Tax Type
Corporation Income Tax
Description
Apportionment of passive income; Protective claim
Topic
Allocation and Apportionment
Collection of Tax
Date Issued
08-11-1994
August 11, 1994
Re: §58.1-1824 Protective claim: Corporate income taxes
Dear*****
This will reply to your letter of July 25, 1994, regarding the protective claim for the 1988 taxable year filed on January 18, 1991 on behalf of ********* (the "Taxpayer"). I apologize for the delay in responding.
FACTS
The Taxpayer was the subject of an office audit, and adjustments were made to the 1988 taxable year. The Taxpayer has filed a protective claim for 1988, contesting the department's right to apportion and tax certain passive income.
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 claim has been treated as a request for an alternative method of allocation and apportionment pursuant to Va. Code §58.1-421.
Because the Taxpayer has contested several different items of income, each will be addressed separately.
Stock sales: In 1988, the Taxpayer realized a capital gain on the sale of stock of Company A. The Taxpayer had acquired an option to buy Company A stock in 1988. Prior to exercising the option, an unrelated third party issued a tender offer for Company A stock at a price that exceeded the Taxpayer's option purchase price. The Taxpayer exercised its option to acquire the stock, and immediately surrendered it pursuant to the tender offer. The Taxpayer never actually paid the purchase price, but merely received a check for the spread between the option price and the tender offer.
Between 1982 and 1984, the Taxpayer acquired shares of common stock of Company B, a publicly held company. The Taxpayer's total ownership interest in Company B never exceeded 6.5%. The Taxpayer sold the Company B stock over an extended period, including sales in 1988.
The Taxpayer believes that the gains realized from the sales of Company A and Company B (the "Companies") should be allocated to its state of commercial domicile.
The Taxpayer owned small minority interests in the Companies. No officer, director or employee of the Taxpayer served as an officer, director or employee of the Companies. The Taxpayer has provided ample evidence indicating that its only relationship with the Companies was as a minority stockholder. The Taxpayer and the Companies were unrelated in every other respect. During the period of its ownership of the Companies, there were no transactions of any type between the Taxpayer and the Companies.
The facts and circumstances surrounding the Taxpayer's investment in the Companies closely resemble those described in Public Document 94-93 (3/29/94), copy attached.
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.
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and the companies, and to determine if the Taxpayer's activities related to its investments in the Companies 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. Inc. v. Director. Div. of Taxation, 112 S. Ct. 2551 (1992).) Evidence regarding these factors was presented 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 the Companies. Based on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and the Companies.
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 investment in the Companies did not complement the Taxpayer's operational activities; no economies were achieved; and, the management of the Companies was at all times separate and distinct from the general management of the Taxpayer.
In light of the substantial evidence provided, it is possible to conclude that: the Taxpayer's investments in the Companies constitute passive investments that are not of an operational nature. Based upon the information provided, the department finds that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Accordingly, permission is hereby granted to allocate the gains recognized by the Taxpayer upon the sales of the Companies out of Virginia apportionable income.
Interest income from other notes receivable: The Taxpayer received interest income from various notes receivable from affiliated companies. Other than general statements regarding the nature of these notes, the Taxpayer has not provided objective evidence indicating that the income arises in the absence of a unitary relationship, or that the income was not operational in nature or did not arise from an operational rather than a passive investment function.
In this particular matter, the Taxpayer must bear the heavy burden of demonstrating that the imposition of Virginia's statute is a violation of the standards enunciated by the United States Supreme Court in Allied-Signal. In Allied-Signal, the court stated
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"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."
Other items: On its tax return and in its protest, various other items of capital gain have been claimed as allocable income. The Taxpayer has not met the burden of proof with respect to these items. Accordingly, permission to use an alternative method of allocation and apportionment for such income must be denied.
Limitation: There is another limitation which will apply to the Taxpayer's allocable income. The gross amount of income which may be considered as allocable income pursuant to this ruling and Va. Code § 58.1-407 exceeds the Taxpayer's Virginia taxable income. However, because there is no express authority in the Code of Virginia for a Virginia net operating loss, neither the adjustments required in determining Virginia taxable income nor allocable income may be used to create a Virginia net operating loss. The amount of income which the Taxpayer may allocate out of Virginia is therefore limited to the sum of its federal taxable income and the adjustments required by Va. Code § 58.1-402. Because there is no provision for a Virginia net operating loss, allocable income from the 1988 taxable year cannot be utilized to reduce Virginia taxable income in any other taxable year.
The protective claim will be adjusted as provided herein, and as reflected on the attached schedules. The apportionment factors will also be adjusted to remove items attributable to allocable income from the denominator of the respective factors. All other aspects of the Taxpayer's allocation and apportionment shall be determined in accordance with Va. Code §§ 58.1-406 through 58.1-420. A refund will be paid as soon as practicable with interest at statutory rates.
This ruling is limited to the taxable year identified herein, and further limited to the activity described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/4924M
Rulings of the Tax Commissioner