Tax Type
Corporation Income Tax
Description
Unitary business principle, Foreign Source Income
Topic
Allocation and Apportionment
Appropriateness of Audit Methodology
Date Issued
05-29-1991
May 29, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear****************
This will reply to your letter of September 13, 1990, 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 its 1985 return, resulting in the assessment of additional tax. The taxpayer objects to five adjustments made to taxable income and requests adjustments to the sales factor.
The issues you raise will be addressed separately.
DETERMINATION
Investment Tax Credit: The taxpayer claimed a subtraction for excess state over federal depreciation deduction due to the basis adjustment for the Investment Tax Credit at the federal level. This subtraction was disallowed by the auditor. You contend that additional depreciation expense, based on the original cost of the asset, is required at the state level because Virginia does not allow an investment tax credit.
It is recognized that the depreciable basis of certain assets is reduced by a portion of the Investment Tax Credit allowed for federal tax purposes, thereby reducing annual depreciation. Virginia does not allow a similar credit and basis reduction. However, there can be no adjustment at the state level to reflect depreciation expense on the full cost of the depreciable assets for state purposes without statutory authority to do so. The Code of Virginia does not provide for such an adjustment; consequently, the subtraction must be disallowed.
Nonbusiness Income: The taxpayer reported a subtraction for nonbusiness income on its Virginia return. The auditor disallowed the subtraction, because the Code of Virginia does not provide for such a subtraction.
Virginia law does not require or permit the subtraction or allocation of "nonbusiness" income; all income (other than dividends) is apportionable. See P.D. 84-210 (10/31/84); P.D. 87-104 (3/27/87); and P.D. 87-224 (10/14/87) (copies enclosed). However, under Va. Code §58.1-421 a corporation is permitted to request an alternative method of allocation and apportionment that would reduce its tax if it can show by clear and cogent evidence that the statutory method is unconstitutional or inequitable as applied to its situation. See Virginia Regulation (VR) 630-3-421, P.D. 86-184 (9/18/86), and P.D. 85-146 (7/2/85) (copies enclosed).
Treating your letter as a request to use an alternative method, I find that you have not demonstrated that the inclusion of the income in question in apportionable income produces an unconstitutional or inequitable result. You have provided no details as to the taxpayer's corporate and operating structure that would prove that the disputed income did not arise from a unitary business. In particular, you have not shown that the activities or investments which generated the disputed income have been consistently treated as not part of a unitary business in the current and prior returns of Virginia and other states. For example, if apportionable income for any taxable year included deductions for wages, stewardship expenses, carrying costs and other expenses related to an activity or investment, then the apportionment of any gain, profit, and other income generated by the activity or investment would be consistent with the taxpayer's treatment.
The department is currently in litigation involving the unitary business principle. This case may or may not have relevance to your factual situation. You may wish to file a protective claim for refund pursuant to Va. Code §58.1-1824 (after paying the assessment) and request that the department hold it without action pending a final decision in Corning Glass Works, Inc. v. Virginia Department of Taxation in the United States Supreme Court. This procedure will allow the department to investigate and ascertain the pertinent facts and apply the relevant principles, if any, of the final decision to the facts of your protective claim.
Foreign Source Income: The taxpayer claimed a subtraction for foreign source income on its return. The auditor reduced the foreign source income subtraction by applying additional expenses to the income. You disagree with this adjustment on two grounds. First, you question the authority to reduce the foreign source income subtraction by expenses. Second, you contend that even if authority exists, the additional expenses applied by the auditor are not directly related to the foreign income and, therefore, should not be used to reduce the subtraction.
Previous rulings by the department have established that the subtraction for foreign source income is computed by reducing gross income from sources without the United States by expenses in accordance with IRC §861 et seq. P.D. 86-154 (8/14/86) (copy enclosed). Virginia law requires use of IRC §861 et seq. whether or not the taxpayer believes certain expenses have any connection to income from foreign sources and regardless of what the expenses would be under generally accepted accounting principles. The regulations under §861 et seq. provide that expenses not definitely allocable are to be apportioned ratably among the statutory groupings of gross income and the residual grouping. You failed to include all applicable expenses (stewardship, legal and accounting, charitable contributions, etc.) in the expenses to be ratably apportioned. The auditor properly applied these expenses to foreign source income, and the corresponding adjustment is correct.
ESOP Contributions: on the 1985 return, the auditor reduced the subtraction for employer contributions to an Employee Stock ownership Plan (ESOP) to agree with the amount shown on federal Form 8007 to compute the federal ESOP tax credit. This is the amount used to calculate the Virginia subtraction. Therefore, the adjustment by the auditor appears to be correct.
U.S. Interest: The auditor reduced the subtraction for U.S. interest reported on the 1985 return. You contend that this amount should not have been adjusted.
The adjustment represents the amount of interest income from the Federal National Mortgage Association (Fannie Mae). Department policy is that interest income attributable to Fannie Mae is fully taxable in Virginia because the obligation is not backed by the full faith and credit of the United States. Therefore, the interest should not have been included in the subtraction for U.S. interest, and the auditor properly included the interest in Virginia taxable income.
Sales Factor: You assert that an adjustment should be made to the sales factor to reflect gross receipts from the sales of marketable securities.
You are correct that the sales factor should include the gross receipts from the sales of marketable securities. However, there is insufficient information to allow the department to make an adjustment. The taxpayer's facsimile Form 1120 that was filed with the department does not show any capital gains and no Schedule D was included in the audit report. Without that information, the department cannot make an adjustment to the sales factor. The department will allow the taxpayer to submit a sales factor which includes the proceeds from marketable securities, provided that a detailed schedule is furnished describing the security sold and showing the gross receipts, cost basis and gain (loss) of each transaction to be included in the sales factor.
Accordingly, the assessments are correct as made. If you choose to submit detailed sales factor information, please send it to the department's Technical Services Section, P.O. Box 6-L, Richmond, Virginia 23282 within the next 30 days. Though you requested a conference, this letter has been issued without one. If you still desire a conference, contact the department within the next 30 days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner