Tax Type
Corporation Income Tax
Description
Foreign source income and expenses; Sales factor and income adjustment
Topic
Collection of Tax
Date Issued
02-18-1994
February 18, 1994
Re: §58.1-1821 Application; Corporate Income Taxes
Dear****************
This will reply to your letter dated June 14, 1993, in which you make application for correction of the assessments for additional corporate income taxes to ****** (the "Taxpayer") for the years ending December 31, 1989 and 1990.
FACTS
The Taxpayer was field audited by the department, and numerous adjustments were made. The Taxpayer has protested two issues, and has made application to the department for a correction of these issues .
RULING
Foreign Source Income and Expenses: An audit adjustment was made to reduce the subtraction allowed pursuant to Va. Code §58.1-402(C) (8), (Foreign Source Income) by expenses allocable and apportionable to such income. You aver that the department lacks the authority to allocate expenses against foreign source income in determining the Virginia subtraction.
The statutory requirement that the subtraction for foreign source income be computed net of related expenses is found in Va. Code § 58.1-402(C), which provides:
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- "[There] shall be subtracted to the extent included in and not otherwise subtracted from federal taxable income: ...
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- [8.] Any amount included therein which is foreign source income as defined in §58.1-302." (emphasis added)
Virginia Regulation (VR) 630-3-302 provides:
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- "[The] federal procedure in Treasury Reg. §1.861-8 is applied to allocate and apportion expenses to income derived from U.S. and foreign sources."
Previous rulings of the department require the Virginia subtraction for foreign source income to be reduced by expenses, determined in accordance with IRC §861 et seq. See Public Document (P.D.) 93-235 (12/28/93) (copy attached). The department's policy in this area has been clearly defined. Virginia law requires the use of the federal sourcing rules of IRC §§861, 862 and 863 whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and regardless of what expenses would be under generally accepted accounting principles.
Therefore, in accordance with the U. S. Treasury regulations under IRC §861, expenses that are not definitely allocable are to be apportioned ratably among the statutory groupings of gross income and the residual groupings.
The department has previously ruled that the proper method of computing nonallocable expenses attributable to foreign source income is to multiply total nonallocable expenses by a ratio, the numerator of which is total Virginia foreign source gross income and the denominator of which is total gross income from without the United States per the Form 1118 (P.D. 93-235). Items which qualify for separate subtractions under other provisions of the Virginia code, such as IRC §78 gross-up, Subpart F income, and dividends from corporations in which the taxpaying corporation owns 50% or more of the voting stock are not subtracted again as foreign source income. Accordingly, they are not included in the numerator of the ratio, but are included in the denominator to the extent included on Form 1118. Allocable expenses, if any, should be applied directly to the category of income to which they relate.
Accordingly, the auditor's adjustment to the foreign source income subtraction will be adjusted for dividends received from 50% or more owned corporations, and expenses will be calculated in the manner described above. Dividends received from 50% or more owned corporations will be allowed as a separate subtraction pursuant to Va. Code §58.1-402(C) (10).
Sales Factor & income adjustment: The department's auditor adjusted the sales factor denominator to reconcile to the gross receipts reflected on the Taxpayer's federal return. The Taxpayer had increased its sales factor denominator by including government contract expense reimbursements which are accrued for financial accounting purposes. These expense items are not reimbursable until actually paid for government contracting purposes. The result of the Taxpayer's calculation is to include the income in the denominator of the sale factor prior to including the income in federal taxable income.
The auditor reconciled the sales factor denominator to the gross receipts reported on federal Form 1120. All receipts, as defined by VR 630-3-302, were included. Accordingly, the auditor's adjustment to the sales factor is proper.
The auditor also adjusted taxable income by the amount of this income, as it represents a consolidating adjustment to federal taxable income. While this is true, there is also a corresponding consolidating entry to expense which offsets the income, resulting in no net increase to federal taxable income. Accordingly, no Virginia adjustment is necessary, and the adjustment to taxable income for this item shall be reversed in both taxable years.
The audit report and assessment will be adjusted in accordance with this letter, and you will receive a revised statement in due course.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/7093M
Rulings of the Tax Commissioner