Tax Type
Corporation Income Tax
Description
Consolidated filer; Canadian subsidiary; Environmental tax; Foreign source income
Topic
Returns/Payments/Records
Date Issued
08-02-1991
August 2, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear*************
This will reply to your letter of December 18, 1990, in which you seek correction of corporation income tax assessments for *************** ("the Taxpayer").
FACTS
The taxpayer filed consolidated Virginia corporation income tax returns for the taxable years ended 1/31/87, 1/31/88 and 1/31/89. The returns were audited and numerous adjustments were made, resulting in the assessment of additional tax. You object to several adjustments.
The issues you raise will be addressed separately.
DETERMINATION
Nexus: The auditor removed the taxpayer's wholly owned Canadian subsidiary from the Virginia consolidated return for the three taxable years under review. You assert that the Canadian subsidiary had nexus in Virginia and should have been included in the consolidated return.
The taxpayer has not established that its Canadian subsidiary has nexus with Virginia because it owns no property and has no employees located in Virginia. Its sales are all in Canada. The fact that the affiliate in Virginia renders services to the Canadian subsidiary does not create nexus with Virginia.
Federal law allows the taxpayer the option of including the foreign subsidiary in the federal consolidated return. Virginia law contains no such election. In fact Va. Code §58.1-443 provides that a consolidated or combined return may not include a controlled foreign corporation the income of which is derived from sources without the United States. In this case, the wholly owned subsidiary is organized under the laws of Canada, its commercial domicile is in that country, and it has no income from sources in Virginia. Therefore, it is not eligible to be included in the taxpayer's Virginia consolidated return.
Exempt affiliate: The auditor included another affiliate in the consolidated Virginia return because its employee based in Virginia clearly establishes nexus with Virginia. You now contend that the affiliate is exempt from Virginia income tax under P.L. 86-272 because the employee engaged only in solicitation activity, and the corporation had no other contacts with Virginia. This is a factual issue that was not raised with the auditor or addressed during the audit. Therefore, I am returning the audit to the auditor for further proceedings on this issue. If after further inquiry the auditor finds that there exists sufficient activity in Virginia to disqualify the corporation from the protection of P.L. 86-272 and you disagree with the findings, you may reapply for correction of assessment under Va. Code §58.1-1821.
Subtraction for Foreign Dividends: For the tax year ended 1/31/87, the auditor computed a subtraction for foreign source income based on the amount of foreign dividends shown on line 8 of Schedule C on the federal return. The taxpayer claims that the subtraction should be greater, because the amount on line 8 of Schedule C is a net amount based on the taxpayer's "equity method" of accounting.
The computation of Virginia taxable income begins with federal taxable income. Therefore, Virginia relies on the amount and character of each item reported on the federal return and supporting schedules. When a taxpayer alleges that an item should be treated differently on a Virginia return than it was on a federal return, the taxpayer must clearly show that the item was erroneously reported on the federal return and must also show that the erroneous item did not affect the amount or characterization of any item of federal taxable income. The taxpayer has failed to justify different treatment for Virginia purposes. The auditor reconciled the subtraction with the total dividends reported on Schedule C; the taxpayer's adjustments would change the characterization of items of federal taxable income. Accordingly, the subtraction as computed by the auditor is accepted.
Excess Cost Recovery: The auditor adjusted the ACRS subtraction reported for the 1/31/89 taxable year by the taxpayer. You claim that the auditor failed to include ACRS subtractions relating to a corporation acquired by the taxpayer on March 1, 1988.
Pursuant to §8 of Virginia Regulation (VR) 630-3-323.1, an acquiring corporation may include the ACRS subtractions of an acquired corporation. Therefore, the ACRS subtractions reported by the acquired corporation may now be included in the taxpayer's consolidated return, provided that the conditions set forth in 8 of VR 630-3-323.1 are satisfied.
Environmental Tax: On its federal return, the taxpayer reported a deduction for the amount of environmental tax paid. The amount of tax was not included in the taxpayer's Virginia taxable income. The auditor adjusted the taxpayer's income by adding the amount of the tax to the taxpayer's income, in accordance with Va. Code §58.1-402 B.4.
Va. Code §58.1-402 B.4. provides that any net income taxes or other taxes which are based on, measured by, or computed with reference to net income, imposed by Virginia or any other taxing jurisdiction and deducted in determining federal taxable income shall be added to Virginia taxable income.
The department has recently ruled that the federal environmental tax deducted in determining federal taxable income must be added back when computing Virginia taxable income. P.D. 91-87 (5/29/91) (copy enclosed). Therefore, the auditor's adjustment is correct.
The audit report will be revised to reflect the principles set forth in this letter. You will receive an updated bill with interest accrued to date. The bill should be paid within 30 days to avoid the accrual of additional interest.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner