Document Number
12-47
Tax Type
Corporation Income Tax
Description
Apportioned income based on property, payroll and sales factors.
Topic
Appropriateness of Audit Methodology
Records/Returns/Payments
Taxability of Persons and Transactions
Date Issued
04-23-2012

April 23, 2012


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 September 30, 2008.

FACTS


The Taxpayer is a construction contractor based in Virginia that performed construction jobs both in and outside the Commonwealth. During the 2007 taxable year, the Taxpayer assigned personnel that resided in Virginia to perform work on jobs in Maryland. The Taxpayer did not report its income on the completed contract basis. As such, it apportioned its income based on property, payroll and sales factors.

Under audit, the Department attributed all of the Taxpayer's sales to Virginia in the sales factor. The auditor determined that the majority of the income producing activities occurred in Virginia because the Taxpayer was located in Virginia, had no permanent locations outside Virginia, and the Taxpayer attributed all of its property and payroll to Virginia. The Taxpayer, contests the auditor's adjustment, asserting that a majority of its employee costs for its employees working on Maryland ("State A") construction projects occurred in State A and therefore should be attributed to State A for purposes of the sales factor.

DETERMINATION


Sales Factor

Within Virginia's three factor formula, Va. 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.

In General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S.E.2d 123 (2004), the Virginia Supreme Court held that 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 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.

While the Taxpayer engages in contract activities outside Virginia, direct costs for officer's salaries, solicitation, advertising, bidding, and administration (including depreciation, overhead and taxes) were incurred in Virginia. The question becomes whether the greater portion of the income producing activity from contracts performed outside Virginia occurred in Virginia or another state. First, the Taxpayer would have to determine the costs associated with each contract for a given taxable year. The computation of such costs per contract would include materials, payroll and equipment used to execute the contract and a portion of the costs incurred at the Virginia headquarters to facilitate, oversee, and administer the contracts.

All of the Taxpayer's employees are Virginia residents. When the Taxpayer contracts for a construction project in another state, it sends employees to the state to perform the contract. The Taxpayer has produced documentation to show that a majority of its costs incurred on projects performed in other states should be attributed outside Virginia. The cost of the Taxpayer's employees that traveled to other states to perform contract activities would be a cost incurred in that other state. The information provided, however, is not of sufficient detail to show whether some employees perform activities on a contract both within and without Virginia.

The Taxpayer further contends that only the costs of the employees that executed the contract should be considered to be direct costs that should be attributed to Maryland. As indicated above, however, Title 23 VAC 10-120-230 requires that the costs of all activities performed by the Taxpayer to complete the construction projects in other states must be included in determining the cost of performance.

Payroll Factor

During the course of our review of this case, the Department determined that the Taxpayer reported the wages of its employees that performed work in Maryland in the numerator of its Virginia payroll factor because their wages were reported to the Virginia Employment Commission (VEC) for unemployment compensation purposes. Under Title 23 VAC 10-120-200 A 4, any wages reported pursuant to the VEC is presumed to be compensation paid in Virginia. When Virginia has entered into a reciprocity agreement with another state, however, the wage reporting for VEC purposes may not be determinative of payroll attributable to Virginia. See Public Document (P.D.) 87-80
(2/27/1987).

In this case, a reciprocity agreement between Virginia and Maryland permits Virginia residents commuting daily to Maryland to have taxes withheld and paid to Virginia only. Thus, if the Taxpayer can show the amount of payroll incurred when its employees commuted to Maryland to perform contract activities, it would be able to attribute such wages outside Virginia for payroll factor purposes.

Further, Title 23 VAC 10-120-200 A 3 provides that when an employee's service is performed both within and without Virginia, the employee's compensation will be attributed to Virginia if the employee's base of operations is in Virginia. Pursuant to Title 23 VAC 10-120-200 B 2, a base of operation is defined as a place from which an employee starts his work and to which he customarily returns in order to receive instructions. However, this regulation also states that "[a] contractor's job site will be considered to be a base of operations".

In this case, some of the Taxpayer's employees performed activities at job sites in other states. As such, the compensation paid to the Taxpayer's employees working at these job sites should not have been included in the numerator of the Taxpayer's payroll factor.

CONCLUSION


The Taxpayer has not provided adequate information to document its cost of performance for each construction project engaged in during the 2007 taxable year for purposes of its sales factor. Further, it appears that the Taxpayer may have improperly attributed wages to Virginia in its payroll factor.

In accordance with this determination, the audit will be returned to the audit staff to adjust the 2007 assessment as noted above. During this process, the Taxpayer may provide information to document its cost of performance per contract as well as compensation paid to employees while working at job sites located in other states. After the auditor makes the appropriate adjustments, the Taxpayer will receive a revised bill. The Taxpayer should remit payment for the outstanding balance as shown on the revised bill within 30 days from the date of the revised bill to avoid the accrual of additional interest.

The Code of Virginia sections, regulations, tax bulletin, 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 determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,



Craig M. Burns
                • Tax Commissioner




AR/1-4681442469.B


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46