Tax Type
Corporation Income Tax
Description
Taxable income; Modifications to federal taxable income; Allocation of foreign source income expenses
Topic
Computation of Income
Date Issued
12-09-1996
December 9, 1996
Re: §58.1-1821 Application: Corporate Income Taxes
Dear*******
This will respond to your letter in which you seek correction of assessments of additional corporate income taxes to************** the "Taxpayers") for the taxable years ended March 31, 1990 and 1991 (the "1989" and "1990" taxable years, respectively). I apologize for the delay in responding to your request.
FACTS
The Taxpayers were field audited, and numerous adjustments were made. You protested two of these adjustments, which will be addressed separately.
DETERMINATION
Consolidated Return
The Taxpayers are members of an affiliated group which file a consolidated federal return. Prior to the 1990 taxable year, the Taxpayers filed Virginia corporation income tax returns on a separate company basis. For the 1990 taxable year, however, the Taxpayers filed as part of a consolidated Virginia return which included several other members of the affiliated group. The department's auditor disallowed the return on the grounds that permission to file a consolidated return had not been granted. Consequently, the auditor computed the Virginia corporate income tax liability of the Taxpayers on a separate company basis, resulting in assessments of additional tax. You request that the department grant permission for the Taxpayer to file Virginia corporate income tax returns on a consolidated basis. If the department denies this request, you ask that the department consolidate the Taxpayers, pursuant to Code of Virginia §58.1 -445, with the other members which joined the 1990 consolidated return.
Virginia Regulation (VR) 630-3-442, effective January 1, 1985, provides that in the first year two or more members of an affiliated group are subject to Virginia corporate income tax they may elect to file on a separate, combined, or consolidated basis. This election is also binding upon new members of the affiliated group who are subject to income taxation by Virginia. Once the election is made, it is irrevocable unless permission to change filing methods is granted by the department.
In the instant case, two of the Taxpayers filed separate Virginia returns prior to the 1990 taxable year. A third Taxpayer, incorporated in 1989, also filed a separate Virginia return for the 1989 taxable year. Since permission to file a consolidated return was required but not requested, the Taxpayers' requirement to file separate returns was still in effect for the 1990 taxable year. The department's auditor, therefore, acted properly in disallowing the consolidated return and computing the Virginia tax liability of the Taxpayers on a separate company basis.
You request that the department accept the consolidated return as filed, effectively granting retroactive permission to change filing methods. The department will not generally grant permission to change to or from the consolidated filing method, since such a change would affect the allocation and apportionment factors and possibly distort the reporting of the business done in Virginia. You state, however, that reporting on a separate company basis distorts Virginia income by neglecting to allocate expenses associated with the performance of services on behalf of the Taxpayers by their common parent. This result is not due to the Taxpayers' election to file separate returns, but rather the inability of the affiliated group to allocate those expenses. You further state that since the affiliated group engages in a unitary business it would have immense difficulty allocating expenses among related corporations. This difficulty, however, does not constitute an extraordinary circumstance sufficient to warrant granting permission to change to filing on a consolidated basis. Accordingly, permission to file a consolidated return cannot be granted.
You alternatively request that the department consolidate the accounts of the Taxpayers with the other members of the consolidated return pursuant to Code of Virginia §58.1-445. The purpose of Code of Virginia § 58.1-445 is to assure that items of income, gain, profit, deduction and capital are properly distributed or apportioned between taxpayers who may be taxable at different rates, by different methods, or by different states. VR 630-3-445 provides that consolidation is appropriate in situations in which federal taxable income is accurately stated, but the income from Virginia sources taxable by Virginia is inaccurately stated.
The department finds that it would be inappropriate to use the provisions of Code of Virginia§ 58.1-445 in this situation. The federal taxable income of each of the Taxpayers is accurately stated, and there is no distortion of the income from Virginia sources taxable by Virginia. You essentially argue that since the Taxpayers are part of an affiliated group engaged in a unitary business, which inherently makes allocation of shared expenses difficult, the department is obliged to accept the consolidated return as filed. Code of Virginia§§ 58.1-302 and 58.1-442 provide that Virginia does not utilize the unitary business concept in corporate income taxation. A review of the consolidated return filed and the auditor's workpapers revealed that two members of the affiliated group had insufficient business activity within Virginia to render any of the apportionment factors positive. Furthermore, you offer no evidence as to how these expenses should be allocated to accurately reflect Virginia taxable income, other than to suggest consolidation. Consolidating the accounts as requested would circumvent the department's long-standing policy regarding the corporate filing status election and the circumstances in which permission to change status is allowed. Accordingly, your request must be denied.
Foreign Source Income
The Taxpayers claimed as a subtraction from federal taxable income foreign source income as defined in Code of Virginia §58.1-302. The department's auditor, in attempting to determine the expenses attributable to this income, allocated the expenses and deductions listed on the consolidated Form 1118 to each of the Taxpayers based on each Taxpayer's relative share of total consolidated foreign source income. You protest the auditor's methodology, claiming that it is arbitrary and unreasonable.
The department's policy that the Virginia foreign source income subtraction must be reduced by related expenses, determined in accordance with the sourcing rules found in Internal Revenue Code (IRC) §861 et seq., is well-established. See Public Document (P.D.) 86-154, (8/14186), copy enclosed. In order to determine those expenses, the department places great reliance on federal Form 1118, since that form is prepared using the IRC sourcing rules. Once the total expenses pertaining to total foreign source income are identified, the formula in P.D. 91-229, (9/30/91), copy enclosed, is employed to determine the expenses actually attributable to the foreign source income eligible for the Virginia subtraction.
In the instant case, the auditor first needed to determine expenses on a separate company basis in order to apply the formula in P.D. 91-229; however, the Forms 1118 for both the 1989 and 1990 taxable years were prepared on a consolidated basis. Since information to prepare a proforma Form 1118 on a separate company basis was unavailable, the auditor utilized an allocation of expenses based on the Taxpayers' relative shares of consolidated foreign source income. This method appears reasonable. A similar method was used in P.D. 92-184, (9/10/92), copy enclosed, when the auditor used 49% of the Form 1118 expenses since 49% of the Form 1118 income was subtracted as foreign source income.
You have provided no specific evidence as to how the auditor's methodology is arbitrary and unreasonable, nor have any alternative calculations been submitted. In reviewing the auditor's calculations, however, the department noted some inconsistencies in the auditor's methodology. These inconsistencies are corrected on the enclosed schedules, which are incorporated in the revised audit report. If you can provide evidence as to the proper allocation of expenses, determined in accordance with P.D. 91-229, we will have the audit staff review this documentation and make any appropriate revisions.
Accordingly, based on the determinations in the above sections, the balance due as reflected on the enclosed revised audit report, is now due and payable. If, however, the expense allocation information referred to above is provided within ninety days, there will be no further accrual of interest beyond the date of this letter on the portion of the assessment attributable to the foreign source income adjustment. Interest will continue to accrue on the portion of the assessment attributable to the consolidated return adjustment if payment is not received within ninety days. The Taxpayers' payment and expense allocation information should be sent 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/99OOG
Rulings of the Tax Commissioner