Document Number
14-148
Tax Type
Corporation Income Tax
Description
No clear and cogent evidence that an alternative method of allocation and apportionment is appropriate.
Topic
Allocation and Apportionment
Appropriateness of Audit Methodology
Pass-Through Entities
Records/Returns/Payments
Subtractions and Exclusions
Date Issued
08-27-2014

August 27, 2014



Re: § 58.1-1821 Application: Corporate Income Tax

Dear *****:

This will reply to your letter in which you seek reconsideration of the Department's determination letter, issued as Public Document (P.D.) 12-218 (12/21/2012), to ***** (the "Taxpayer") for the taxable year ended December 31, 2010. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer was an out-of-state S corporation that operated as a holding company. It had sales, property and payroll in Virginia and filed a unified nonresident return on behalf of its numerous nonresident shareholders. On its 2010 return, the Taxpayer subtracted a gain resulting from the distribution of stock of ***** (Corporation A) to its shareholders. During processing, the Department disallowed the subtraction and reduced the amount of refund claimed by the Taxpayer.

The Taxpayer filed an appeal, contending it did not have a unitary relationship with Corporation A, and its ownership in Corporation A stock was not operational in nature. It requested a refund of Virginia income tax paid for the taxable year ended December 31, 2010.

In P.D. 12-218, the Department denied the Taxpayer's request for a refund because it determined that a gain resulting from the distribution of Corporation A stock was subject to apportionment. While acknowledging no unitary relationship existed between the Taxpayer and Corporation A, the Department found the distribution of stock to shareholders was an activity conducted within the normal operations of Corporation A.

The Taxpayer seeks a reconsideration, asserting that the Department erred when it concluded the stock distribution was apportionable income. The Taxpayer cites the United States Supreme Court's decision in Meadwestvaco Corporation v. Illinois Department of Revenue, 553 U.S. 16, 128 S.Ct. 1498 (2008) to support its position.

DETERMINATION

Investment Pass-Through Entities

Virginia Code § 58.1-486.2 A provides that "a pass-through entity that has taxable income for the taxable year derived from or connected with Virginia sources, any portion of which is allocable to a nonresident owner," must pay withholding tax. The amount of tax that must be withheld is "equal to five percent of the nonresident owner's share of income from Virginia sources of all nonresident owners" that may be lawfully taxed by Virginia and which is allocable to a nonresident owner. See Va. Code § 58.1­-486.2 B 1.

Virginia pass-through entities that are established solely to invest in intangible personal property, such as stocks and bonds, and that have no employees, and no real or tangible property are not considered to be carrying on a trade or business. See Public Document (P.D.) 94-275 (9/16/1994) and Tax Bulletin (VTB) 05-6 (5/6/2005). Thus, income from the intangible property held by an investment pass-through entity is not income from Virginia sources. As such, pass-through entities that are established solely to invest in intangible personal property and that have no employees and no real or tangible property are not required to withhold Virginia income tax.

In this case, although the only activity performed by the Taxpayer was holding the stock of other corporations, it had employees and owned property. As such, it was not an investment pass-through entity and was required to pay withholding tax.

Apportionment of Income

A corporate taxpayer's entire federal taxable income, adjusted and modified as provided in Va. Code §§ 58.1-402 and 58.1-403, less dividends allocable pursuant to Va. Code § 58.1-407, is subject to apportionment in accordance with Va. Code §§ 58.1­408 through 58.1-421. However, the Department will allow an alternative method of allocation and apportionment if a taxpayer can show that the imposition of Virginia's statute is in violation of the standards enunciated by the United States Supreme Court in Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992). In order to meet the standards set in Allied-Signal, Inc., a taxpayer must demonstrate that its investments are not operational assets involved in a unitary business.

In considering the existence of a unitary relationship, the Supreme Court has focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. See Mobil Oil Corp. v Commissioner of Taxes, 445 U.S. 425 (1980); F. W. Woolworth Co. v. Taxation and Revenue Dept. of N.M., 458 U.S. 352 (1982); and Allied-Signal.

The decision of the United States Supreme Court in Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 119 L.Ed.2d 533 (1992), also made it clear that the payee and payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. In P.D. 12-218, the Department concluded the Taxpayer's primary function is to hold and manage the companies in order to provide a return for its shareholders, and the distribution of stock to its shareholders was an activity conducted within its normal operations.

According to the Taxpayer, the Meadwestvaco decision requires that a unitary business relationship must be proven to exist before any other determination as to whether a state can impose tax on an item of income. Because the Department acknowledged the Taxpayer did not have a unitary relationship with Corporation A, the Taxpayer contends the form of business or the purpose of its investment in Corporation A's stock is not relevant to the determination of the taxability of the gain. Under these circumstances, the Taxpayer believes the Meadwestvaco decision eliminated the consideration as to whether the ownership and sale of stock in a corporation fulfills an operational or investment function. Based on this reasoning, the Taxpayer asserts the gain from the stock distribution should not be included in apportionable income.

The Department disagrees. While the United States Supreme Court states in Meadwestvaco supra at 29, 128 S.Ct. 1507 that the decision in Allied-Signal did not create "a new ground for the constitutional apportionment of extrastate values in the absence of a unitary business," it opined the operational function analysis in Allied-Signal could be influential to the finding that an asset was a unitary part of a business being conducted in the taxing jurisdiction. Accordingly, the form of an entity's business and the purpose of its investments continue to be relevant in determining an asset was a unitary part of the business conducted by such entity.

The Taxpayer, an S corporation, was a holding company with ownership interests in a number of companies, including 100% ownership is several manufacturers of food and beverage products. No evidence has been provided to indicate that the Taxpayer had a unitary relationship with any of the entities in which it invested. Consequently, the Department concluded in P.D. 12-218 that the sole business activity of the Taxpayer consisted of acquiring, holding, managing, evaluating and disposing investments in other entities.

The Taxpayer, however, also served as a conduit for a number of pass-through entities, some of which operated in Virginia. Accordingly, the Taxpayer passed through income and other tax attributes to its shareholders. For Virginia income tax purposes, the Taxpayer elected to file a unified income tax return on behalf of its shareholders. The evidence available suggests, however, that each of the Taxpayer's subsidiaries retains its own management with little oversight from the Taxpayer.

In light of the evidence, the Department concludes the Taxpayer's primary function was to manage the investments in other going concerns. Selling stock or otherwise disposing of an investment would be a normal function of such management. As such, the Department considers the distribution of Corporation A's stock to be a unitary part of the Taxpayer's normal business.

Accordingly, the Taxpayer has not demonstrated by clear and cogent evidence that an alternative method of allocation and apportionment is appropriate. Therefore, the disallowance of the subtraction for the gain on the distributions of Corporation A's stock to its shareholders was correct and the Taxpayer's request for refund is denied.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions 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/1-5324618651.B

Rulings of the Tax Commissioner

Last Updated 09/22/2014 13:42