Tax Type
Corporation Income Tax
Description
Domestic international sales corporations (DISCs),
Topic
Computation of Income
Royalties
Date Issued
12-20-1996
December 20, 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 "Taxpayer") for the 1992,1993 and 1994 taxable years.
FACTS
The Taxpayer is a manufacturer of tangible personal property headquartered outside Virginia. Pursuant to a field audit, adjustments were made to remove amounts classified as "Performance of Services" on the federal Forms 1118 from the Virginia foreign source income ("FSI") subtraction. You protest these adjustments, contending that these amounts constitute technical fees and thus qualify for the Virginia FSI subtraction. You also contend that the department erred in disallowing subtractions from federal taxable income for deemed dividends distributed by a former Domestic International Sales Corporation ("DISC").
DETERMINATION
Technical Fees
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- Code of Virginia §58.1-302 defines foreign source income, in pertinent part, as:
Rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property, including rents, royalties, or fees for the use of or the privilege of using without the United States any patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like properties.
- Code of Virginia §58.1-302 defines foreign source income, in pertinent part, as:
In the instant case, the Taxpayer has provided copies of contracts pertaining to its licensing of technology to be used outside the United States. This technology clearly falls within the context of "other like property" referred to in Code of Virginia § 58.1-302. In nearly all instances, the Taxpayer received either a royalty or a license fee for granting the right to use its technology. These royalties and fees were classified as "Gross Rents, Royalties and License Fees" on the corresponding federal Form 1 1 1 8, and were included in the Virginia FSI subtraction calculated by the department's auditor
Also provided with these contracts were additional contracts which specified the various services the Taxpayer would perform for the licensee. In all instances, these service contracts arose contemporaneously with the contracts granting the license. The services specified in these contracts were necessary in order for the licensee to implement the technology which it had been licensed. Without these services, the license would have been worthless to the licensee. Conversely, the Taxpayer would not have performed these services if there had not been an underlying agreement protecting its intellectual property rights. The consideration paid for these services, to the extent those services were performed outside the United States, clearly qualifies as "technical fees" for purposes of the Virginia FSI subtraction.
While all the contracts reviewed by the department contained provisions for technical fees which were incidental to the licensing of technology, one contract provided for additional services which the department cannot characterize as incidental. This contract stipulated that the Taxpayer would be paid a fee for providing management services for the licensee. These services included implementing changes in the licensee's financial systems as well as personnel policies and operating procedures. The Taxpayer was also engaged to achieve economies of scale in purchasing. These services fall beyond the scope of being incidental to the licensing of the Taxpayer's technology, and thus do not constitute foreign source income as defined by Code of Virginia §58.1-302.
DISC Dividends
Code of Virginia § 58.1-402.C. 3 provides that dividends from a DISC can be subtracted from federal taxable income if fifty percent or more of the DlSC's income for the preceding year, or the last year the DISC had income, was assessable by Virginia. Pursuant to this statute, if the return for the prior year, or the last year the DISC had gross income, shows that either all income was taxable in Virginia or that fifty percent or more of the net income was allocated and apportioned to Virginia, then the deemed dividends from the DISC in the current year can be subtracted from federal taxable income.
In the instant case, the department's auditor disallowed the subtraction of the DISC dividends from federal taxable income. Since the DlSC's income in the last year which it had income was not fifty percent or more assessable by Virginia, the disallowance of the DISC deemed dividends is correct. The auditor's calculation of allocable income, however, reduced gross dividends by the DISC dividends, which removed the DISC dividends from allocable income. These deemed DISC dividends are also considered dividends for allocation purposes under Code of Virginia § 58.1-407. Consequently, the DISC dividends will be allocated to the Taxpayer's state of commercial domicile.
Accordingly, the auditor's report will revised in accordance with the enclosed schedules and the determination herein. Since the Taxpayer paid the contested amount in full upon submittal of its protest, a refund, with interest at statutory rates, will be issued in due course.
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner