Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Capital gains from passive investment
Topic
Allocation and Apportionment
Date Issued
10-22-1996
October 22, 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 additional corporate income tax to ********* (the "Taxpayer") for the 1993 and 1994 taxable years. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a publicly held corporation headquartered outside Virginia. In 1990 and 1992, the Taxpayer raised capital through preferred and common stock offerings. The proceeds were invested and have been subsequently managed by an independent investment advisor. The funds have been predominantly invested in short--term municipal securities. None of the funds have been utilized to acquire fixed assets or augment normal working capital requirements.
In taxable years 1993 and 1994, the Taxpayer realized capital gains and interest income from these investments. The Taxpayer treated this income as nonapportionable nonbusiness income. The treatment was subsequently disallowed by the department during a field audit. The Taxpayer protested the department's right to apportion and tax such income, claiming that the income is allocable to its state 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 §§ 58.1-402 and 58.1-403, 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.
The Taxpayer's protest is based on the claim that the imposition of Virginia statute violates the standards enunciated by the U.S. Supreme Court in Allied-Signal. Inc. v. Director, Division of Taxation, 112 S. Ct. 2251 (1992). 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."
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- "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 nature of the Taxpayer's investments (municipal securities) precludes the presence of a unitary relationship between the Taxpayer and issuer. The probative question, therefore, is whether the income from these securities fulfilled an investment or operational function.
In Public Document (P.D.) 94-58, (3/15/94), copy enclosed, the department addressed the issue of whether investment income served an operational or investment function. The department examined levels of long-term debt, concluding that significant amounts of debt create a strong presumption that cash reserves or investments fulfill an integral operational function. This operational function was achieved, the department reasoned, by either contributing to debt retirement or maintaining a strong financial position to facilitate operational relationships involving banking and credit. The department also examined the function of the investment within the context of normal working capital requirements.
In the instant case, the Taxpayer had a relatively small amount of long-term debt in comparison to current liabilities at the beginning of taxable year 1993, and none at all throughout 1994. Cash (excluding investments) and accounts receivable at the conclusion of 1992, 1993, and 1994 were sufficient to cover total current liabilities. While cash provided by operating activities was slightly negative in 1993, this deficit was easily covered by existing cash balances. In 1994, operating cash flow was significantly positive. The Taxpayer's increasing investment in fixed assets was financed by operations as evidenced by the Taxpayer's financial statements, which exhibited increasing sales and operating income for 1991-1994. In addition, no dividends were paid by the Taxpayer during those years, thereby enabling operating results to finance expansion and maintain working capital requirements while reducing the likelihood that investments would be needed to supplement working capital.
The facts and circumstances surrounding the Taxpayer's investment income resemble those described in P.D. 94-178, (6/8/94), copy enclosed, in which the department granted a taxpayer permission to use an alternative method of allocation and apportionment. In the instant case, as in P.D. 94-178, the investment was financed through the issuance of stock, maintained in a segregated fund, and not relied upon to supplement operations. The department concluded that the investment in P.D. 94-178 constituted one which was conducted independently from the management and investment of necessary working capital balances.
The evidence provided by the Taxpayer supports the contention that the income in question was generated through a passive investment with non-unitary payers and therefore is not subject to apportionment under the guidelines established in Allied-Signal. Accordingly, permission is hereby granted to allocate the investment income out of Virginia apportionable income for the taxable years 1993 and 1994. The assessments have been abated as described herein and on the enclosed schedules.
This ruling is limited to the activity described herein for taxable years 1993 and 1994, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10859G
Rulings of the Tax Commissioner