Tax Type
Corporation Income Tax
Description
Foreign source income; Construction-in-progress; Audit adjustments
Topic
Collection of Tax
Date Issued
03-04-1994
March 4, 1994
Re: §58.1-1821 Application; Corporate Income Taxes
Dear*********
This will reply to your letter dated March 16, 1993, in which you make application for correction of the assessments for additional corporate income taxes to ******* (the "Taxpayer") for the fiscal years ending September 30, 1989 and 1990.
FACTS
The Taxpayer was field audited by the department, and numerous adjustments were proposed. The Taxpayer has protested several issues on various grounds, 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 contend that expenses should be allocated using the income baskets as provided on federal Form 1118, rather than in general. Also, you contend that foreign source income from the performance of services should be included in the calculation.
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: ...[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.) 91-229 (9/30/91) (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. 91-229). 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.
Section 904 of the Internal Revenue Code provides for the separate application of the federal foreign tax credit limitation with respect to certain categories or "baskets" of foreign source income. Accordingly, federal Form 1118 must be prepared with respect to the separate baskets as required by federal law. The foreign tax credit limitations of §904 of the Internal Revenue Code do not apply to the Virginia foreign source income subtraction. In addition, these limitations do not affect the federal rules used in the subtraction. Therefore, foreign source income and expenses reported on Form 1118 shall be considered for purposes of the Virginia foreign source income subtraction regardless of the limitations of 904 of the Internal Revenue Code. See P.D. 91-59 (3/29/91) (copy attached).
The subtraction for foreign source income is limited to: (i) interest; (ii) dividends; (iii) rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property; and (iv) gains, profits, or other income from the sale of intangible or real property located without the United States. Other types of income, not specifically enumerated in Va. Code §58.1-302, do not qualify for the subtraction regardless of the source of the income.
Compensation for labor or personal services performed does not qualify for the Virginia foreign source income subtraction regardless of its source. In order to qualify for a subtraction pursuant to this regulation, technical fees must arise in connection with, and be incidental to, passive types of income in the nature of rents, royalties, or license fees. Income arising primarily from personal services, or from a contract to perform personal services, shall not qualify for the subtraction. The fact that "technical services" or services of a "technical nature" are performed does not automatically qualify such income for the subtraction. See P.D. 87-211 (9/15/87) (copy attached). Accordingly, no adjustment will be made with respect to foreign source income from services performed.
Property factor: For purposes of determining its Virginia apportionment percentage, the Taxpayer prepared a schedule upon which it attempted to account for various corporate changes during the year. The Taxpayer was a party to several significant transactions (spinoff's, mergers, etc.) during the year. The Taxpayer prepared its schedule in such a fashion that the fluctuations caused by these transactions were "averaged," and believes that such schedule should be used for purposes of apportionment.
The Taxpayer has also protested an adjustment made by the auditor with respect to construction-in-progress.
In the course of the audit, the department's auditor requested apportionment schedules prepared in accordance with Virginia law and regulations. The Taxpayer informed the auditor that their apportionment schedules were not maintained in the format prescribed for Virginia purposes. Accordingly, the auditor used his judgment, and the available information, in determining the proper Virginia property factor. This is necessary wherever a taxpayer's records and schedules are not prepared in accordance with Virginia law and regulations.
VR 630-3-411 allows taxpayers to elect to use average monthly values for the property apportionment factor where substantial variances exist. However, the Taxpayer's apportionment schedules were not prepared in accordance with the method prescribed in the regulation. The Taxpayer has not provided average property values prepared on a monthly basis in accordance with the regulation.
The Taxpayer's protest cites an error in the balances used for construction-in-process. However, the balances provided by the Taxpayer as of the end of one year do not agree to the balance as of the beginning of the subsequent year. No explanation of this discrepancy has been provided.
In administrative and judicial proceedings to correct an assessment, Virginia law presumes that the assessment is correct and the burden is on the taxpayer to prove what the correct tax should be. In issues regarding factual matters, a taxpayer bears the heavy burden of proof. In its protest, the Taxpayer has not met this burden, nor has it demonstrated that its method of apportionment is more appropriate than that determined by the auditor. In the absence of adequate documentation supporting the Taxpayer's computation of the correct tax, I will not disturb the judgement of the auditor. Accordingly, no relief is granted with respect to this issue.
Sales Factor: The department's auditor adjusted the sales factor denominator to reconcile to the gross receipts reflected on the Taxpayer's federal return. The Taxpayer contends that various miscellaneous income items belong in the sales factor. The items protested appear to primarily be rebates, accounting adjustments, and sundry receipts.
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. Rebates and various accounting adjustments do not qualify as a gross receipt within the meaning of VR 630-3-302. The Taxpayer has not provided sufficient documentation to verify that sundry income has not already been included in figures used by the auditor. In accordance with P.D. 92-45 (4/27/92) (copy attached) the department cannot allow a taxpayer to include in the denominator of the sales factor receipts from an unknown or unidentified source.
In the absence of adequate documentation supporting the Taxpayer's computation of the correct tax, I will not disturb the judgement of the auditor. Accordingly, no relief is granted with respect to this issue.
In summary, the subtraction for foreign source income will be adjusted to allow a separate subtraction for dividends received from subsidiaries in 50% or more of the voting stock is owned. Foreign source income shall be reduced by related expenses provided herein. No adjustments shall be allowed respect to the property or the sales factors.
The audit report and assessment will be adjusted in accordance with this letter, and you will receive a revised statement in due course.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/6857M
Rulings of the Tax Commissioner