Tax Type
Corporation Income Tax
Description
Apportionment of income; Gain from sale of wholly owned bank
Topic
Allocation and Apportionment
Date Issued
04-25-1994
April 25, 1994
Re: §58.1-1824 Protective Claim: 1982 Taxable year
Dear****************
This will reply to the protective claim filed on August 9, 1988, for the taxable year ended December 31, 1982, on behalf of ************* (the "Taxpayer").
FACTS
On its 1982 Virginia tax 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 ("Company A"). 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 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 Taxpayer is a large multi-national corporation, headquartered outside of Virginia. In the 1930's, the Taxpayer formed Company A, a state chartered bank. In 1982 the Taxpayer sold 100% of the stock of Company A. For state income tax purposes, the gain from the sale of Company A was allocated to the Taxpayer's state of commercial domicile.
The Taxpayer is one of the world's largest manufacturers in its particular industry. Company A was chartered to conduct banking operations in a state outside of Virginia. The Taxpayer and Company A were obviously not engaged in the same industry. Company A did not operate outside of its state of charter. During the period that the Taxpayer held Company A's stock, there were no common officers. Company A's officers were chosen for their expertise in the banking industry. Given the extensive federal and state regulation, the management of the Taxpayer could not control Company A.
There were no intercompany loans made or secured between the Taxpayer and Company A, and the Taxpayer did not obtain or negotiate terms for loans obtained by Company A. The Taxpayer did not provide any collateral for loans made to Company A by unrelated third parties. Company A did not make loans to any affiliates of the Taxpayer. Because of heavy state and federal regulation, and to avoid any appearance of impropriety, the Taxpayer did not do business with Company A. The Taxpayer only used Company A for purposes of clearing payroll checks. This service is currently provided by the new owners of Company A. Transactions between the Taxpayer and Company A were limited to some data processing, and some leased space. All charges were at arm's length, subject to regulations, and examined pursuant to regulatory as well as independent audits.
The Taxpayer has provided extensive documentation demonstrating that its relationship with Company A was similar to the fact patterns in Public Documents 93-140 (6/4/93) and 94-93 (3/29/94), copies attached.
The management of Company A felt that it could not compete as a banking institution without expansion and the acquisition of additional banking facilities. The Taxpayer, being unwilling to restructure its corporate structure to accommodate bank holding company rules, decided to forgo expansion in favor of a sale of Company A.
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 focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. Evidence affecting these factors was provided 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 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: 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 engaged in unrelated industries; the management of Company A was at all times separate and distinct from the Taxpayer; 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, and the extensive federal and state regulatory control exercised over banks, 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, and 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, Inc. v. Director. Div. of Taxation, 112 S. Ct. 2551 (1992). 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 1982 out of Virginia apportionable income. The sales factor for 1982 will also be adjusted to remove allocable income from the denominator.
All other aspects of the Taxpayer's 1982 allocation and apportionment shall be determined in accordance with §§ 58.1-406 through 58.1-420. The Taxpayer's 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 from the date the contested tax was paid. This ruling is limited to the 1982 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/3038M
Rulings of the Tax Commissioner