Tax Type
Corporation Income Tax
Description
Capital gain on sale of subsidiary
Topic
Allocation and Apportionment
Returns/Payments/Records
Date Issued
06-04-1993
June 4, 1993
Re: §58.1-1821 Application; Corporate Income Taxes
Dear*************
This letter is in reply to the amended return (Form 500X) filed by***********(the "Taxpayer") for taxable year 1990, and to your letter of November 17, 1992 in which you have provided supplemental information.
FACTS
The Taxpayer is a corporation domiciled outside of Virginia that operates a chain of retail stores in Virginia and other states. During 1983 the Taxpayer acquired 100% of the stock of another company (the "Subsidiary"). The Subsidiary was a vertically integrated business involving the manufacture, wholesale and retail sales of product sold by the Taxpayer at its retail stores. The Taxpayer sold 50% of its stock in the Subsidiary in 1986, and sold the remaining 50% of the stock in 1990.
The Taxpayer filed an amended federal income tax return for the 1990 taxable year to correct various components of federal taxable income. An amended Virginia income tax return was filed to report the resulting changes in Virginia taxable income.
On the 1990 amended Virginia income tax return, the Taxpayer claimed a deduction from income apportionable to Virginia equal to the amount of gain recognized on the sale of the Subsidiary's stock. The Taxpayer has claimed that the gain realized on the sale of the stock is not subject to apportionment, and should be allocated to the state of commercial domicile in accordance with the decision of the U. S. Supreme Court in Allied-Signal, Inc. v. Director, Division of Taxation (112 5. Ct. 2251 (1992)).
DISCUSSION
The Code of Virginia does not provide for the allocation of income other than certain dividends. Accordingly, a taxpayer's entire federal taxable income, adjusted and modified as provided in Va. Code §§58.1-402 and 58.1-403, less dividends allocable pursuant to Va. Code §58.1-407 subject to apportionment. The Taxpayer's subtraction of the capital gain has been treated as a request for an alternative method of allocation and apportionment in accordance with Va. Code §58.1-421.
The decision of the U.S. Supreme Court in Allied Signal made it clear that the payee and payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. In the absence of a unitary relationship, apportionment is permitted when the investment serves an operational rather than a passive investment function. The Court also made it clear that the test is fact sensitive.
DETERMINATION
The Taxpayer's in the Subsidiary had a direct relationship to the marketing and distribution of the Subsidiary's product at the Taxpayer's retail stores. Product was purchased by the Taxpayer from the Subsidiary for sale at its retail stores. Product was marketed at the retail stores under the trade name of the Subsidiary. The Subsidiary's brand name was displayed on outdoor signs on or adjacent to the Taxpayer's stores. The Subsidiary also directly marketed its product at the retail level in Virginia under the same trade name through other outlets. The Taxpayer has offered nothing to differentiate its activities from those in Mobil Oil Corp, v, Commissioner of Taxes of Vermont 445 U.S, 425, where the Supreme Court held that the retail marketing and sale of petroleum products formed a unitary relationship with other aspects of a vertically integrated petroleum business.
In Exxon Corp. v, Wisconsin Dept. of Revenue, 447 U. 5. 207, the Court held that Exxon's marketing of petroleum products helped provide an outlet for its products and therefore constituted a unitary relationship with other aspects of the petroleum business. In contrast to Mobil Oil, this case involved divisional accounting within a single corporation. Accordingly, a bright line does not exist that would allow the separation of a unitary relationship through the use of separate corporate entities.
Through the period that the Taxpayer owned 100% of the Subsidiary, all of the Subsidiary's directors were either directors or officers of the Taxpayer. The Taxpayer purchased a large amount of product from the Subsidiary pursuant to a product purchase agreement, and marketed the product under the Subsidiary's brand name, The marketing relationship, product purchase agreement and common directors clearly indicate that a unitary relationship existed between the Taxpayer and the Subsidiary. The Taxpayer has not provided clear and cogent evidence to prove that a unitary relationship did not exist, nor has the Taxpayer provided evidence that its relationship with the Subsidiary changed significantly after the initial sale of 50% of its stock. To the contrary, the evidence shows that the Taxpayer continued to purchase a significant portion of its product from the Subsidiary. The product purchase agreement did not change as ownership decreased from 100% to 50%. The Taxpayer has not demonstrated that third parties were able to purchase product under similar terms, or that similar terms were available to the Taxpayer from unrelated suppliers (the Taxpayer is contractually bound to a product purchase agreement that requires a significant annual minimum purchase of product that may equal or exceed one-third of all product purchased by the Taxpayer for resale). Although the Subsidiary had entered into other agreements to sell product to third parties, the Taxpayer has indicated that such agreements did not contain equivalent terms,
The Taxpayer has compared its situation after the initial sale of 50% of the Subsidiary to ASARCO Inc, v. Idaho State Tax Commission (102 5, Ct. 3103 (1982)) with respect to ASARCO's ownership of Southern Peru Copper Corp. After the initial sale of 50% of the Subsidiary's stock, three of the Subsidiary's six directors were also officers or directors of the Taxpayer. In ASARCO, 6 of the 13 Southern Peru directors were appointed by ASARCO, six appointed by the other shareholders, and one director was appointed jointly. There was no management contract or other agreement imposed on the Taxpayer with respect to their involvement in the Subsidiary. In ASARCO, the ownership of 51.5% of Southern Peru is distinguished by such an agreement. The Taxpayer had a product purchase agreement and brand name marketing arrangement with the Subsidiary, but has not produced any evidence which would demonstrate that third parties purchased product under similar terms, or that the Taxpayer could replace the agreement and brand name within a short time if it were lost. In ASARCO, Southern Peru sold 20-30% of its output to third parties; the balance was sold to its shareholders in proportion to their ownership interests. Evidence was provided that ASARCO could have replaced this output contract within a short time if were lost. Finally, the Court held that ASARCO's mining operation in Idaho was unrelated to Southern Peru's autonomous business. In the instant case, the Taxpayer and the Subsidiary were jointly involved in marketing the Subsidiary's products at the Taxpayer's retail locations in Virginia. This clearly indicates that the Taxpayer's business operations in Virginia are related to the Subsidiary's business, and that both benefited from the purchase agreement, marketing arrangement, and brand name recognition. I find that the differences between the facts in ASARCO and those of the Taxpayer, when combined with the other significant marketing and purchasing relationships between the Taxpayer and the Subsidiary, render such a comparison inappropriate and unpersuasive.
There is no question that there was a flow of goods between the Taxpayer and the Subsidiary. The marketing of product by the Taxpayer under the Subsidiary's trade name created name brand recognition for the Taxpayer and greater potential for market share for the Subsidiary. It is apparent that there was also a flow of values between the companies. The importance to the Subsidiary to have a market for its product, the need of the Taxpayer to have available inventory, and the benefits to both companies of name brand recognition all indicate that the investment was of a significant operational nature.
Even if a unitary relationship ceased to exist before the sale of the Subsidiary's stock, it is clear that the Taxpayer used its operations to increase the market share and name brand recognition for the Subsidiary's product and thereby enhanced the value of its investment in the subsidiary. The availability of the Subsidiary's product at the Taxpayer's retail locations presumably increased its customer traffic and enhanced the Taxpayer's retail operations. This does not appear to be a passive investment in which the Taxpayer relied entirely on the management of the company in which it invests for earnings growth and enhanced value, and for which there were no operational reasons to select, acquire, manage or dispose of the investment.
In any proceeding relating to the interpretation of the tax laws of the Commonwealth of Virginia, the burden of proof is on the taxpayer. In this particular matter, the Taxpayer must bear the heavy burden of demonstrating that the imposition of Virginia's statute is a violation of the protection afforded by the United States Supreme Court in Allied Signal. Based upon the information provided, I do not find that the Taxpayer met the burden of proof, Accordingly, permission to use an alternative method of allocation and apportionment pursuant to Va. Code §58.1-421 to allocate capital gains is hereby denied.
Your amended return will be processed without the deduction for allocated capital gains. Also, the deduction claimed for the environmental tax will be disallowed in accordance with P. D. 91-87 (5/29/81) a copy of which is attached.
Sincerely,
W. H. Forst
Tax Commissioner
TPD/648lM
Rulings of the Tax Commissioner