Tax Type
Corporation Income Tax
Description
Apportionment of income; Gain from sale of subsidiary's stock
Topic
Allocation and Apportionment
Date Issued
04-11-1994
April 11, 1994
Re: §58.1-1821 Application: Corporate income taxes
Dear*********
This will reply to the protective claim filed on February 27, 1992, and your letters dated November 18, 1992, and May 27, 1993, in which you applied for a refund of corporate income taxes on behalf of ************* (the "Taxpayer") for the 1988 taxable year.
PROCEDURAL HISTORY
Pursuant to an amended 1988 Virginia income tax return, the Taxpayer has 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 ("Company A"). You contend 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 large multi-national corporation, headquartered outside of Virginia. During 1982 and 1983, the Taxpayer acquired 50.5% of the stock of Company A. Company A was incorporated in a foreign country, and is a publicly traded corporation engaged in business in that country. The remaining 49.5% of Company A was held by an unrelated third parties. The third party shareholders were in no way related to the Taxpayer.
In 1988, the Taxpayer sold the stock of Company A to an unrelated third party. For state income tax purposes, the gain from the sale of Company A was allocated to the Taxpayer's state of commercial domicile.
All of Company A's commercial activity was in the foreign country. Company A never had any commercial activity outside of the foreign country. The Taxpayer's investment in Company A was made from excess cash of the company; no borrowing was required for the acquisition. The amount invested by the Taxpayer (less than 0.5% of its total assets) was clearly immaterial to its total assets. Furthermore, the Taxpayer did not use the Company A stock as collateral for any loan.
After the Taxpayer acquired the 50.5% interest in Company A, the management of Company A continued to have the authority to execute, perform, approve, and authorize actions necessary and proper with respect to the operation of Company A's business. Although the Taxpayer imposed guidelines for certain transactions for which Company A had to receive the Taxpayer's approval, during the period of the Taxpayer's ownership only three transactions actually required the nonbinding approval of the Taxpayer's board of directors. These transactions included approvals to sell excess properties, approval to a subsidiary, and approval to construct a new headquarters building. The Taxpayer's interaction with Company A primarily consisted of nonbinding oversight in order to ensure that the officers and directors of Company A maintained their fiduciary responsibilities towards all shareholders. The person who exercised the nonbinding oversight was the president of one of the Taxpayer's subsidiaries located in the foreign country.
The Taxpayer had other investments in the same foreign country in which Company A operated. The Taxpayer owned 100% of one corporation (Company B) and 51% of another publicly traded corporation (Company C). The Taxpayer did business through Companies B and C in the foreign country. The Taxpayer used its investments in B and C as part of its integrated operations in this foreign country, and marketed its own product line extensively through them. However, the Taxpayer did not integrate Company A into its operations. While the Taxpayer used Companies B and C to enhance its market share, Company A's sales of the Taxpayer's products were immaterial in every respect. For the fiscal year ended March of 1988, only 4% of Company A's sales were of the Taxpayer's products. By contrast, for the same period, 65% of the combined sales made by B and C consisted of the Taxpayer's products. It is clear that although the Taxpayer had the opportunity, it did not integrate its product line into Company A, or utilize Company A as a significant source of market share.
The Taxpayer originally held 4 of the 13 seats on Company A's board of directors. These directors did not hold other positions. There were no joint meetings between the two boards, and the Taxpayer's board did not control dividend payments by Company A.
During the period of ownership there were no common managers or directors or transfers of personnel or staff. There were no shared or common accounting or administrative staff, transportation services or resources, pension or profit sharing plans, technology or development, marketing, manufacturing or distribution services and resources. Employees of the Taxpayer and Company A did not belong to the same collective bargaining unit or union. There were no joint management or employee training programs, and no common life, health, annuity or survivor benefit programs for employees of the companies. There were no common bonus or incentive plans for employees of the companies. There were no instances where the Taxpayer controlled the management activity of Company A without the involvement or approval of Company A's board of directors.
During the period of ownership, no intercompany loans were made or secured between the two entities. The Taxpayer did not obtain or negotiate loans on behalf of Company A. The companies had independent banking accounts, financial arrangements, and financial advisors.
The Taxpayer did not in any way or manner control the price or marketing of any product or service of Company A. There were no negotiated agreements, contracts, or memorandums of understanding between the Taxpayer and Company A establishing costs or reimbursements for shared products or services. There were no cost allocation agreements or arrangements between the two entities. There were no common goals or plans for acquisition, diversification, or extension of their businesses. There were no common purchasing, selling, marketing or advertising activities. During the period of the two companies affiliation, there was no restructuring or reorganization of either entity, and the Taxpayer did not cause any marginal or unprofitable operation of Company A to be eliminated.
There was no sharing of technological services or products. The companies did not share any common costs. There was no sharing of office space, warehouses, data processing, machinery or equipment facilities, or services between the two entities. There was no property rented between the companies, and no intercompany purchases or reimbursements.
The Taxpayer's decision to sell its investment in Company A was in large part based of the appreciation of the foreign currency and real estate of the foreign country. The valuation used for the sale was affirmed by an outside investment banking firm who handled the submission of bids from interested parties.
DETERMINATION
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and Company A, and to determine if the Taxpayer's activities related to the investment in Company A 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.) The Taxpayer has presented evidence regarding each of these factors in clear and objective terms. There was no indication of a flow of goods or of a flow of values between the Taxpayer and Company A. Based on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and Company A.
In considering the operational aspects of the investment, the department considered the evidence provided to support the Taxpayer's position. The evidence indicated that: Company A was not used to 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 Company A was at all times separate and distinct from 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 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 Company A, nor does it appear that the ownership of the Company A enhanced the operational activity of the Taxpayer. Accordingly, I conclude that the Taxpayer made a passive investment in the Company A 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 of Company A 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 Company A, permission is hereby granted to allocate the capital gain recognized by the Taxpayer on the sale of the Company A stock in 1988 out of Virginia apportionable income. The sales factor for 1988 will also be adjusted to remove the gross proceeds of the allocable income from the denominator.
All other aspects of the Taxpayer's 1988 allocation and apportionment shall be determined in accordance with §§58.1-406 through 58.1-420. The protective claim will be revised in accordance with this ruling and the attached schedules, and a refund will be issued in due course with interest at statutory rates.
This ruling is limited to the 1988 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,
Danny M. Payne
Acting Tax Commissioner
OTP/6477M
Rulings of the Tax Commissioner