Tax Type
Corporation Income Tax
Description
Airline industry; Foreign source income, Property and payroll; Landing fees
Topic
Allocation and Apportionment
Collection of Tax
Date Issued
11-05-1992
November 5, 1992
Re: Va. Code §58.1-1821 Application Taxable Years 1986 and 1987
Dear***************
This will reply to your letter dated June 20, 1990 in which you protest certain adjustments pursuant to an audit of***************(the "Taxpayer") conducted by this Department.
FACTS
The taxpayer's Virginia income tax returns were subject to numerous adjustments as a result of an audit. You protest six of those adjustments, which are examined below.
RULING
Foreign Source Income: The taxpayer subtracted what it classified as foreign source income in determining Virginia taxable income. The foreign source income subtracted was solely income from the performance of airline services.
Va. Code §58.1-302 defines subtractible foreign source income as being one of the following types: interest, dividends, rents, royalties, license and technical fees, and gains or other income from the sale of intangible or real property. Regardless of the treatment in previous audits, service income is not one of the types of income which qualifies as foreign source income under Virginia law. Consequently, the income is not eligible for the foreign source income subtraction, and the auditor's adjustment is correct.
Property Apportionment Factor: The taxpayer used a ratio of plane miles flown within Virginia to plane miles flown everywhere in determining the amount of flight equipment to be apportioned to Virginia. The amount of Virginia flight equipment was recomputed by the auditor, using a ratio of Virginia total departures to everywhere total departures, respectively by equipment type.
Movable property is required to be included in a property factor numerator to the extent of its utilization in Virginia. See Va. Code §58.1-410. The statute refers to the number of days utilized in Virginia, but authorizes other reasonable methods. For determining the utilization of flight property in Virginia, the use of mileage or departure information is reasonable. As noted in our earlier rulings on the subject, particularly P.D. 90-158 (9/6/90) and P.D. 90-173 (9/21/90), the use of departures is an acceptable, even preferable, alternative to mileage information.
Virginia's current policy is that utilizing departures in determining flight apportionment is the method most consistent with Virginia's statute and regulations. However, taxpayers may continue to elect to use mileage information because of its long term acceptance by the Department, provided that overflight miles are included in the numerator along with miles flown from or to Virginia airports. Excluding overflight miles from the numerator, while including them in the denominator, distorts the property factor. See Public Document (PD) 90-158. Departure information may be required to be used if adequate mileage information is unavailable.
Since the auditor could not verify the mileage information originally used to compute Virginia property, it was recomputed utilizing departure information. Although it appears that the auditor properly adjusted Virginia property, you may submit additional information verifying flight mileage. However, the Virginia mileage must be computed as outlined above. If you can not verify the mileage information, the auditor's adjustment will stand.
Some airline industry members have suggested that §9125 of the Revenue Reconciliation Act of 1990 prohibits the use of overflight miles in tax apportionment formulas determining airlines' taxable income. The legislative history of §9125 clearly indicates otherwise, since it was originally intended to address a sales and use tax issue, or other transactional taxes imposed on a flight by flight basis.
An apportionment formula utilizing departures is not prohibited by Sec. 9125, since each departure "takes off and lands in" a given state. Even if Sec. 9125 impacted income tax computations, the taxable years at issue are unaffected, since the Act was effective November 5, 1990. See P.D. 91-42 (3/19/91) (copy enclosed).
Rental Expense: The taxpayer originally utilized the rent expense from Form 1120, Line 16 to compute the capitalized rent included in the property denominator. The auditor reduced the original capitalized rent expense by subtracting the following: landing fees, certain "Schedule M" adjustments, and certain "reclassifications," resulting in the "book" rental expense being capitalized and included in the property factor denominator.
The term "annual rent" means the amount of money paid by a taxpayer for the use of real or tangible personal property. Amounts paid as service charges are not included. See VR 630-3-410.C2.
The landing fee amount subtracted appears to be payment for landing privileges, and not property rental payments. Accordingly, this amount is a service charge, and was properly excluded by the auditor.
The "Schedule M" adjustments removed by the auditor appear to be for rental expense on capitalized leases. For Virginia income tax purposes, capitalized leases are treated as leases to the extent that they are treated as such for federal income tax. However, because the taxpayer has not provided a breakdown of capitalized lease payments by state, the amount includible in the Virginia property numerator is not determinable.
Therefore, the auditor properly excluded the "Schedule M" adjustments from the property factor denominator. However, the taxpayer may submit a listing which breaks down the "Schedule M" adjustments by state, so that the proper amount may be included in the property numerator and denominator. The same finding and treatment applies to the "federal reclassifications" excluded by the auditor.
Computer property: The taxpayer originally included computer property in the property numerator classified as "installment sale property." The purchaser possesses and utilizes the property. The taxpayer retains the right of use or possession of this property until transfer of title, which occurs with the final installment payment.
In general, property is includible in the property apportionment factor if it is (1) owned or rented by a taxpayer, and (2) is used by a taxpayer. A "right" to use property does not satisfy the requirement of property utilization in a trade or business by the taxpayer. Accordingly, the auditor properly excluded this property from the property denominator.
Payroll Factor: A portion of the payroll expense as originally reported was removed to adjust the denominator to the Federal Form 940 payroll, less foreign payroll. You accepted the portion of this adjustment relating to the variance; however, you protest removing foreign payroll expense from the payroll denominator.
U.S. compensation effectively connected with the taxpayer's U.S. business is included in the payroll factor. The payroll factor includes foreign payroll if the underlying foreign source income is subject to both Virginia and federal income tax. For example, compensation is excluded if it is related to the production of interest, dividends, rents, royalties, or capital gains subtracted as foreign source income. In the instant case, the taxpayer is not permitted to subtract foreign source income that is effectively connected with the foreign payroll expense. Accordingly, the taxpayer properly included foreign payroll in the payroll denominator, and the audit report must be revised.
Summary: All requested information should be submitted within thirty days of the date of this letter. Upon receipt, the audit report will be redetermined in accordance with the findings herein. Shortly thereafter, you will be billed for the amount owed with interest accrued to date. The bill should be paid within thirty days of receipt in order to avoid additional interest charges.
Although you requested a conference, the facts and issues in this case are well documented and appear to be quite clear, eliminating the need for a conference.
Please direct the requested information to:
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- Technical Services Section
Virginia Department of Taxation
P.O. Box 1880
Richmond, Virginia 23282-1880
- Technical Services Section
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W. H. Forst
Tax Commissioner
OTP/4419G
Rulings of the Tax Commissioner