Tax Type
Corporation Income Tax
Description
Apportionment of income; Gain from sale of stock in foreign corporation
Topic
Allocation and Apportionment
Date Issued
06-30-1994
June 30, 1994
Re: §58.1-1824 Protective Claim: 1989 Taxable year
Dear***************
This will reply to your letters of February 8, 1993, March 16, 1993, July 1, 1993, August 30, 1993, and June 16, 1994, regarding the protective claim for corporate income taxes filed by**********(the "Taxpayer") for the 1989 taxable year.
PROCEDURAL HISTORY
Pursuant to an amended 1989 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 S 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 1981 the Taxpayer acquired 50% of the stock of Company B. Company B was incorporated in a foreign country, and owned a minority interest in Company A. Company A was also incorporated in a foreign country. The Taxpayer's investment in Company B created objections which were filed with the European Economic Community on antitrust grounds. With a view towards satisfying EEC objections, in 1984 the Taxpayer restructured its holdings. As a result of the restructuring, the Taxpayer obtained direct ownership of approximately 29% of Company A's common stock.
In 1989, the Taxpayer sold 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.
During the period that the Taxpayer owned Company A stock, there were no intercompany loans made or secured between the companies. The Taxpayer never obtained or negotiated terms for loans obtained by Company A, and never provided any collateral for loans made to Company A by third parties.
The Taxpayer never provided any corporate service or product to Company A. There were never any agreements, contracts or memorandums of understanding between the companies with regard to establishing cost or reimbursements for shared services or products.
To the best of the Taxpayer's knowledge and belief, employees of the Taxpayer and Company A did not belong to the same common collective bargaining unit or union. However, if such common union representation did exist in any country, the companies did not jointly bargain together with any such union.
There were no common or joint management or employee training programs, nor were there any common employee benefit programs for employees or management personnel of the companies.
There were no common or joint goals or plans for acquisition, diversification, or extension of the business between the companies. There were no common bonus or incentive plans for management or employees of the Taxpayer and Company A. There were no common services or products provided in the ordinary course of business by either company, nor were there any products produced by either company and utilized by the other.
As part of the original 1981 transaction that included the purchase of the Company B stock, the Taxpayer also acquired the exclusive rights in the United States and Latin America to use certain trademarks. However during the period at issue, the Taxpayer never utilized any of these trademarks and consequently no royalty payments were made.
The Taxpayer and Company A had no joint or common banking, financing or financial advisory services. The companies had no shared office space, warehouses, data processing facilities, machinery and equipment, transportation facilities or services, and there were no rentals of property or equipment between the companies. The companies had no common purchasing selling, marketing or advertising activities.
The Taxpayer had no approval authority over any budgets, contracts or capital expenditures of Company A. The companies had no common policies or procedures for capital investments or repair projects.
Under the terms of the purchase agreement, the Taxpayer was not permitted any representation on the Company A Board of Directors. The Taxpayer had no authority to control dividend payments made by Company A. The Taxpayer had no operations reporting requirements for Company A and was limited in the information it could receive from Company A because it was in direct competition with Company A in a number of markets.
There were no occasions where the Taxpayer controlled Company A's management or activities either with or without Company A's Board approval. There were no joint meetings of the management personnel or supervisors of the companies except for quarterly meetings of certain financial staff members of the two companies. The purpose of these meetings was for the Taxpayer to secure adequate financial information necessary for the Taxpayer to complete its quarterly earnings report to shareholders and at the same time not violate the EEC competition laws.
The companies had no joint administration manuals or general instructions for management or employees, nor were there any organization charts showing any reporting relationships between the Taxpayer and Company A because none existed. The Taxpayer never eliminated or caused to eliminate any marginal or unprofitable operations of Company A. There were no personnel exchanges between the companies.
To the best knowledge and belief of the Taxpayer. there was no change in the management personnel of Company A, there were no changes in location of Company A's headquarters or support operations, and Company A had no change in their external auditors, legal counsel, or advertising firms after the Taxpayer became an investor.
In 1988, the Taxpayer was challenged by another state as to the apportionability of interest and dividends received from Company B attributable to its holdings in Company A. The Court found that the Taxpayer held only a non-controlling interest, which was that of an investor. The Court cited that there was no exchange of technology, no information sharing agreements, and no sales or purchases between the two organizations. The Court found that the Taxpayer had not realized any business advantage from the investments such as new market territories, discounts, or loans. The Court held that because the Taxpayer was primarily an investor who simply received dividends and interest on capital investment, such income constituted nonbusiness income that could not be apportioned. The Supreme Court of that state upheld that decision.
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. Pursuant to a decision from the Supreme Court of another state, the Taxpayer was found to have a nonunitary relationship with 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 1989 out of Virginia apportionable income. The sales factor for 1989 will also be adjusted to remove the gross proceeds of the allocable income from the denominator.
All other aspects of the Taxpayer's 1989 allocation and apportionment shall be determined in accordance with §§58.1-406 through 58.1-420. The protective claim will be processed 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 1989 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
Tax Commissioner
OTP/6746M
Rulings of the Tax Commissioner