Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Out-of-state real property
Topic
Allocation and Apportionment
Date Issued
03-28-1995
March 28, 1995
Re: §58.1-1821 Application: Corporate income taxes
Dear**************
This will reply to your letter of May 12, 1994, in which you apply for correction of an assessment of additional corporate income taxes to**********(the "Taxpayer") for the taxable year ended March 31, 1993.
FACTS
The Taxpayer was the subject of an office audit for the taxable year ended March 31, 1993, and an assessment was made as a result of that audit. The Taxpayer has contested the department's right to apportion and tax the gain realized on the sale of real property located outside of Virginia. The Taxpayer believes that such income is allocable to its slate of commercial domicile.
DETERMINATION
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 Code of Virginia §§58.1402 and 58.1403, less dividends allocable pursuant to Code of Virginia §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 Code of Virginia §58.1-421.
You state that the real property was purchased in 1981, and since owning the building the Taxpayer never used it for operational purposes. You state that from 1981 until the date of sale the building was rented to an unrelated party. However, these statements do not agree with other information available to the department, which is summarized as follows:
- 1. The following explanation was provided in the Taxpayer's Virginia return:
- Taxpayer had moved its corporate headquarters to a new location and had leased its old headquarters (located at [the location of the real property sold]) to an unrelated party for a number of months.
On [date of sale] the taxpayer sold the building at [the location of the real property sold] to an unrelated party for a capital gain of ...
- Taxpayer had moved its corporate headquarters to a new location and had leased its old headquarters (located at [the location of the real property sold]) to an unrelated party for a number of months.
- 2. The Taxpayer's corporate letterhead reflects the address of the property sold as its own address as of a letter to the department dated September 13, 1983.
3. The following statements were contained in the Taxpayer's Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended March 31, 1992:
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- In addition, prior to May, 1991, the Company was the named tenant of [real property sold], a portion of which was subleased to [tenant] for the full remaining term of the lease. In May, 1991, the Company exercised its option to purchase the facility and renegotiate the lease with [tenant]. In June 1992, the Company entered into a contract to sell the facility to an unrelated third party...
5. The department's auditor remembers conducting an audit of the Taxpayer at the location of the real property which was sold. - In addition, prior to May, 1991, the Company was the named tenant of [real property sold], a portion of which was subleased to [tenant] for the full remaining term of the lease. In May, 1991, the Company exercised its option to purchase the facility and renegotiate the lease with [tenant]. In June 1992, the Company entered into a contract to sell the facility to an unrelated third party...
The information available to the department leads to the conclusion that the real property was in fact used (as a leasehold) by the Taxpayer as part of its operational activities, and that only a part of the building may have been subleased to a tenant. However, it appears that the tenant was at one time a division of the Taxpayer.
The fact that income is allocated or apportioned to another state does not by itself bar Virginia from apportioning and taxing that same income. The Taxpayer has not furnished any substantive documentation to refute the statutory method, other than general statements that the gain was nonbusiness income. Even if the Taxpayer had vacated the property prior to its sale, there is nothing which indicates the gain realized was attributable to the 13 month period between exercising the purchase option and entering into a contract to sell the building.
The Taxpayer has not shown that the statutory method of apportionment produces an unconstitutional result. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Mooreman Manufacturing Company v. Bair, 437 U.S. 279, 98 S.Ct. 2340 (1978).
The Taxpayer has failed to demonstrate that the real estate holding was not an operational asset involved in a unitary business. In this particular matter, the Taxpayer must do more than show that the tenant is an unrelated third party, or that the real property is 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. Inc. v. Director. Division of Taxation, 112 S. Ct. 2251 (1992). In Allied-Signal, the court stated:
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.
The real question therefore, is whether the gain on the sale of the real property arises from an operational function. The income in question arises from real property (leasehold) used in the Taxpayer's business, which generally constitutes an operational asset. 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 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. Accordingly, permission to use an alternative method of
allocation and apportionment for gain on the sale of the real property is hereby denied.
The assessment is upheld, and is now due as reflected on the attached schedule. The balance due including interest,***** must be paid within 30 days to prevent the accrual of additional interest.
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- Sincerely,
Danny M. Payne
Tax Commissioner
- Sincerely,
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OTP/8157M
Rulings of the Tax Commissioner