Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Capital gains from passive investment
Topic
Allocation and Apportionment
Date Issued
09-13-1993
September 13, 1993
Re: §58.1-1821 Application: Corporate Income Taxes
Dear*******
This will reply to your letter dated April 29, 1993, in which you make an application for correction of an assessment for additional corporate income taxes to **********(the "Taxpayer") for the 1990 taxable year.
PROCEDURAL HISTORY
The Taxpayer filed a separate corporate income tax return for 1990. On the 1990 return, the Taxpayer claimed a subtraction from Virginia apportionable income equal to the amount of capital gain recognized on the sale of the stock of several corporations (the "Corporations"). 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 §58.1-421.
The decision of the U. S. Supreme Court in Allied-Signal. Inc. v. Director Div. of Taxation, 112 S. 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. 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.
FACTS
The Taxpayer is a national corporation, primarily engaged in motion picture theater exhibition, and headquartered outside of Virginia. The Taxpayer acquired the stock of the Corporations as an investment pursuant to instructions from the Taxpayer's parent company. When purchased, the Corporations were engaged in various businesses which were different and unrelated to that of the Taxpayer. Although, one of the Corporations was a movie theater, the Taxpayer owned less than .01% of that entity. The Taxpayer's ownership in the Corporations ranged from .01% to 1.9%.
During the period the Taxpayer owned the Corporations, there were no common officers or members of the board of directors between the corporations. The Taxpayer's board of directors did not control the Corporations' board of directors. The Taxpayer's board did not have approval authority over expenditures made by the Corporations, did not control or direct the payment of dividends by the Corporations, and had no committees to monitor or plan the Corporations' operations. The Corporations' board set their own goals and policies.
The Taxpayer and the Corporations did not obtain services from common divisions, departments, or service providers. Each company had its own legal counsel and accounting staff, which provided no legal or accounting services to the other.
The Taxpayer and the Corporations each had their own advertising departments, responsible for the preparation of the respective corporation's advertisements. The Taxpayer and the Corporations 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 Corporations each had their own insurance department. The Taxpayer and the Corporations did not use the same banks. The Taxpayer did not charge any overhead costs to the Corporations, nor did the Corporations charge any overhead costs to the Taxpayer. The Taxpayer and the Corporations did not share common selling facilities, common office facilities, nor 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 Corporations.
The companies did not make intercompany loans; the Taxpayer made no loans to the Corporations, and the Corporations made no loans to the Taxpayer. The Taxpayer never guaranteed any loans taken by the Corporations, nor did such loans require the Taxpayer's approval. The Corporations were not required to seek the Taxpayer's approval before making major purchases. The Corporations did not need approval from the Taxpayer to enter or sign major contracts.
The Taxpayer did not alter the Corporations' existing management teams. The Corporations' management teams continued to manage the business at the Corporations' headquarters. The Corporations were responsible for their own personnel, and did not need to obtain approval to promote personnel, or to grant salary increases or bonuses. The Corporations independently hired personnel, including top executives. The Taxpayer and the Corporations did not maintain any common training programs. Executives of the Taxpayer never traveled to the Corporations' locations, nor did executives of the Corporations visit the Taxpayer's locations for reporting and similar meetings. Employees were not transferred between the companies.
There were no material intercompany transactions between the Taxpayer and the Corporations. The Taxpayer never purchased raw materials, inventory, nor office equipment for the Corporations.
Corporate vehicles were not purchased, leased, or rented under a common plan. The Taxpayer never purchased anything for the Corporations, and the Corporations 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 Corporations. 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 Corporations, and to determine if the Taxpayer's activities related to the investment in the Corporations 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 Corporations. Based on the information provided the Department, it does not appear that a unitary relationship existed between the Taxpayer and the Corporations.
In considering the operational aspects of the investment, the Department considered the evidence provided to support the Taxpayer's position. The evidence indicated: the Corporations, with one immaterial exception, were existing businesses in different lines of business; the businesses did not complement the Taxpayer's operational activities before or after the acquisitions; no integration of the businesses ever occurred; no economies were achieved; the companies were physically separated at all times; the management of the Corporations remained intact after the acquisitions; 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 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 Corporations, nor does it appear that the ownership of the Corporations enhanced the operational activity of the Taxpayer. Accordingly, I conclude that the Taxpayer made a passive investment in the Corporations 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 Corporations 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 Corporations, permission is hereby granted to allocate the capital gain recognized by the Taxpayer on the sale of the Corporations' stock in 1990 out of Virginia apportionable income. All other aspects of the Taxpayer's 1990 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.
This ruling is limited to the 1990 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
OTP/6377L
Rulings of the Tax Commissioner