Tax Type
Corporation Income Tax
Description
Interest income
Topic
Allocation and Apportionment
Date Issued
07-29-1984
July 31, 1984
Re: Application for Correction of Assessments
Corporation Income Taxes
Fiscal Years Ended March 31, 1980 and 1981
Dear ***************
This will respond to your letter of January 26, 1984 in which you appeal pursuant to § 58-1118 of the Code of Virginia for correction of corporation income tax assessments and to your subsequent correspondence submitted in support of your appeal.
Facts
Taxpayer, a ************ corporation which maintains its commercial domicile in Virginia, was assessed on November 1, 1983 with additional Virginia corporation income taxes for its fiscal years ended March 31, 1980 and March 31, 1981. On January 26, 1984, Taxpayer timely protected the assessments under the provisions of § 58-1118 of the Code of Virginia.
During the years at issue, Taxpayer earned substantial amounts of interest which it reported as apportionable income in its Virginia corporation income tax returns. In audit, adjustments were made to include interest income in allocable income as required by Virginia Code § 58-151.040 for the years involved and Taxpayer's protest is limited to this issue.
The interest at issue consisted of interest earned on escrowed funds, interest on a note arising from the sale of a wholly owned subsidiary, interest on investment of proceeds from the sale of a wholly owned subsidiary, interest from various short term investments and interest from miscellaneous business sources.
In its protest, Taxpayer argues that its interest income should be considered apportionable income rather than allocable income because:
1) In preparation of its tax returns, Taxpayer relied on the instructions to Schedule A of Form 500 which stated:
"Interest that is generated by and related to normal business activities is apportionable since not specifically related to special control of the headquarters office. This includes interest on trade receivables, carrying charges or service charges, and all time price differential charges by whatever name called."
2) All interest except a minor amount of interest from short term investments was directly related to one or more of Taxpayer's principal business activities conducted in states other than Virginia and not specifically related to special control of the headquarters office in Virginia.
In the alternative, it is argued that only net interest income, after deducting interest expense and appropriate fees and service charges, may be allocated.
Determination
Virginia law (§ 58-151.040) applicable to taxable years beginning prior to January 1, 1981 provided for the allocation of interest income except interest derived from investments in subsidiary corporations.
Departmental policy under the provision of Code § 58-151.040 recognized certain business related interest as apportionable income, as was noted by Taxpayer. However, in the case of Commonwealth of Virginia v. Champion International Corporation (220 VA 981 (1980)) the court ruled that all interest income, whether or not business related, is required by Virginia statutes (prior to repeal) to be allocated to the state of the corporation's commercial domicile. The department is required to adhere to the court's decision whether or not the result of its application is favorable to a taxpayer. Accordingly, all interest income at issue must be allocated to Virginia, the state of Taxpayer's commercial domicile.
In regard to Taxpayer's alternative argument, § 58-151.040 of the Code of Virginia, as it existed for the years here involved, provided for the allocation of interest and made no reference to net interest. However, in light of Code § 58-151.038 which provides for the allocation and apportionment of Virginia taxable income (net income), the department recognizes that certain expenses, principally interest on obligations, may be attributable to interest income in computing net interest income for purposes of allocation. It is our general view that money is fungible and that unless borrowed money is borrowed and used for a specific purpose, the interest paid on such borrowed money is considered related to all income producing activities and properties of the taxpayer and thus attributable to all gross income which the income producing activities and properties of the taxpayer generate, have generated or could reasonably have been expected to generate.
In the matter at issue, I find portions of interest income to have been earned from investments to which certain interest expense is directly attributable and other portions from activities and properties to which no interest expense is directly attributable.
In protest, Taxpayer has established that in order to take advantage of favorable market conditions, it did from time to time sell product it did not have in inventory and, to cover such sales, borrowed product from other sources, to be returned from future production. Interest was paid on the value of the borrowed product until returned and by agreement Taxpayer was required to place the proceeds from sales of some of the borrowed product in escrow until repayment of the borrowed product. The escrowed funds were placed in interest bearing accounts which produced a substantial portion of the allocable interest income here involved.
I find interest expense paid on borrowed product sold to be specifically related to and directly attributable to interest earned from the proceeds of sales of borrowed product, by agreement placed in interest bearing escrow accounts. Schedule A accompanying this determination reflects the computation of such attributable interest expense.
I find no interest expense directly attributable to any other categories of interest income at issue. However, interest on funds borrowed for general business purposes is deemed attributable to such interest income in the ratio that properties producing such income bear to total properties of the business, Schedule B accompanying this determination reflects the computation of such attributable interest expense.
Revised assessments will be due and payable upon receipt with interest at applicable rates to date of payment.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner