Tax Type
Corporation Income Tax
Description
Apportionment of income; Sale of investments made from idle funds
Topic
Allocation and Apportionment
Date Issued
06-08-1994
June 8, 1994
Re: §58.1-1821 Application: Corporate income tax
Dear**************
This will reply to letters of May 11, 1994, and September 2, 1992, in which application was made for correction of an assessment of additional corporate income taxes to*********(the "Taxpayer") for the taxable year ended June 30, 1991.
FACTS
The Taxpayer realized capital gains from the investment of idle funds during the taxable year ended June 30, 1991. Pursuant to an office audit, a subtraction claimed by the Taxpayer for allocable capital gains was disallowed. The Taxpayer contests this determination, and believes that the capital gains realized on the sale of investments made from idle funds is allocable to its state of commercial domicile.
RULING
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 protest 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 §. 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.
During the taxable year the Taxpayer made numerous short-term investments with its idle funds. All of the gains were from securities held for less than one year. Without exception, all of the securities which were sold were acquired during the taxable year. A review of the security trading activity indicates that the security transactions were of very short duration. The stock positions were typically held for a matter of days (usually ranging from 1 to 14 days). In no case was a security held for more than two months.
The Taxpayer has classified all such investments as marketable securities, and included such investments as part of current assets in its financial statements. The Taxpayer's financial statements also revealed that proceeds from the sale of marketable securities for the taxable year ended June 30, 1991 were approximately 10 times the amount reported for the preceding taxable year, and 3.5 times the amount reported for the taxable year ended June 30, 1992. Statements included in Form 10K filed by the Taxpayer with the Securities and Exchange Commission reveal that the Taxpayer invested "excess cash" in equity securities, a practice which the Taxpayer does not intend to continue.
The Taxpayer is a publicly traded transportation company, maintaining significant trade receivables and capital investment in property, plant and equipment. The total operational working capital required by the Taxpayer obviously cannot be readily identified as a fixed amount at any given time, and the idle funds may have merely been a temporary investment of operational working capital. The Taxpayer has not demonstrated how much of its cash and marketable securities available at any time were necessary to handle reasonably anticipated cash needs, such as current liabilities, current debt service or balloon payments, or other known working capital commitments. The Taxpayer has not demonstrated the "average" or typical amount of working capital which is necessary for any period, and without such evidence it is impossible to determine how much is reasonably necessary for operational cash flow needs.
The Taxpayer has significant amounts of long-term debt, and has presented no factual data indicating that its working capital balance was not necessary for, or related to, the operational retirement of scheduled debt service. The presence of long-term debt implies a need to refinance, extend, or renew such financing. Some financing arrangements may require that certain financial ratios be present and maintained; others may be negotiated on a more favorable basis if liquidity and other financial ratios are favorable. The operational benefits of a strong financial position cannot be ignored where there is no evidence indicating that the company can operate effectively without them.
The Taxpayer has not demonstrated by clear and cogent evidence that their investments were other than short term positions taken to maximize the return on working capital balances. The intent to maximize the return on working capital balances does not create a passive investment where the working capital is an integral element of the operational activities. In Allied-Signal, the court stated:
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The existence of a unitary relation between payee and payor is one justification for apportionment, but not the only one. Hence, for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms a part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank.
We agree that the payee and the payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. Container Corp. says as much. What is required instead is that the capital transaction serve an operational rather than an investment function. (Emphasis added)
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner