Tax Type
Corporation Income Tax
Description
Capital losses; Net operating loss deductions
Topic
Allocation and Apportionment
Computation of Income
Date Issued
04-28-1992
April 28, 1992
Re: § 58.1-1821 Application; Corporation Income Tax
Dear ****
This will reply to your letter of May 31, 1990, in which you seek correction of corporation income tax assessments for ***** (the "Taxpayer").
FACTS
The taxpayer was included in a consolidated federal return and filed a separate Virginia return for the years under review. The taxpayer was audited, and numerous adjustments were made. The issues you raise will be addressed separately.
DETERMINATION
Capital losses: An adjustment was made to the computation of Virginia taxable income by adding back "capital losses" subtracted on the consolidated federal return. You contend that the losses qualify for Internal Revenue Code (IRC) § 1231 treatment and propose that they be allowed as ordinary losses in computing Virginia taxable income.
The department has previously ruled on the treatment of capital losses and § 1231 losses, and the possibility of different characterization for consolidated federal return and separate Virginia return purposes. See P.D. 91-225 (9/18/91) (copy enclosed).
You state that your review of the related federal forms 1120 and 4797 indicates that the losses arose from the sale of assets used in the taxpayer's business; therefore, IRC § 1231 should apply and the losses, which exceeded the taxpayer's gains, should be treated as ordinary losses and allowed in their entirety. However, no documentation has been supplied to substantiate your claim. According to the auditor, supporting schedules were not available at the time of the audit, and no such information has been provided with your letter. Without the federal forms and the supporting schedules, the department is unable to determine the character of the losses.
The department will allow you to submit documentation to substantiate your claim that the taxpayer's losses qualify for treatment under IRC § 1231. The documentation must include federal Form 4797 and supporting schedules, as filed with the Internal Revenue Service, showing the proceeds, basis and gain and loss amounts for each corporation. The documentation must be sufficiently detailed to reconcile to amounts reported on the consolidated federal return and on the separate Virginia return.
Net operating loss deduction (NOLD): The auditors disallowed an NOLD reported on the taxpayer's return for the taxable year ending June 30, 1986, because of a lack of substantiation of the loss. You disagree with the disallowance, and state that your review of workpapers reveals that a 1984 NOLD carryforward was available to offset income on the 1986 return.
Virginia law has no separate provision for a NOLD. Therefore, an NOLD is allowable for Virginia purposes only to the extent that the NOLD is allowable as a deduction in computing federal taxable income for Virginia purposes, i.e., as if federal returns had been filed on the same basis as Virginia returns for all affected years.
At the time the audit was conducted, prior years' federal taxable income documentation was not available. According to the auditor, there were no prior federal returns available to substantiate the NOLD's. The auditor was justified in disallowing the NOLD carryforward because the taxpayer's lack of supporting documentation made it impossible to verify previous net operating losses and their utilization. In addition, the auditor could not verify the portion of the loss absorbed on the 1985 return or how Virginia taxable income was computed on that return.
You have submitted an explanation of the utilization of the NOLD carryforward. However, there is no documentation to support your explanation nor the amounts stated therein. You also have asserted that the taxpayer incurred NOLD's in 1986 and 1987, but furnish no details or documentation. Therefore, the department cannot accept your position.
The department will allow you to submit information to substantiate the carryforward amount and the NOLD's for 1986 and 1987; the information must include federal returns from 1984-1987, showing the federal taxable income and the utilization of the NOLD's.
Property factor - safe harbor leases: The auditor eliminated safe harbor lease property from the denominator of the property factor for two years under review. You maintain that the property should be included in the property factor.
Virginia Regulation (VR) 630-3-409(A)(6) provides that safe harbor leases are treated as leases for Virginia income tax purposes to the same extent that they are treated as leases for federal income tax purposes. The "lessee" will be treated as a corporation renting property, and the value of the property (eight times the annual rental) will be included in the property factor. The "lessor" will be treated as a corporation owning property, and the value of the property (original cost) will be included in the property factor.
The auditor reconciled the property factor denominator to assets reported on Schedule L of the federal return; the safe harbor lease property was not included on this schedule. You state that the property was properly excluded from Schedule L, in accordance with principles established by the Financial Accounting Standards Board. Assuming that this position is correct, documentation is required to verify the existence and value of the leases included in the denominator of the property factor. The taxpayer failed to provide such documentation during the audit.
The department will allow you supply information to substantiate the existence and value of the safe harbor leases. The information must include copies of the agreements and show the original cost of the property.
Should you choose to submit the required information regarding § 1231 losses, NOLD's, and safe harbor leases, please send it to the department's Technical Services Section, P.O. Box 6-L, Richmond, Virginia 23282, within 30 days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner