Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Gain from sale of subsidiary
Topic
Allocation and Apportionment
Date Issued
06-04-1993
June 4, 1993
Re: §58.1-1821 Application; Corporate Income Taxes
Dear*************
This will reply to your letter dated February 20, 1992 in which you make an application for correction of an assessment for additional corporate income taxes to ***********(the "Taxpayer") for the 1987 taxable year.
PROCEDURAL HISTORY
The Taxpayer filed a combined return for 1987 with other affiliated corporations. On the 1987 return, the Taxpayer claimed a subtraction from Virginia apportionable income equal to the amount of a capital gain recognized on the sale of the stock of another corporation (the "Subsidiary"). The Taxpayer was audited by the department, and the subtraction was disallowed on the basis that the Code of Virginia does not provide for such a subtraction. You protest this adjustment, and aver that this capital gain is not properly subject to apportioned taxation in Virginia.
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 is 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 §58.1-42l.
The decision of the U.S. Supreme Court in Allied-Signal, Inc. v. Director, Div. of Taxation, 112 5. Ct. 2551 (1992) 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. n 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.
FACTS
The Taxpayer is a large multi-national corporation, primarily engaged in manufacturing, and headquartered outside of Virginia in State "A". The Taxpayer acquired the stock of the Subsidiary in 1982 as an investment pursuant to instructions from the Taxpayer's parent company. When purchased, the Subsidiary was a large multinational corporation engaged in the distribution of products different and unrelated to those manufactured by the Taxpayer, and was headquartered outside of Virginia in State "B".
The Taxpayer reported the entire gain from the sale of the Subsidiary on its income tax return filed in State A and paid tax on the entire gain to State A. The Attorney General of State A determined in a written opinion that the Taxpayer and the Subsidiary were not engaged in a unitary business, and therefore the entire gain was allocable to State A. No other state has sustained an apportionment of the Taxpayer's gain from the sale of the Subsidiary, and over thirty states have now accepted the Taxpayer's allocation of the entire gain to State A.
During the period the Taxpayer owned the Subsidiary, there were no common officers between the corporations, and only one person sat on the board of directors of both companies. The Subsidiary's board of directors meetings took place in State B. The Taxpayer's board of directors did not control the Subsidiary's board of directors. The Taxpayer's board did not have approval authority over expenditures made by the Subsidiary, did not control or direct the payment of dividends by the Subsidiary, and had no committees to monitor or plan the Subsidiary's operations. The Subsidiary's board set its own goals and policies.
The Taxpayer and the Subsidiary did not obtain services from common divisions or departments. Each company had its own legal division and accounting staff, which provided no legal or accounting services to the other. A single certified public accounting firm was not used by the Taxpayer and the Subsidiary as auditors or for the preparation of tax returns. The Taxpayer and the Subsidiary shared the same chart of accounts, however, all affiliates of publicly traded companies have common charts of accounts, as required under both Securities and Exchange Commission rules and Generally Accepted Accounting Principles.
The Taxpayer and the Subsidiary each had their own advertising department, responsible for the preparation of the respective corporation's advertisements. The Taxpayer and the Subsidiary each had their own computer staffs, responsible for their respective company's computer system. The hardware used in their respective computer systems was not purchased, rented, or leased under a common plan. The Taxpayer and the Subsidiary each had their own insurance department. The Taxpayer and the Subsidiary did use some of the same banks, however each company also maintained accounts at different banks. The Taxpayer did not charge any overhead costs to the Subsidiary, nor did the Subsidiary charge any overhead costs to the Taxpayer. The Taxpayer and the Subsidiary did not share common selling facilities, common office facilities or common manufacturing facilities. Neither a common shipper nor a common transportation service was designated by the companies. There were no common patents, patterns, or designs used by the Taxpayer and the Subsidiary.
