Tax Type
Corporation Income Tax
Description
Net operating losses
Topic
Penalties and Interest
Returns/Payments/Records
Date Issued
04-20-1982
April 20, 1982
Re: 58-1118 Application for taxable year - 1974
58-151.0103 - change in federal taxable income; final determination
Dear ************************
After careful review of your application I have concluded that there is nothing in our law which would permit me to grant the relief you seek. Virginia starts with federal taxable income however it is determined even though, in this case, the result may appear to be inequitable.
Facts
Taxpayer is presently an inactive subsidiary corporation. The issues arise from taxpayer's 1974 liquidation under § 332 I.R.C. After the liquidation the basis of taxpayer's assets in the hand of the parent is determined under § 334(b)(2) I.R.C.
During the late 1960's taxpayer provided data processing services and was developing a major computer program. Taxpayer elected to deduct its development costs under § 174 I.R.C. which resulted in substantial net operating losses. During this period taxpayer filed separate Virginia returns and consolidated federal returns with its then parent, a corporation unrelated to the present parent.
Taxpayer was acquired by its present parent and liquidated early in 1974. After audit the I.R.S. determined that an amount equal to the fair market value of the computer program on the date of liquidation should be added to Taxpayer's 1974 income invoking the tax benefit rule. (For an explanation of the tax benefit rule see Rev. Rul. 74-396.)
Taxpayer reported the change in its federal taxable income as required by § 58-151.0103. The Department determined that the additional income was apportionable income and assessed additional tax. Within 90 days taxpayer applied for correction of an erroneous assessment under § 58-1118.
Determination
Taxpayer protests the assessment on the grounds that it received no Virginia tax benefit from the deduction of development expenses because it filed separate Virginia returns. If separate federal returns had been filed large amounts of net operating losses (far greater than the amount of the adjustment) would have expired unused. In other words, the federal adjustment is due solely to the fact that taxpayer's former parent benefited from the filing of a consolidated federal return, not to the fact that taxpayer deducted the development costs.
Your argument misses the point. The adjustment was made to taxpayer's income for 1974 because the I.R.S. determined that taxpayer's liquidating distribution of a valuable computer program was an event inconsistent with the deduction of development costs in prior years. There is no indication in the revenue agent's report that the filing of consolidated returns was involved in the application of the tax benefit rule.
By deducting development cost taxpayer reported losses on its Virginia returns and paid no Virginia income tax for several years. Thus taxpayer received some Virginia tax benefit from the deduction although it would appear that taxpayer did not receive the maximum possible Virginia tax benefit. However there is no requirement in Virginia law that taxpayer receive the maximum benefit possible, or indeed, any benefit, before recognizing a change in federal taxable income for Virginia income tax purposes. The nature of adjustments to federal taxable income is taken into account only to determine if the changes affect Virginia additions, subtractions, allocation and apportionment.
There is a substantial question as to whether the I.R.S. was justified in invoking the tax benefit rule at all. A similar case is presently pending before the U.S. Supreme Court. United States v. Bliss Dairy, Inc., 645 F 2d 19 (CA 9, 1981) cert. gr. 50 U.S.L.W. 3570. The question arises because taxpayer did not actually receive or recover any benefit when it distributed its assets to its parent. The federal circuit courts are in conflict on this issue and the Supreme Court may resolve the conflict by ruling against the I.R.S. position.
However, the federal determination is not being challenged in Tax Court and is therefore final for federal purposes; that is, the I.R.S. has the right to take action to collect it. Therefore there is a final determination within the meaning of §§ 58-151.0103 and 58-151.0104.
Taxpayer may be contemplating a federal refund suit, particularly if the U.S. Supreme Court rules against the I.R.S. position in Bliss Dairy, Inc., supra. In the event taxpayer is successful in such an action this will be another "final determination" allowing taxpayer to claim a refund of Virginia income tax. § 58-1118.1.
Accordingly the assessment of additional Virginia income tax is correct. You will shortly receive an updated bill with interest accrued to date, which should be paid immediately to prevent further interest accruing.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner