Tax Type
Corporation Income Tax
Description
Apportionment method; Installment method of accounting
Topic
Allocation and Apportionment
Date Issued
02-25-1993
February 25, 1993
Re: §58.1-1821 Application; Corporation Income Taxes
Dear ****
This will respond to your letter dated April 5, 1991 requesting revision of certain audit adjustments made in the audit of ***** (the "Taxpayer") for the 1987 and 1988 taxable years.
FACTS
The taxpayer recognizes sales income using the installment method of accounting for federal income tax purposes. The taxpayer computed Virginia taxable income for the above taxable years by subtracting the installment receipts received in each year, then multiplying the subtracted amount by the apportionment factor percentage of the origination year. For instance, in apportioning to Virginia gross profit received in 1987 resulting from a 1983 sale, the taxpayer would use the 1983 apportionment factor instead of the 1987 factor.
This method of apportionment was disallowed upon audit, and the taxpayer appeals to the department for acceptance of its apportionment methodology.
RULING
A taxpayer subject to tax in more than one state must use a single apportionment formula, in this case the three factor formula (Public Document (P.D.) 90-128 (8/22/90) copy enclosed). Your method would separately account for installment sales receipts and use a different formula for each receipt depending upon the year in which the sale occurred. Your proposed apportionment method is not supported by existing law; therefore, the assessment at issue is clearly consistent with the requirements of the statutory apportionment method.
However, I will treat the returns and the taxpayer's application as a request for permission to use an alternative apportionment method under VR §630-3-421(B). The policies which apply to requests for an alternative method under Va. Code §58.1-421 are well established. See VR §630-3-421, P.D. 86-184 (9/18/86) (copies enclosed).
All events test: You assert that "all activities and events giving rise to the generation of the income is [sic] obviously completed in the year of the sale." If this were true, then all of the income would be accrued and taxable in the year of the sale. At least one crucial event, payment, did not occur in the year of sale. Also, your method ignores any activities related to collecting the installment payments in years after the sale.
Separate accounting: The methodology you propose for including installment sales in Virginia taxable income is essentially separate accounting for these sales. In general, the use of separate accounting is held in disfavor (Department of Taxation v.
Lucky Stores, 217 Va. 121 (1976)).
Apportionment factor: As you have shown in your illustrative example, the method you suggest could result in a higher Virginia income tax for the taxpayer. However, under Va. Code §58.1-421, the department is not permitted to grant permission to use an alternative method which could result in a tax greater than that computed using the statutory method (P.D. 86-184 (9/18/86) copy attached).
You cite VR 630-3-416.D, Example 4, in support of your position, stating that this example "makes it clear that the subsequent collection of the note plays no role in determining the sales factor." In fact, this example specifically points out that the sales factor (in years after the sale) is most definitely influenced by subsequent collections, by stating in pertinent part: "Interest and other income arising from the notes will be assigned to the state in which" the recordkeeping and collection activity for the note occur. See VR 630-3-416.D, Example 4. This means that for purposes of computing the sales factor numerator in years subsequent to the origination of an installment sale, the gross profit and interest income from installment notes would be included in the Virginia numerator only if the recordkeeping and collection activities were in Virginia.
In further support of your position, you cite P.D. 88-172 (6/29/88), in which the Department stated that the repayment of funds lent to a borrower is not a gross receipt for sales factor computation purposes. This is true because the repayment of loan principal is not includible in income; and therefore, should not be included in apportionment factor computation. To the extent that an installment payment received is a repayment of funds, the P.D. 88-172 premise is true. However, since an installment payment has elements of capital gain and interest as well, these elements are includible in the apportionment factor computation.
Since the auditor properly used Internal Revenue Form 6252, Line 17, as a basis in computing the sales factor numerator and denominator, no double taxation results from the sales factor computation method in Example 4. Revenue receipts are included in the sales factor in the same year they are recognized as income under the installment sale method. Therefore, this method is internally consistent.
Furthermore, there is not an absolute correlation between the income earned in a particular year, and the amounts included in the apportionment factor computation in that year. There is a flow of value among taxable years. For instance, property is utilized in more than one year. Also, a corporation's income earning efforts often result in deductible expenses in one year, but generate taxable income and gross receipts which may be included in the apportionment factor of a subsequent year. Because of the flow of value between taxable years, there is no compelling reason to use the apportionment factor in the year the sale occurred to apportion installment payments received in future years.
In order to be granted a change in apportionment from the statutory method, the taxpayer must show extraordinary circumstances. However, based on the above analysis, I find no extraordinary circumstances in the instant case. Accordingly, I find that the assessment of additional tax was correct for the periods 1987 and 1988.
In your letter you requested a hearing if relief could not be granted on the basis of your written application. If you still desire a conference, please let us know within 15 days of the date of this letter, and one will be scheduled. If we do not hear from you within this time, this letter will be considered final and collection actions will be reinstated.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/5135G
Rulings of the Tax Commissioner