-272 would be subject to the Virginia income tax.

Corporation B

According to the information provided, Corporation B's activities are limited to purchasing Corporation A's receivables and immediately selling them to Corporation C. Corporation B's income is limited to the net proceeds from the resale of the receivables to Corporation C. Corporation B lacks any connections with Virginia that would create nexus for income tax purposes. In addition, Corporation B does not have any positive apportionment factors. As such, Corporation B would not be subject to Virginia income tax.

Corporation C

Corporation C's activities are limited to purchasing Corporation A's receivables from Corporation B and collecting the payments on these receivables. Corporation C does not have its own employees, but does have Corporation A's employees servicing its receivables in Virginia. Such servicing activities include the review of existing customers' credit worthiness and the discussion of delinquent accounts. Such activities exceed the protection provided by P.L. 86-272. As such, the issue is whether the activities conducted by Corporation A on behalf of Corporation C, extend to Corporation C for purposes of P.L. 86-272.

In Public Document (P.D.) 01-136 (9/18/2001), the Department ruled that the provision of services in Virginia by an independent contractor on behalf of the taxpayer was the purchase by the taxpayer of services from a vendor that were then resold to the taxpayer's customers. Such activity would not create nexus for the taxpayer purchasing the services. The result would be different if the contractor is not considered to be independent. See P.D. 99-278 (10/14/1999).

In the instant case, Corporation C is indirectly owned in its entirety by Corporation A. As such, Corporation A is clearly not an independent contractor when it services receivables on behalf of Corporation C. As such, Corporation C has nexus with Virginia.

Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G exempts activities that are de minimis in nature. Under this regulation, consideration will be given to the nature, continuity, frequency, and regularity of the unprotected activities in Virginia, compared to the nature, continuity, frequency, and regularity of such activities outside of Virginia. Pursuant to Wrigley, all non-ancillary 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, it is unclear whether Corporation A's collection activities in Virginia would exceed the de minimis standards set forth in Wrigley.

However, even if Corporation C were to establish nexus with Virginia, the facts provided raise the question as to whether the Corporation C has any Virginia source income. Corporation C has no property or payroll in Virginia. In addition, it is possible that Corporation C would not have a positive sales factor. Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are deemed in Virginia if:
  • 1. The income producing activity is performed in Virginia;
  • 2. The income producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

Pursuant to Title 23 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.

Based on facts as stated in this request, Corporation C would incur no direct costs in Virginia in accordance with Title 23 VAC 10-120-230. Thus, Corporation C would not have a positive sales factor and have no income from Virginia sources. In other words, if Corporation follows Virginia's regulation, it would not be subject to Virginia income tax even if it did have nexus.

Under the General Motors decision, the cost of Corporation A's collections actions within Virginia would have be included in Corporation C's computation as to whether the proceeds from an applicable account receivable are deemed to have occurred in Virginia for purposes of its Virginia sales factor. Under this scenario, Corporation C could have a positive sales factor and be subject to Virginia income tax if Corporation A's collection activities are not de minimis in nature.

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 § 58.1-446. 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.

The Virginia Supreme Court's opinion in Commonwealth v. General Electric Company, 236 Va. 54 (1988), upheld the Department's authority to equitably adjust the tax of a corporation pursuant to Va. Code § 58.1-446 (or its predecessor) where two commonly-­owned corporations structure an arrangement in such a manner as to reflect improperly, inaccurately, or incorrectly the business done in Virginia or the Virginia taxable income. Generally, the Department will exercise its authority if it finds that a transaction, or a party to a transaction, lacks economic substance or transactions between the parties are not at arm's length. The Department has exercised its authority under Va. Code § 58.1-446 in situations involving the factoring of receivables. See P.D. 03-56 (8/8/2003).

In the instant case, Corporation A's accounts receivable are being factored to Corporation C through Corporation B. Because Corporation A is subject to Virginia income tax, and Corporation B and Corporation C may not subject to Virginia income tax, such a transaction effectively decreases Corporation A's Virginia taxable income. 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 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 Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,

                • Janie E. Bowen
                  Tax Commissioner



AR/1-2163754820.B


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46