The companies did not make intercompany loans; the Taxpayer made no loans to the Subsidiary, and the Subsidiary made no loans to the Taxpayer. The Taxpayer never guaranteed any loans taken by the Subsidiary, nor did such loans require the Taxpayer's approval. The Subsidiary was not required to seek the Taxpayer's approval before making major purchases. The Subsidiary did not need approval from the Taxpayer to enter or sign major contracts.
The Taxpayer did not alter the Subsidiary's existing management team. The Subsidiary's management team continued to manage the business at the Subsidiary's headquarters in State B. The Subsidiary was responsible for its own personnel, and did not need to obtain approval to promote personnel, or to grant salary increases or bonuses. The Subsidiary independently hired personnel, including top executives. The Taxpayer and the Subsidiary did not maintain any common training programs. Executives of the Taxpayer never traveled to the Subsidiary's locations, nor did executives of the Subsidiary visit the Taxpayer's locations for reporting and similar meetings. Employees were not transferred between the companies. During the period the Taxpayer owned the Subsidiary, only two middle management employees changed employment from the Taxpayer to the Subsidiary.
There were no material intercompany transactions between the Taxpayer and the Subsidiary. The Taxpayer never purchased raw materials, inventory or office for the Subsidiary.
Corporate vehicles were not purchased, leased, or rented under a common plan. The Taxpayer never purchased anything for the Subsidiary, and the Subsidiary never purchased anything for the Taxpayer. There were no intercompany sales between the companies, and no common research and development.
There were no common brand names, company names, symbols, trademarks or logos used by the Taxpayer and the Subsidiary. There was no public identification whereby someone purchasing the product of one company would identify it with the other.
DETERMINATION
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and the Subsidiary, and to determine if the Taxpayer's activities related to the investment in the Subsidiary were in any way connected to the Taxpayer's operational activities.
In considering the existence of a unitary relationship, the Supreme Court has focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. (See Mobil Oil Corp. v Commissioner of Taxes, 445 U.S., 425 (1980); F. W. Woolworth Co. v. Taxation and Revenue Dept. of N.M., 458 U.S., 352 (1982); and Allied-Signal.) Each of these factors was addressed in depth by the Taxpayer in clear and objective terms. There was no indication of a flow of goods or of a flow of values between the Taxpayer and the Subsidiary. on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and the Subsidiary.
In considering the operational aspects of the investment, the department considered the evidence provided to support the Taxpayer's position. The evidence indicated that: the Subsidiary was an existing multi-national business in a different line of business; the business did not complement the Taxpayer's operational activities before or after the acquisition; no integration of the two businesses ever occurred; no economies were achieved; the two companies were physically separated at all times; the management of the Subsidiary remained intact after the acquisition; there was no intent to create consumer awareness of the common ownership; there was no attempt to take advantage of the fact that common ownership existed; and with few immaterial exceptions, no business transactions of any type occurred between the companies. In light of the substantial evidence provided, it does not appear that the Taxpayer used its own operational activities to enhance the value of its investment in the Subsidiary, nor does it appear that the ownership of the Subsidiary enhanced the operational activity of the Taxpayer. Accordingly, I conclude that the Taxpayer made a passive investment in the Subsidiary that was not of an operational nature. As the Taxpayer's headquarters and management of its investment function was located outside of Virginia, the gain recognized by the Taxpayer on the sale the Subsidiary did not relate to the Taxpayer's operational business carried on in Virginia.
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 prove by clear and cogent evidence that Virginia's statutory method of allocation and apportionment would result in a tax on income derived from a discrete investment function having no connection with Virginia in violation of the principles set forth in Allied Signal. Based upon the information provided, I find that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Because of the extraordinary circumstances surrounding the relationship between the Taxpayer and the Subsidiary, permission is hereby granted to allocate the capital gain recognized by the Taxpayer on the sale of the Subsidiary's stock in 1987 out of Virginia apportionable income. All other aspects of the Taxpayer's 1987 allocation and apportionment shall be determined in accordance with §§58.1-406 through 58.1-420. The audit report will be revised in accordance with this ruling and a refund will be issued in due course.
This ruling is limited to the 1987 taxable year, and further limited to the transaction described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner