Tax Type
Corporation Income Tax
Description
Foreign Source Income
Topic
Computation of Tax
Date Issued
05-29-1991
May 29, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear*****************
This will reply to your letter of June 20, 1989, in which you seek correction of corporation income tax assessments for***************(the "Taxpayer").
FACTS
On its 1984, 1985 and 1986 corporation income tax returns, the taxpayer claimed a subtraction for foreign source income. Following an audit of the returns, the department reduced the subtraction by applying additional expenses to the foreign source income. While agreeing that a reduction is proper, you object to the manner in which the auditor determined the expenses and submit supplemental information which you claim more accurately reflects the expenses related to foreign source income.
DETERMINATION
Previous rulings of the department require the Virginia subtraction for foreign source income to be reduced by expenses, determined in accordance with Internal Revenue Code (IRC) §861 et seq. P.D. 86-154 (8/14/86). To compute the expenses, our auditors are justified in presuming that the information on federal Form 1118 is correct and accurate. The department will accept supplemental information which differs from what is on Form 1118 if it more accurately complies with IRC §861 et seq. and the supplemental information would not have materially affected federal tax liability. P.D. 87-149 (6/8/87) (copy enclosed).
If the limitation computed on federal Form 1118 actually affected federal tax liability the department presumes that the taxpayer took steps to ensure that all income classifications and expense allocations were accurately computed and fully consistent with IRC §861 et seq. In this situation supplemental information is unlikely to be accepted unless the taxpayer can show, for example, that it merely eliminates limitations imposed by IRC §904 rather than IRC 861, or that it more accurately computes or characterizes an item shown on Form 1118 without materially affecting federal tax liability.
We cannot accept the information you submitted because you have not prepared it in compliance with IRC §861 et seq. or reconciled it to the actual Form 1118 filed, nor have you demonstrated that the information would not have materially affected federal tax liability. For example, the regulations under IRC §861 provide that interest expense not definitely allocable and charitable contributions are to be apportioned ratably among the statutory groupings of gross income and the residual grouping. You excluded interest and charitable contributions from your computation, stating the expenses did not have a foreign component during each of the years in the audit.
In the absence of acceptable supplemental information, the proper method of computing nonallocable expenses attributable to foreign source income would have multiplied a ratio, the numerator of which is total Virginia foreign source income and the denominator of which is total income from without the United States per federal Form 1118, with total nonallocable expenses. Dividends and gross-up income qualify for subtractions under other provisions of the Code of Virginia; therefore, they are not subtracted again as foreign source income, nor are they included in the numerator of the ratio. However, such income must be included in the denominator of the ratio, to the extent included on Form 1118. Allocable expenses, if any, should be applied to the category of income to which they belong. The audit report will be adjusted to reflect this method.
You will shortly receive a revised audit report reflecting the corrections required to conform the audit to the principles set forth in this letter and an updated bill with interest accrued to date. The bill should be paid within 30 days to avoid the accrual of additional interest. Although you requested a conference, this letter has been issued without one. If you still desire a conference you should request one within 30 days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner