Tax Type
Retail Sales and Use Tax
Description
Domestic International Sales Company
Topic
Allocation and Apportionment
Property Subject to Tax
Subtractions and Exclusions
Date Issued
01-13-1982
January 13, 1982
Re: § 58-1118 Application § 58-151.083 Adjustment DISC Income
This ruling is issued in response to your application under §58-1118, Code of Virginia, a taxpayer conference held April 29, 1981 and additional information submitted.
FACTS
Taxpayer is a multinational company engaged in the manufacture and sale of a diversified line of products. Taxpayer's International Sales Company (TISC0) is a wholly owned subsidiary which qualifies as a Domestic International Sales Company (DISC) under §§991-997 I.R.C. TISCO is not subject to Virginia income tax.
For 1975, 1976 and 1977 TISCO filed forms 1120-DISC with the Internal Revenue Service in which it elected to compute its federal taxable income using the 50-50 combined taxable income method. Taxpayer filed a separate Virginia return for those years.
After audit the Department assessed additional tax for all three years. Within 90 days taxpayer applied under § 58-1118 protesting only the portion of the assessments resulting from an equitable adjustment of the tax under § 58-151.083 based upon consolidation of Taxpayer and TISCO.
DETERMINATION
In its application and in conference Taxpayer advanced a number of arguments which are discussed below.
Taxpayer's first argument was that it complied in all respects with federal law concerning DISC income; that the relationship between Taxpayer and TISCO was proper under federal law; that Virginia taxable income is federal taxable income plus and minus certain items and therefore Virginia taxable income is not "improper" within the meaning of §58-151.083.
§ 58-151.083 provides in pertinent part: "In case it shall appear to the Department of Taxation that any arrangements exist in such a manner as improperly to reflect the business done or the Virginia taxable income earned from business done in this State, the Department of Taxation may, in such manner as it may determine, equitably adjust the tax". (emphasis added)
In deciding whether to invoke this section the Department is not limited to considering whether just the Virginia Taxable income is improperly reflected, as Taxpayer contends. The section refers to "Virginia taxable income earned from business done in this State" which means the Department must also consider "income from Virginia sources," §§ 58-151.03© and 58-151.02(g), and income subject to tax after the allocation and apportionment formulas, §58-151.041. "improperly" in this context means "incorrectly" or "inaccurately." There is no requirement that the Department find violation of federal law, intent to evade taxation or false, fraudulent or other illegal actions. Other sections in the Virginia Code provide substantial civil and criminal penalties for such conduct. See, for example, §§58-44.1, 58-151.088, 58-151.089. This interpretation is in accord with the general meaning of "improper" and with the use of the term in other sections of title 58. See, for example, §58-1119.
Analysis of TISCO's federal returns for 1976 and 1977 discloses that TISCO owns no tangible property. All of its assets are cash, securities or receivables. TISCO paid no salaries or wages and had no employees. Clearly taxpayer used its property and employees to produce TISCO's income. This distorts Virginia taxable income earned from business done in this State three ways:
1. The expenses reduce Virginia taxable income while the gross income produced by Taxpayer's efforts is shifted to TISCO.
2. TISCO's income is returned to Taxpayer in the form of allocable dividends instead of apportionable income from sales,
3. Taxpayer's apportionment factors include property and payroll used to produce TISCO income.
Accordingly, the Department finds that the arrangement between taxpayer and TISCO improperly reflects the Virginia taxable income earned from business; done in this State.
Taxpayer's second argument is that since 50% or more of TISCO's income was included in Taxpayer's income as a deemed dividend, none of TISCO's income can be consolidated with taxpayer because of §58-151.013 (e)(4)(B). This section provides a subtraction for dividends received from a DISC "...fifty percent or more of the income of which was assessable...under the income tax laws of this State.' (emphasis supplied). It is the income of the DISC, not its dividends which must be assessable.
Since TISCO did no business in Virginia and is not subject to Virginia income tax, none of TISCO's income is assessable in Virginia and the subtraction does not apply. See Corporate Income Tax Circular No. 3.
In any event, this provision is irrelevant when an adjustment is made under §58 151.083 on the basis of consolidation since intercorporate transactions, such as dividends, are eliminated. Thus the deemed dividends from TISCO have been subtracted from Taxpayer's Virginia taxable income as part of the consolidation. For this reason Taxpayer's argument concerning the constitutionality of §58-151.013(c)(4)(B) is not discussed.
Taxpayer's last argument is that Congress preempted the right of Virginia to tax DTSC income when it enacted §§ 991-997 I.R.C.
Virginia is not trying to tax TISCO's income. The adjustment was made to properly determine TAXPAYER'S income. Taxpayer's employees managed and controlled TISCO and produced TISCO's income. The relationship between Taxpayer and TISCO was not subject to § 482 I.R.C. (arms length transactions). § 994(a) I.R.C. Under these circumstances Taxpayer and TISCO must be viewed for Virginia tax purposes as a single integrated taxable entity; and the adjustment is based on a proper method of determining income from Virginia sources of such an entity. Exxon Corp. v. Wisconsin Department of Revenue, 447 U.S. 207, 100 S.CT. 2109 (1980); Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 100 S. CT. 1223 (1980).
As a general rule, Virginia does not permit or require the unitary business concept discussed in Mobil, supra, §58-151.081, unless the Department finds that Virginia taxable income from business done in Virginia is improperly reflected. § 58-151.083.
Furthermore, nothing in the DISC provisions of the Internal Revenue Code expressly prohibits the states from taxing DISC income. The intent of Congress in enacting these provisions was to encourage exports by granting a deferral of federal taxes on a portion of export earnings. Unfortunately, the mechanism chosen by congress to temporarily defer federal taxes on some export income has the unintended side effect of permanently shifting all export income among some of the States which use formulary apportionment.
There is nothing in Virginia's law, nor in the Department's application of §58-151.083, which frustrates the deferral of federal taxes or prevents a corporation from taking advantage of the federal deferral. In our federal system it is not unusual for items to be taxed differently by the federal and state governments.
Accordingly I hold that the assessment is correct as made. The assessment should now be paid and you will shortly receive an updated bill with interest to date.
It should be noted that the issue of §58-151.083 adjustments for DISC income is presently before the Circuit Court of the City of Richmond, Division I, in the case styled General Electric Company v. Commonwealth of Virginia. You may wish to preserve your judicial remedies pending final decision in the General Electric case by filing a protective claim under §58-111 9.l.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner