Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Income from unitary business operations
Topic
Allocation and Apportionment
Date Issued
09-07-1994
September 7, 1994
Re: §58.1-1821 Application: Corporate income tax
Dear****************
This will reply to letters of June 9, 1994, and November 5, 1993, in which application was made for correction of an assessment of additional corporate income taxes to************** (the "Taxpayer") for the taxable years ended May 31, 1990, 1991, and 1992.
FACTS
The Taxpayer claimed a subtraction for certain nonbusiness income on its Virginia corporate income tax returns. Pursuant to an audit, the subtractions claimed by the Taxpayer for such nonbusiness income were disallowed. The Taxpayer contests this determination, and believes that such nonbusiness income should not be subject to apportioned taxation by Virginia.
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 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.
Interest income. The Taxpayer is a member of a large affiliated group (the "Group"), ultimately owned by a publicly traded corporation. During the taxable years in question, the Taxpayer made numerous loans to related parties. The related parties are owned by various members of the Group. The Taxpayer has classified 100% of the interest income received from such related parties as nonbusiness income.
The Group is engaged in three major lines of business, each dealing in large part with the exploration, development and management of natural resources. The Taxpayer
principal businesses are highly complementary, resulting in a sharing of expertise and experience. This synergy provides considerable benefits to customers through access to up-to-date technical and marketing information, and innovative product research and development. The Group's activities also extend to specialized support undertakings which include finance, research, information technology, engineering, environmental planning, shipping and other transport activities.
A centrally headquartered marketing division works closely with various operating divisions in preparing and implementing strategies and programs to meet current and future customer needs. This division operates a world-wide regional marketing office as well as providing central market research and analysis of associated support services. The Group considers market development and customer contact to be a joint effort which is conducted by regional marketing offices and by personnel from each operating division. The Group has similarly pooled resources for its exploration, finance and environmental quality units.
The Taxpayer has earned interest income from loans made to various members of the Group. Loans have been made to operating companies engaged in various aspects of harvesting and utilizing natural resources, as well as to support companies that engage in marketing and finance activities on behalf of other members of the Group. The loans appear to have been made to those members of the Group in need of funds, as opposed to loans made as part of a pattern of passive investment. The Group appears to move capital between member, on an as needed basis.
The various members engage in activities which generally relate to the overall business theme of the Group; natural resources. Generally, members appear to be complementary to rest of the Group's activities. The choice of investing in any particular company appears to be driven by the impact such member will have on the operational activities of the Group as a whole. The members therefore appear to have been chosen because of their ability to complement operational activities, as opposed to their merits as a passive investment. The complementary benefits and services provided and enjoyed by members of the Group, such as marketing, technical resources and other functions, when combined with the similarity of the Groups overall undertakings, lead to the conclusion that the Group is a unitary operation operating on a global basis.
The Taxpayer has not demonstrated by clear and cogent evidence that their investments were other than loans between members of a unitary group of corporations, of which the Taxpayer is a member. In addition, some of the loans were made to "support organizations" which provide services to other members of the Group.
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)
- 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.
Based on the information provided, it is not possible to conclude that the Taxpayer's loans to affiliates are fairly characterized as passive investments. 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 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. Based upon the information provided, the Taxpayer has not met the burden of proof.
Capital Gain. The Taxpayer realized a capital gain from an award by a federal court which decided that the government had to pay the Taxpayer for taking its property. The property taken was the right to extract minerals from property leased by the Taxpayer. The Taxpayer contends that the gain is unrelated to the Taxpayer's operations carried on in Virginia, and relates to the loss of the right to mine minerals as opposed to the loss of the leases themselves. The Taxpayer believes that the gain should not be subject to apportioned taxation in Virginia.
The Group is one of the largest vertically integrated natural resource companies in the world. The Group holds and leases vast amounts of land, from which it mines natural resources for sale. The Group also mines natural resources used in manufacturing its products. The Group engages in the development and production of oil, minerals and steel. The Taxpayer, as a member of the Group, engages in mineral exploration both within and without of Virginia.
The Taxpayer clearly uses its mineral holdings (including the rights to mine minerals) as an operational asset, involved in a unitary manufacturing business.
Guidance on this issue may be drawn from the decision of the Oregon Tax Court in Willamette Industries, Inc. v. Department of Revenue, Or. Tax Ct., Oct. 6, 1992, 12 OTR 291. In that case, the Oregon Tax Court found that oil and gas royalties received by a timber company, engaged in the unitary business of forest management, logging and the production of various wood and paper products, could be apportioned to Oregon even though the real property was located in other states. The Oregon court stated:
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- "What is determinative here is that the income arises from plaintiffs' business assets. If plaintiffs invested in oil lands devoid of timber with no relation to plaintiffs' trade or business, the income would be nonbusiness income and subject to allocation. Here, however, the timberland is acquired, managed and used in plaintiffs' trade or business. The oil and gas royalties are simply incidental business income arising from this business property."
- "What is determinative here is that the income arises from plaintiffs' business assets. If plaintiffs invested in oil lands devoid of timber with no relation to plaintiffs' trade or business, the income would be nonbusiness income and subject to allocation. Here, however, the timberland is acquired, managed and used in plaintiffs' trade or business. The oil and gas royalties are simply incidental business income arising from this business property."
In this particular matter, the Taxpayer must do more than show that the payor of the gain is an unrelated third party, or that the property rights are located outside Virginia. Rather, 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.
The real question therefore, is whether the capital gain arises from an operational function. The income in question arises from the Taxpayer's intent to exploit land holdings for their various natural resources. As the U. S. Supreme court made clear in Corn Products Co. v. Commissioner, 350 U. S. 46, 50-53 (1955), capital transactions can serve either an investment function or operational function. In the instant case, the foregone mineral rights clearly relate to the Taxpayer's unitary business operations. Based upon the information provided, the Taxpayer has not met the burden of proof with respect to their claim.
Accordingly, permission to use an alternative method of allocation and apportionment of the aforementioned interest income and capital gain is hereby denied.
Foreign source income. In the course of reviewing your application, was determined that certain of the items of interest income constitute foreign source income. Accordingly, a subtraction will be allowed for foreign source interest income in accordance with Va. Code §58.1-402. In addition, upon review of the auditor's adjustment, it appears that the foreign source income subtraction was reduced by related expenses in accordance with department policy. However, the subtraction will be adjusted to the extent that expenses have been applied to reduce foreign dividends received from 50% or more owned corporations in accordance with P.D. 93-235 (12/28/93), copy attached.
Capital loss. In the course of reviewing your protest, it was determined that a capital loss from the taxable year ended May 31, 1990 had not been carried forward in determining federal taxable income on a separate company basis for Virginia purposes. Accordingly, this loss will be allowed against the capital gain recognized during the taxable year ended May 31, 1991.
The assessment shall be adjusted as provided herein and as reflected on the attached schedules. The balance due,
should be paid within 30 days to prevent the accrual of additional interest. Your payment may be sent to******* c/o Office of Tax Policy, Department of Taxation, P.O. Box 1880, Richmond, Virginia 23282-1880.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7495M
Rulings of the Tax Commissioner