July 27, 2021
Re: Ruling Request: Allocation and Apportionment of Income
Dear *****:
This will respond to your request that ***** (the “Taxpayer”) be permitted to use an alternative method of apportionment for Virginia income tax purposes.
FACTS
The Taxpayer, a family limited partnership, owns a rental property in Virginia and three similar properties in other states. The Taxpayer states the income or loss of each rental property is readily available. The Taxpayer believes that Virginia’s apportionment method does not accurately reflect income earned in Virginia and requests permission to allocate income to Virginia based on separate accounting for the 2014 taxable year and thereafter.
RULING
If the entire business of the pass-through entity is not deemed to have been transacted or conducted within Virginia, then such pass-through entity's income from Virginia sources is the portion of income allocated and apportioned to Virginia in the same manner as corporations. See Public Document (P.D.) 07-150 (9/21/2007). Accordingly, partnerships that have income that is subject to tax in Virginia and at least one other state are required to apportion income as provided in Virginia Code §§ 58.1-408 through 58.1-421
The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state’s method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair, 437 U.S. 267, 98 S. Ct. 2340 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.
An apportionment formula used as an approximation of an entity’s income reasonably related to the activities conducted within a taxing state will only be disturbed when the taxpayer has proved by “clear and cogent evidence” that the income attributed to the state is in fact “out of all reasonable proportion to the business transacted . . . in that state,” Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123, 135 (1931), or has “led to a grossly distorted result,” Norfolk & Western R. Co. v. Missouri State Tax Commission, 390 U.S. 317, 326 (1968).
Recently, the Virginia Supreme Court’s decision in Corp. Exec. Bd. Co. v. Va. Dep't of Taxation, 297 Va. 57, 822 S.E.2d 918 (2019) found that Virginia’s apportionment method did not violate the Due Process or Commerce clauses of the United States Constitution or Virginia Code § 58.1-421 and did not create a distorted result because the tax imposed on services rested upon the labor of employees in Virginia. Recognizing the United States Supreme Court’s decision in Moorman Mfg., 437 U.S. at 274, Virginia’s highest court acknowledged that the existence of double taxation does not, by itself, violate the United States Constitution. Further, it conceded the inevitability of states devising different schemes of taxation and apportionment. Corp. Exec. Bd., 297 Va. at 72, 822 S.E.2d at 925 Thus, states are granted wide latitude in adopting apportionment formulas. See Moorman Mfg., 437 U.S. at 274.
Title 23 of the Virginia Administrative Code (VAC) 10-120-280 goes even further by permitting taxpayers an alternative method when the statutory method of allocation and apportionment is inequitable. Under the standards of the regulation, a statutory method can be found to be inequitable if: (1) it results in double taxation of the income, or a class of income, of the taxpayer; and (2) the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.
The Department’s long-standing policy holds the use of separate accounting in disfavor. See Department of Taxation v. Lucky Stores, Inc., 217 Va. 121, 225 S.E.2d 870 (1976), P.D. 85-61 (3/18/1985), P.D. 86-88 (4/30/1986), P.D. 92-85 (6/1/1992), P.D. 06-13 (2/7/2006), P.D. 07-75 (5/18/2007), P.D. 11-138 (7/28/2011) and P.D. 13-86 (6/10/2013). The fact that separate accounting produces a different result from the statutory method is not sufficient to show the statutory apportionment method is inequitable. The Taxpayer has provided no evidence to demonstrate the statutory apportionment method is inequitable. Further, the Department has previously addressed this issue with regard to taxpayers engaged in the business of renting real estate in P.D. 99-195 (7/21/1999) and P.D. 09-47 (4/27/2009).
In addition, the Taxpayer has not followed the established procedure for requesting an alternative apportionment method. The policies that apply to requests for an alternative method of allocation and apportionment under Virginia Code § 58.1-421 are well established. In order for a taxpayer to request an alternative method of allocation and apportionment, the taxpayer must file the return using the statutory method and pay any tax due. Next, the taxpayer is required to file an amended return proposing an alternative method within the time prescribed for filing amended returns claiming refunds. The amended return must include a statement of why the statutory method is inapplicable or inequitable and an explanation of the proposed method of allocation and apportionment. The Department will not grant an alternative method of allocation and apportionment unless it determines: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer's situation; or 2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state's method of apportionment. See Title 23 VAC 10-120-280.
In the context of a ruling request, when a taxpayer does not provide the Department with the opportunity to examine the records underlying the claim, the taxpayer cannot demonstrate that Virginia’s factor formula produces an unreasonable or distorted result. Further, because constitutional apportionment is designed to approximate income from business transactions within a state and not result in actual income from business transactions within a state, a taxpayer's argument that Virginia’s statutory method does not accurately reflect income in Virginia cannot be accepted.
The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Based on the facts presented, the Taxpayer has not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer’s business. Furthermore, the Taxpayer’s request is not in accordance with the procedure for requesting an alternative method of allocation and apportionment outlined in Title 23 VAC 10-120-¬280. Based on the foregoing, I must deny the Taxpayer’s request to use an alternative method of allocating and apportioning income.
The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions 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/577o