Tax Type
Corporation Income Tax
Description
Foreign hotel management; Capital loss carryover; Foreign source income
Topic
Computation of Income
Date Issued
11-03-1986
November 3, 1986
Re: §58.1-1821 Application; Corporate Income Tax
§58.1-302 Foreign Source Income
§58.1-402 Federal Taxable Income; Capital Loss Carryover
Dear **********************
This is in response to your letter of October 15, 1985, applying for correction of an assessment of income tax for taxable years 1981 and 1982. After reviewing the assessment it appears that the assessment for 1981 was made after the period for assessing additional tax had expired. Accordingly, the assessment for 1981 will be abated.
Capital loss carryover
In 1981 the taxpayer incurred a substantial net capital loss which could not be used due to the limitation in I.R.C. §1211. on the federal consolidated return the consolidated loss was carried back to 1978 and 1979 and entirely absorbed. However, if the federal returns had been prepared on the same basis as the Virginia returns, i.e. separate, none of the loss would have been absorbed in 1979 and some of the loss would still be available for use in the 1982 return.
Therefore the taxpayer's 1982 federal taxable income for Virginia purposes should reflect the carryover of the 1981 loss to the extent it could not have been absorbed in 1978, as if separate federal returns had been filed.
The taxpayer did not file an amended 1978 Virginia return to claim a refund due to the change in federal taxable income attributable to the carryback of the 1981 capital loss. The period for filing such a return was tied to the period for filing an amended 1981 return and expired before this application for correction was filed. Therefore a refund of 1978 taxes can not be made.
Foreign Source Income
The taxpayer carries on substantial business activities without the United States and receives income which may be characterized as follows:
hotel franchise and license agreements
hotel management contracts
ownership and operation of a hotel
Although all of this income is treated as income from without the United States for federal purposes, the Virginia subtraction is limited to the specific types of income from without the United States set forth in §58.1-302.
Income from franchise and license agreements clearly qualifies as "rents, royalties, or fees for the use of or the privilege of using any . . . franchise."
The taxpayer concedes that income from the ownership and operation of a hotel does not qualify as foreign source income. Therefore this income will be included in Virginia Taxable Income and the property, payroll and sales of the foreign hotel will be included in the denominator of the apportionment factors.
The taxpayer contends that income from hotel management contracts is income from the performance by the taxpayer of "managerial/technical services," thus qualifying as "technical fees" under the definition of foreign source income. The full text of the relevant paragraph of the definition is as follows:
Rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property, including rents, royalties, or fees for the use of or the privilege of using without the United States any patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like properties. §58.1-302.
A review of the legislative history of the act which created the foreign source income subtraction (chapter 402, 1981 Acts of Assembly, S.B. 641) reveals that the purpose of the act was to restructure the allocation and apportionment provisions of Virginia law in reaction to the Supreme Court's decision in Commonwealth v. Champion Int. Co., 220 Va. 981 (1980). The act removed all classes of income except dividends from allocable income and allowed a subtraction for foreign source income. The types of income which were allocable under former law bear a striking similarity to the types of income included in the definition of foreign source income under current law. It appears that part of the purpose of the foreign source income subtraction. was to prevent apportionment of certain types of income, such as royalties, which would have been allocated to a foreign country under former law.
The words "technical fees from . . . services performed" cannot be taken out of their context to create a subtraction for income earned from the performance outside the United States of any service which can be characterized as of a technical nature. The words are incorporated in a subsection dealing with passive income from the rental of real estate and with income from patents, copyrights and other intangible property. "[W]hen general words and specific words are grouped together, the general words are limited and qualified by the specific words and will be construed to embrace only objects similar in nature to those objects identified by the specific words." Commonwealth v. United Airlines, 219 Va. 374 at 389, 248 S.E.2d 124 (1978).
The income earned in the taxpayer's day to day management of a hotel under a management contract is not similar in nature to fees charged for occasional technical assistance incidental to a contract relating to the rental of property located without the United States or the licensing of a patent, copyright, trademark, trade brand, franchise and other like property for use without the United States.
Therefore the income received by the taxpayer from management contracts does not qualify as foreign source income under Virginia law. The income will be included in apportionable income and the apportionment factors.
Property factor
In view of the information submitted with your application, the adjustment to the 1982 property factor for "unsupported amounts" will be removed from the audit. You concede that the auditor properly removed construction in progress from the factor. Although you claim that the return as originally filed did not include property and not in use, the amounts claimed reconcile to the balance sheet on I.R.S. form 1120 without adjustment. Therefore it appears that the auditor properly made an adjustment to remove property and equipment not in use from the property factor.
Determination
The assessment for 1981 will be abated. The assessment for 1982 will be adjusted in accordance with the principles set forth in this letter. You will receive a revised audit report and bill with interest accrued to date. In order to avoid additional interest the revised bill should be paid within thirty days.
Sincerely,
W. H. Forst Tax
Commissioner
Rulings of the Tax Commissioner