12-36 | Virginia Tax

Tax Type

Corporation Income Tax

Description

VA activities appear to create nexus, allowing tax on the VA income

Topic

Allocation and Apportionment

Nexus

Pass-Through Entities

Taxable Transactions

Taxability of Persons and Transactions

Date Issued

03-28-2012

March 28, 2012

Re: Request for Ruling: Corporate Income Tax

Dear *****:

This will reply to your letter in which you request a ruling concerning corporate income tax nexus on behalf of your client (the "Taxpayer").

FACTS

The Taxpayer, an entity headquartered outside Virginia, maintains an Internet website that provides online business profiles and marketing services for businesses. Revenue is generated from advertising fees and subscriptions. Advertising revenue includes fees for performance-based cost per click, impressions-based displays, and contextual advertising. Subscription revenue is derived from businesses desiring to ensure it will receive higher search ratings.

The Taxpayer does not operate a facility in Virginia, but does own several Internet servers in Virginia that are maintained and managed by an unrelated third party. The Taxpayer employs one sales person in Virginia whose activities are limited to solicitation, and all orders are sent to the corporate headquarters for approval. Based on the facts presented, the Taxpayer requests a ruling that it does not have nexus with Virginia for purposes of corporate income tax. In addition, should the Department rule that it does have nexus, the taxpayer requests a ruling as to how its sales factor should be computed.

RULING

Nexus

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 the applicable apportionment factor positive. See Va. Code §§ 58.1-408 through 58.1-414. The existence of a positive Virginia apportionment factor establishes income from Virginia sources.

Public Law (P.L.) 86-272, 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. 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 sale of other than tangible personal property. See Public Document (P.D.) 91-33 (3/18/1991) and P.D. 93-75 (3/17/1993). 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). The Department has a long-established policy of narrowly interpreting the provisions of P. L. 86-272.

The Taxpayer indicates that its Virginia employee is engaged in the solicitation of sales, but has provided no detailed explanation of the specific duties and responsibilities of such employee. In Wrigley, the United States Supreme Court set forth a number of activities that constitute mere solicitation of sales. Such activities include in-state recruitment, training, and evaluation of sales representatives, use of hotels and homes for sales-related meetings, provision of product displays and promotional materials, and the use of a business owned automobile by sales personnel. In addition, the Department has issued numerous public documents addressing whether specific activities would be considered to be ancillary to solicitation. See P.D. 92-150 (8/24/1992), P.D. 94-111 (4/14/1994), P.D. 95-57 (3/28/1995), P.D. 96-1 (1/4/1996), P.D. 96-281 (10/11/1996), 97-232 (5/21/1997), P.D. 97-447 (11/10/1997), P.D. 01-157 (10/19/2001), 08-142 (7/30/2008), and P.D. 09-142 (10/23/2009). The Taxpayer should analyze the activities conducted in Virginia by its employee to verify if any of the activities exceed the mere solicitation of sales.

Assuming the salesperson’s activities do not exceed the protection afforded under P.L. 86-272, the Taxpayer's only connection with Virginia would be the server equipment located at a facility operated by an unrelated third party. In Wrigley, the United States Supreme Court held that automobiles used by the sales professionals are included in activities considered to be ancillary to solicitation. The Department has extended such treatment to computers that are provided to the sales professionals for the purpose of preparing sales presentations, reports to record the sales professional's activities, and other administrative functions.

The facts presented, however, do not indicate that the server equipment in Virginia is connected with the Taxpayer's solicitation activities. Instead, the servers are used to provide online business profiles and marketing services for the Taxpayer's customers. Such activities conducted in Virginia would clearly exceed the protections afforded under P.L. 86-272.

The Taxpayer indicates that it does not have access to the servers located at the unrelated third party's secured facility in Virginia. The unrelated third party charges the Taxpayer a fee to maintain the servers in good working condition. Software updates are made from the Taxpayer's headquarters. The Taxpayer asks the Department to rule that the servers do not create nexus because it does not have physical access to the unrelated third party's facility.

Title 23 of the Virginia Administrative Code (VAC) 10-120-90 G exempts activities that are de minimis in nature. Under this regulation, consideration is 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 Virginia. Pursuant to Wrigley, all nonancillary activities are examined to determine if, when considered together, they create more than a de minimis connection to Virginia. Without a full examination of the activities conducted in Virginia by the Taxpayer, a determination cannot be made as to whether such activities discussed in the preceding sections would be a de minimis connection with Virginia.

Based on the facts presented, the Taxpayer's activities in Virginia would appear to create nexus, allowing the Commonwealth to impose tax on the Taxpayer's income apportioned to Virginia. As previously stated, a corporation or pass-through entity will have income from Virginia sources if there is sufficient business activity within Virginia to make the applicable apportionment factor positive. See Va. Code §§ 58.1-408 through 58.1-416. The existence of a positive Virginia apportionment factor establishes income from Virginia sources. In this case, the Taxpayer would have positive payroll and property factors.

Apportionment

The Taxpayer also asks for a ruling concerning how it would compute its sales factor. It is engaged in providing services to its customers through the Internet. 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; or

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 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). This 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 presented in your letter, direct costs for officer's salaries, solicitation, advertising, and administration (including depreciation, overhead and taxes) were incurred outside Virginia. In addition, the Taxpayer would incur some direct costs associated with its personnel and servers in Virginia. The question becomes whether the greater portion of the income producing activity for each advertising fee and subscription charge is performed in Virginia or another state.

The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct cost associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would riot be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.

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, public documents, 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 *****.

- - - - Sincerely,

- - - - Craig M. Burns
        Tax Commissioner

AR/1-4892367730.o

Rulings of the Tax Commissioner