Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment
Topic
Allocation and Apportionment
Date Issued
10-31-1996
October 31, 1996
Re: § 58.1-1821 Application: Corporation income tax
Dear**********
This will reply to your letter in which you apply for correction of an assessment of additional corporate income taxes to****** (the "Taxpayer") for the 1992 taxable year. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer was the subject of a field audit. An adjustment was made on the Taxpayer's Virginia return to include a capital gain recognized by one of its affiliated corporations on the sale of common stock warrants of an unrelated company. Less than two weeks prior to the sale of the stock warrants, the Taxpayer had transferred the warrants to this affiliate, which is based in Delaware. The transfer was made pursuant to Internal Revenue Code § 351 in exchange for an increased tax basis in the affiliated corporation.
The department's auditor determined that the transfer of the stock warrants constituted an arrangement between the Taxpayer and the affiliated corporation, which had the effect of distorting income from business done in Virginia. You now contest this adjustment on the basis that such income was not related to the Taxpayer's operational business in Virginia and is allocable investment income.
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 pursuant to Code of Virginia § 58.1-421.
The Taxpayer has indicated that it was never a shareholder in the unrelated corporation. In addition, the information provided indicates that the Taxpayer and the unrelated corporation were not related in any other respect.
Even so, the Taxpayer must do more than show that the income is derived from an investment in an unrelated third party. Rather, the Taxpayer bears the 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:
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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 real question therefore, is whether the capital gain arose from an operational function. In this case, the warrants were acquired in 1989 in the same transaction in which the Taxpayer purchased a subsidiary of the unrelated corporation. The Taxpayer continued to maintain an operational investment in the subsidiary through the audited periods. In the 1992 Consolidated Statement of Cash Flows, the gain on the sale of the warrants is categorized as cash flows from operating activities. In addition, you have indicated that the purpose of the transfer was to provide the affiliated corporation (a finance corporation) with additional working capital for use in its financing activities. In summary, this does not appear to be a passive investment for which there were no operational reasons to select, acquire, manage or dispose of the common stock warrants.
Based upon the information provided, the Taxpayer has not met the test set forth in Allied Signal. Accordingly, permission to use an alternative method of allocation and apportionment for capital gain earned from the sale of the common stock warrants is hereby denied.
Accordingly, the assessment is upheld. The balance due on the attached schedule should be paid within 30 days to prevent the accrual of additional interest. Your payment may be sent to Office of Tax Policy, Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218-1880. If you have any additional questions regarding this ruling, please don't hesitate to call*********** in the Office of Tax Policy at**************.
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Sincerely,
Danny M. Payne
Tax Commissioner
OTP/9686O
Rulings of the Tax Commissioner