Tax Type
Corporation Income Tax
Description
Joint Venture
Topic
Allocation and Apportionment
Date Issued
10-07-1996
October 7, 1996
Re: § 58.1-1821 Application: Corporate Income Taxes
Dear****************
This will reply to your letter in which you apply for correction of assessments of corporate income tax to******(the "Taxpayer") for the 1990-1992 taxable years. I apologize for the delayed response.
FACTS
The Taxpayer is a large manufacturing corporation headquartered outside Virginia. During the course of a field audit, several adjustments were made. You disagreed with two adjustments, which will be addressed separately.
DETERMINATION
Allocation of Capital Gain
In taxable year 1990, the Taxpayer recognized a capital gain on the sale of two stock holdings. The Taxpayer treated this capital gain as nonapportionable, nonbusiness income which it allocated to its state of commercial domicile. This treatment was disallowed by the auditor, who reclassified the capital gain as apportionable income.
In 1977, the Taxpayer acquired a 15% ownership position in a natural resource company. This investment was made after the Taxpayer had been apprised of the opportunity by its external financial consultants. In 1982, the natural resource company created a related corporation, and the Taxpayer received an ownership share in that corporation identical to its share in the natural resource company. The following year the Taxpayer acquired an additional 1.75% share in both companies (the "Corporations"), which it sold four years later.
During the term of the investment, the Taxpayer's manufacturing processes did not use any goods or services produced by the Corporations, nor did the Corporations use any goods or services produced by the Taxpayer. There was no transfer or common use of physical facilities, personnel or intangible assets between the Taxpayer and the Corporations. There were no loans between the Taxpayer and the Corporations, nor did the Taxpayer provide any services on behalf of the Corporations related to negotiating or obtaining financing. All financial and banking arrangements of the Corporations were separate from those of the Taxpayer. There were no joint marketing campaigns, administrative policies or labor negotiations. The Taxpayer did exercise its authority to appoint two members to each of the Corporation's board of directors. Each board had fourteen members, and required a simple majority to approve or disprove any proposal.
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 §§ 58.1-402 and 58.1-403, 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.
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 this test is fact sensitive.
In determining the existence of a unitary relationship, the department has utilized the three objective factors enunciated by the Supreme Court: (1) functional integration; (2) centralization of management; and (3) economies of scale. Evidence regarding these factors was presented by the Taxpayer in clear and objective terms. There was no flow of goods or a flow of values between the Taxpayer and the Corporations.
Based on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and the Corporations.
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 Corporations were not an integral component of the Taxpayer's ability to obtain financing on favorable terms before or after the acquisition; the Corporations were not needed to supplement the Taxpayer's working capital requirements; no economies were achieved; the Taxpayer and the Corporations operated in separate, unrelated industries; there was no attempt to take advantage of the fact that common ownership existed; and, there were no business transactions between the Taxpayer and the Corporations.
The evidence provided indicated that the Taxpayer's investment in the Corporations was of a passive nature, and the Taxpayer's sale of its investment did not enhance its operational activities carried on in Virginia. I find that the Taxpayer has demonstrated by clear and cogent evidence that an alternative method of allocation and apportionment is appropriate. Accordingly, permission is hereby granted to allocate the capital gain recognized by the Taxpayer on the sale of the Corporations' stock in 1990 out of Virginia apportionable income.
This determination is limited to the year and transaction described herein, and shall not be applicable to any other year or transaction.
Property and Sales Factors
The Taxpayer was a member of three joint ventures during the 1990-1992 taxable years. The joint ventures filed federal partnership returns each year. The agreements signed by each member of the joint venture indicated that each member's rights and obligations were equivalent to those of a general partner. The department's auditor did not include the Taxpayer's proportionate share of joint venture sales and property in the respective apportionment factors.
Internal Revenue Code (IRC) § 761 defines a partnership as "a syndicate, group, pool, joint venture, or other unincorporated organization" which is not a trust, estate, or corporation. Since Virginia is a federal conformity state, a joint venture is also a partnership for virginia tax purposes.
Virginia Regulation (VR) 630-3-409 states that "for purposes of the property factor each item of partnership property shall have the same character for a corporate general partner as if direct corporate ownership of the property existed." In Public Document (P.D.) 92-57, (4/29/92), copy enclosed, the department explained its statutory authority for inclusion of the general partner's proportionate share of payroll and sales in the respective apportionment factors.
According to the terms of the joint venture agreements presented, it is evident that the Taxpayer functioned in a capacity equivalent to a general partner. The Taxpayer's proportionate share of joint venture sales and property are therefore required to be included in the sales and property factors.
Your assessments will be adjusted as described herein and on the enclosed schedules. Please remit the balance due, ****within sixty days to prevent the further accrual of interest. Please send your payment to ****Office of Tax Policy, P.O. Box 1880, Richmond, Virginia 23218-1880. If you have any questions regarding this determination, you may contact ******directly at ****** .
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/9607G
Rulings of the Tax Commissioner