Tax Type
Corporation Income Tax
Description
Include dividends/interest/rents/capital gains/ordinary gains in allocable income
Topic
Allocation and Apportionment
Appropriateness of Audit Methodology
Date Issued
10-13-1982
October 13, 1982
Re: Taxpayer
Corporation Income Tax; § 58-151.051
Request for Alternative Method of Allocation and Apportionment
Dear ****************
I have reviewed your letter of May 5, 1982, requesting permission to use an alternative method of allocation and apportionment. Specifically, you request permission to include dividends, interest, rents, capital gains and ordinary gains in allocable income, which would be allocated to North Carolina.
Taxpayer filed its return for calendar year 1981 using the requested method. After an office audit the department included all income in apportionable income and assessed additional tax.
Corporation Income Tax. Circular No. 1 sets forth the criteria applied to requests for an alternate method of allocation and apportionment. In pertinent part it states:
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- A request for permission to use an alternate method of allocation and apportionment shall be accompanied by data sufficient to show either:
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- (1) That the statutory method is in fact inapplicable because it produces an unconstitutional result under the particular facts and circumstances of the taxpayer's situation; or
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- (2) That the statutory method is in fact inequitable because:
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- (a) It results in double taxation of the income, or a class of income, of the taxpayer; and
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- (b) The inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.
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Taxpayer has not shown that the statutory method produces an unconstitutional result. The U.S. Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate the income from business transacted within a state. Because each state has its own variations in what is allocated and in how the remainder is apportioned it is inevitable that some overlap will occur; that is, some income will appear to be taxed by more than one 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, for example, Moorman Mfg. Co. v. Bair, 437 U.S. 279, 98 S.Ct. 2340 (1978).
Virginia's statutory method of apportioning all income of a corporation (except certain dividends) is designed to produce a tax that is rationally related to the business transacted within Virginia. The facts suggest that there is some overlap in income between Virginia and North Carolina, but that is not sufficient to show that Virginia's apportionment method is unconstitutional, either in general or as applied to Taxpayer.
Corporation Income Tax Circular No. 1 also says that relief may be granted if the statutory method of allocation and apportionment produces a tax that is inequitable and the inequity is attributable to Virginia.
There are three stages to determining a state income tax. First, the income must be determined. Each state has its own rules for determining income. Some rely on federal taxable income; there are many different rules for items such as foreign source income, interest on state obligations, depreciation, consolidated returns and use of world wide combined reporting.
Second, the income must be divided among the states. Some states use separate accounting; most use some variation of allocation and apportionment.
Third, a rate of tax is applied to the taxable income attributed to the state. Not only do the rates vary but there are numerous types of credits allowed.
Taxpayer alleges that at the second stage there is an overlap of certain income which was attributed to, and taxed by, both Virginia and North Carolina. But there may be other differences in the first and third stages which compensate for the overlap. I must consider the whole process by which the tax is computed, not merely the isolated part of the process where the alleged inequity occurred.
Furthermore, there is no showing that the inequity, if any, is attributable to Virginia. The overlap has occurred not because of Virginia law or North Carolina law but because the laws of the two States differ. The fact that two laws differ provides no basis for concluding that one or the other is inequitable.
The General Assembly has provided a statutory method of allocation and apportionment that applies to all corporations; there is no election or discretion allowed to taxpayers or to the Department of Taxation. I construe § 58-151.051 as authorizing me to allow use of an alternative method only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Accordingly, permission to use an alternative method of allocation and apportionment is denied.
However, in the course of auditing Taxpayer's return, certain dividends were inadvertently included in apportionable income. § 58-151.037 provides that "(d)ividends received to the extent included in Virginia taxable income are allocable . . . ." The return discloses that $ ****of dividends were received. After the 85 percent dividends received deduction, $12.00 was included in Virginia taxable income and is allocable to North Carolina. The assessment will be adjusted accordingly.
For the reasons stated, permission to use an alternative method of allocation and apportionment is denied. The assessment, as adjusted, should now be paid.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner