Tax Type
Corporation Income Tax
Description
Gain from sale of subsidiary's stock
Topic
Allocation and Apportionment
Date Issued
12-21-1993
December 21, 1993
Re: Va. Code §1824: Protective Refund Claim - 1985-1986
Dear**************
This letter is in response to your letter of June 10, 1991, filing for a protective claim for refund pursuant to §58.1-1824 of the Virginia Code on behalf of *************** ("Taxpayer") .
PROCEDURAL HISTORY
The Taxpayer filed a consolidated Virginia corporate income tax return for the tax years ending December 31, 1985, and December 31, 1986. On those returns, the Taxpayer claimed a subtraction from Virginia apportionable income equal to the amount of capital gain recognized on the sale of the stock of ***********("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. The Taxpayer protests this adjustment, and avers 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 Virginia Code §§ 58.1-402 and 58.1-403, less dividends allocable pursuant to Virginia Code §58.1-407, is subject to apportionment. The Taxpayer's subtraction of the capital gain was treated as a request for an alternative method of allocation and apportionment in accordance with Virginia Code §58.1-421.
The Taxpayer originally contacted the Department by letter dated May 10, 1989, making an application for correction of the assessment for the additional corporate income tax for the 1985 and 1986 taxable years. By letter dated January 11,1990,1 upheld the Department's assessment and suggested to the Taxpayer that it pay the tax and file for a protective refund claim pursuant to §58.1-1824 of the Virginia Code pending the resolution of several related cases, including Corning Glass Works, Inc. v. Virginia Department of Taxation, being litigated at the time.
FACTS
The Taxpayer is a national corporation, primarily engaged in the manufacturing and selling of paper and related products. The Taxpayer is headquartered outside of Virginia. The Taxpayer acquired stock in the Subsidiary in the 1960's. The Subsidiary produces pulp and certain wood products such as lumber, plywood, and waferboard.
In 1983, the United States District Court, Fourth Division of the District of Minnesota, entered an anti-trust consent decree which, among other things, prohibited the Taxpayer from nominating more than three nominees for election to membership on the Subsidiary's board of directors, prohibited the companies from exchanging production and other competitively sensitive information, and severely limited the amount of involvement the Taxpayer could have in the operations of the Subsidiary and its subsidiaries.
Prior to the entry of the anti-trust consent decree, the Taxpayer appears to have never exercised actual control of the operations of the Subsidiary and at no time did its combined direct and indirect ownership of the Subsidiary exceed 28%. During the period the Taxpayer owned the Subsidiary, there were no common officers or members of the board of directors between the corporations (although two of the Taxpayer's officers were members of the Subsidiary's board of directors). 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, departments, or service providers. 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, nor common manufacturing facilities. There were no common patents, patterns, or designs used by the Taxpayer and the Subsidiaries. Employees were not transferred between the companies.
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, and was precluded by the anti-trust consent decree from sharing such information with the Taxpayer.
There were no material intercompany transactions between the Taxpayer and the Subsidiary. The Taxpayer purchased less than 5% of its pulp supply from the Subsidiary and the Subsidiary sold an equally insignificant amount of its total supply to the Taxpayer. There was no common research and development, in fact the corporations were prohibited from sharing such information by the anti-trust consent decree.
There appears to have been 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 whether a unitary relationship existed between the Taxpayer and the Subsidiary, and to determine whether the Taxpayer's activities related to the investment in the Subsidiary were in any way connected to the Taxpayer's operational activities.
In Corning Glass Works, Inc. v. Virginia Department of Taxation, 241 Va. 353 (1991), the Virginia Supreme Court held that a company prohibited from interacting with a subsidiary as a result of an anti-trust consent decree, did not have a unitary relationship with the subsidiary. The facts of the instant case are substantially similar to those of Corning As in Corning, the Taxpayer is prohibited from influencing the Subsidiary's board of directors by a limitation of 3 nominees to the board. The parties are also prohibited from sharing trade secrets and are required to engage in what can best be described as "arms-length" transactions.
In considering the existence of a unitary relationship, the United States 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, Inc. v. Director Div. of Taxation, 112 S. Ct. 2551 (1992). Each of these factors was addressed by the Department in its review of the Taxpayer and the evidence presented. There was no indication of a flow of goods or of a flow of values between the Taxpayer and the Subsidiary. Based on the information provided the Department, and the existence of the anti-trust consent decree, it does not appear that a unitary relationship existed between the Taxpayer and the Subsidiary.
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.
In considering the operational aspects of the investment, the Department considered the evidence provided to support the Taxpayer's position. Although the Subsidiary was in a similar line of business as the Taxpayer, the anti-trust consent decree dictated that the two companies operate independently. It also appears as if the companies operated independently prior to the anti-trust consent decree.
Clearly, after the entry of the anti-trust consent decree, the Subsidiary's business did not complement the Taxpayer's operational activities. Even prior to the consent decree, no integration of the businesses ever occurred; no economies were achieved; the companies were physically separated at all times; the management of the Subsidiary was independent of the Taxpayer; 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 minimal business transactions 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, l conclude that the Taxpayer had 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 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 out of Virginia apportionable income. All other aspects of the Taxpayer's 1985 and 1986 allocation and apportionment shall be determined in accordance with §§58.1-406 through 58.1-420.
A review of the information provided indicates that the Virginia tax attributable to the sale of the Subsidiary exceeds the audit assessment and the amount for which a protective claim was filed. Therefore, your protective claim is hereby allowed in the amount claimed ********** assessed tax and accrued interest paid on 3/21/90), with interest from the date the assessment was paid.
This ruling is limited to the 1985 and 1986 taxable years, 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/5264L
Rulings of the Tax Commissioner