Tax Type
Corporation Income Tax
Description
Combined return adjusted; Additional income, Foreign source income
Topic
Subtractions and Exclusions
Taxable Income
Date Issued
05-02-1991
May 2, 1991
Re: §58.1-1821; Corporation Income Tax
Dear***************
This will reply to your letter of September 21, 1989, in which you seek correction of a corporation income tax assessment for*****************(the "Taxpayer").
FACTS
The taxpayer was field audited and numerous adjustments were made to the 1985 combined Virginia return. You protest four adjustments: (1) the increased addition to Virginia taxable income for taxes deducted on the federal return; (2) the disallowance of a portion of the foreign source income subtraction claimed on the Virginia return; (3) the reduction of the numerator and denominator of the single apportionment factor used by the taxpayer, a financial corporation; and (4) the reduction of the denominator of the property factor of an affiliated corporation included in the combined return.
The issues you raise will be addressed separately.
DETERMINATION
Addition to Virginia Taxable Income - Taxes: on its 1985 combined return, the taxpayer increased its Virginia taxable income by net income taxes deducted on its federal return. The auditor increased the income by adding back additional taxes deducted on the federal return. You claim that these taxes should not have been added back, as they were not based on net income.
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. In this case, the additional taxes added back by the auditor were levied by cities. It appears that the auditor reconciled to total state and local taxes deducted on the federal return. Since this figure includes all state and local taxes, whether or not measured by net income, we will accept your breakdown of net income taxes. The audit will be revised to remove this adjustment.
Reduction of the Foreign Source Income Subtraction: on federal Form 1118 (Foreign Tax Credit Computation) the taxpayer listed interest income and "other income" from foreign sources. on its Virginia return, the taxpayer reported a subtraction for the total net amount of foreign source income as shown on Form 1118. A review of the audit report reveals that the auditor determined that the "other income" did not satisfy the Virginia definition of foreign source income and removed it from the subtraction.
The department has previously ruled on the subtraction of foreign source income listed as "other income" on federal Form 1118. See P.D. 90-2 (1/2/90) (copy enclosed). Specifically, items sourced without the United States under Internal Revenue Code (IRC) §863 do not qualify as foreign source income under Va. Code §58.1-302.
You fail to explain why the "other income" should qualify as foreign source income under Virginia law. Without more information detailing the nature of the income, the portion of the subtraction attributable to "other income" must be disallowed.
Accordingly, the adjustment made by the auditor is correct.
Adjustment to the Apportionment Factor (Financial Corporation): The taxpayer is a financial corporation required to apportion income using a single factor apportionment formula based on cost of performance, in accordance with Va. Code §58.1-418.
The taxpayer's computation is based on a New York tax memorandum used for computing the income tax for that state. In the computation, it is assumed that receipts arising from a Virginia location are attributable 80% to Virginia and 20% to the out-of-state headquarters or other locations.
Virginia uses costs of performance to reflect the locations at which the taxpayer employs personnel, real and tangible property to earn its income. Virginia law does not provide for assuming that a flat percentage of receipts is attributable to a state based on where the transaction occurs, and I do not believe your assumed flat percentage approach accurately reflects the taxpayer's cost of performance in Virginia and cost of performance everywhere.
It is recognized that the auditor's method, in which 100% of receipts derived from a Virginia transaction are attributed to Virginia, does not represent a true financial factor. However, the factor was based on the best information available to the auditor at the time. In the absence of a true financial factor based on cost of performance in Virginia compared to cost of performance everywhere, you have not shown that the assessment is erroneous. However, the department will allow you to submit a factor based on costs in Virginia to costs everywhere per VR 630-3-418, within 30 days. You must provide sufficient detail to allow the computations to be verified and reconciled to the return information.
Reduction of the Property Factor Denominator: The taxpayer's combined return included an affiliated corporation which uses the three factor apportionment formula. The auditor reduced the denominator of the property factor of the affiliated corporation; you did not receive an explanation for the adjustment.
The first adjustment to the denominator was made because the capitalized rent expense used by the taxpayer to determine the average value of property rented did not agree with the amounts shown on federal Form 1120. The auditor adjusted the capitalized rent expense to agree with the amounts included on Form 1120. The auditor properly relied on the amounts on the federal form and adjusted the denominator of the property factor accordingly. It appears this adjustment is correct.
The second adjustment was made because of an error in computing total ending property for 1985. The taxpayer included an amount for "discrepancy" but provided no explanation as to what this represented. The auditor removed this amount from the computation of average property everywhere. This adjustment appears to be correct.
Accordingly, the audit report will be revised to remove the adjustment adding back additional taxes to Virginia taxable income. In all other respects, the assessment is correct. If you choose to submit cost of performance information, please submit it to the department's Technical Services Section, P.O. Box 6-L, Richmond, VA 23282 within the next 30 days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner