Tax Type
Corporation Income Tax
Description
Royalty Payments
Topic
Collection of Tax
Royalties
Date Issued
03-16-1994
March 16, 1994
Re: §58.1-1821 Application: Corporate Income Taxes
Dear**************
This will reply to your letter of October 15, 1993, in which you applied for a correction of additional corporate income taxes to***********(the "Taxpayer") for the taxable years ended December 31, 1989 and 1990, and to your 1989 refund claim filed separately on October 15, 1993.
FACTS
The Taxpayer was field audited, and several adjustments were made. You contest the adjustment made by the department's auditor to disallow deductions claimed for royalty payments made to a related party, and aver that such payments are deductible by the Taxpayer. You have also filed a refund claim for 1989, contending that the taxpayer is exempt from taxation for that year.
DETERMINATION
Royalties
The Taxpayer is a multinational manufacturer, headquartered outside of Virginia. During 1989 and 1990, the Taxpayer paid royalties to a subsidiary ("S") for the license of technology. Because of the limited business activity reported by S, the department's auditor disallowed these royalties pursuant to the authority granted by Va. Code Sec. §58.1-446.
The royalties in question were paid pursuant to technology license agreements between the Taxpayer and S. The license is for technology vital to the production of product by the Taxpayer. The technology is highly proprietary, and in certain circumstances is patented.
S is in the business of acquiring and developing technology for license to others. S owns all the technology for the Taxpayer's worldwide affiliated group which includes all of the Taxpayer's domestic and foreign subsidiaries. It maintains an office and its technology related documents and blueprints outside Virginia. S has full and part-time employees. All license agreements, patents, and other documents must be approved and signed by an officer of S at its office.
S has entered into an agreement with the Taxpayer for the development of new technology and the maintenance of existing technology. Fees for these services are calculated on a cost-plus basis, with a markup factor. Pursuant to this agreement, S paid the Taxpayer in excess of ***********during 1989 and 1990. These fees were included in the income which the Taxpayer apportioned to Virginia. Rights to technology developed as a result of such efforts are the property of S. S has also acquired technology from unrelated third parties. This technology is sometimes licensed to S for its use, and sometimes acquired for a lump sum payment.
S has licensed some of the same technology used by the Taxpayer to affiliates in foreign countries at the same royalty amount changed to the Taxpayer. In at least one instance, the taxing authority of a foreign country has approved the arm's length nature of the royalty amount. S has licensed technology to joint ventures involving the Taxpayer and unrelated third parties, and has licensed technology directly to at least 14 different unrelated third parties.
Va. Code §58.1-446 provides, in pertinent part:
-
- "... when such a corporation sells its products, goods or commodities to another corporation or acquires and disposes of the products, goods or commodities of another corporation in such manner as to create a loss or improper taxable income, and such other corporation by stock ownership, agreement or otherwise controls or is controlled by the corporation liable to taxation under this chapter, the Department may require such facts as it deems necessary for the proper computation Provided by this chapter and may for the purpose determine the amount which shall be deemed to be the Virginia taxable income of the business of such corporation for the taxable year. In determining such income, the Department shall have regard to the fair profits which, but for any agreement, arrangement or understanding, might be, or could have been, obtained from dealing in such products, goods or commodities.
...In case it appears to the Department that any arrangements exist in such a manner as improperly to reflect the business done or the Virginia taxable income earned from business done in this Commonwealth, the Department may, in such manner as it may determine, equitably adjust the tax. " (Emphasis added.)
- "... when such a corporation sells its products, goods or commodities to another corporation or acquires and disposes of the products, goods or commodities of another corporation in such manner as to create a loss or improper taxable income, and such other corporation by stock ownership, agreement or otherwise controls or is controlled by the corporation liable to taxation under this chapter, the Department may require such facts as it deems necessary for the proper computation Provided by this chapter and may for the purpose determine the amount which shall be deemed to be the Virginia taxable income of the business of such corporation for the taxable year. In determining such income, the Department shall have regard to the fair profits which, but for any agreement, arrangement or understanding, might be, or could have been, obtained from dealing in such products, goods or commodities.
The Taxpayer has demonstrated that S has a viable economic substance as evidenced by its employees, assets, and substantial business activity. The royalty payments have been shown to reflect arm's length prices, evidenced by third party activity and the approval of taxing authorities in foreign countries. S has engaged the Taxpayer to research and develop new technology, and has paid the Taxpayer over **************for such services during the audit period. The licenses relate to valuable technology related to a complex manufacturing process. The importance of this technology to the business conducted by the Taxpayer can be demonstrated by substantial licensing activity of the same technology to unrelated third parties. S licenses technology to third parties on a regular and continuous basis. Finally, the intangible assets licensed by S to the Taxpayer are not used in Virginia.
Based on the information provided by the Taxpayer, I do not find sufficient evidence to conclude that an arrangement exists in such a manner as to improperly reflect the business done or the Virginia taxable income earned. Accordingly, the auditors adjustment for royalty expense shall be reversed.
Claim for refund
The Taxpayer's activities in Virginia during 1989 and 1990 were limited to sales of its products to customers in Virginia. In 1989, the Taxpayer apportioned sales to Virginia. In 1990 the Taxpayer apportioned sales, property and payroll to Virginia, based on the presence of salesmen and inventory in Virginia. The Taxpayer now believes that it is exempt from Virginia taxation pursuant to Public Law (P.L.) 86-272, §15 U.S.C.A., §§381-384, and has filed a refund claim for 1989 requesting a refund of all taxes paid for that year.
Virginia is precluded from imposing its income tax by P.L. 86-272 if a foreign corporation's activities within Virginia are limited to solicitation of orders for the sale of tangible personal property if the orders are sent outside Virginia for approval or rejection, and if approved, the orders are filled by shipment or delivery from outside Virginia. The department narrowly interprets P.L. 86-272 within the context of the decision of the U.S. Supreme Court in Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 112 S. Ct. 2447, (1992). Activities which are neither ancillary to solicitation, nor de minimis in nature, are not considered to be protected by P.L. 86-272 for Virginia purposes.
The Taxpayer's refund claim does not contain any detail of its activities within Virginia during 1989. Absent a detailed analysis of all of the Taxpayer's activities in Virginia, including objective documentary evidence where necessary, it is not possible to determine whether Virginia is precluded from imposing the income tax. Pursuant to Va. Code §58.1-205, any assessments of tax by the department shall be deemed prima facie correct. 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 tax is barred by the narrow scope of P.L. 86-272. Based on the information provided, I do not find that the Taxpayer met the burden of proof. Accordingly, the claim for refund is hereby denied.
The assessment will be adjusted in accordance with the attached schedules. The balance due including interest, ***** must be paid within 30 days to prevent the accrual of additional interest.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/7459M
Rulings of the Tax Commissioner