Tax Type
Corporation Income Tax
Description
Allocation of income; Income from operational function
Topic
Allocation and Apportionment
Date Issued
03-28-1997
March 28,1997
Re: § 58.1-1821 Application: Corporation Income Tax
Dear****************
This will reply to your letter in which you are requesting a refund of corporation tax for ************ (the "Taxpayer") for the taxable years 1989, 1990 and 1991. I apologize for the delay in responding.
FACTS
Pursuant to amended 1989,1990, and 1991 Virginia corporation income tax returns, the Taxpayer has claimed a subtraction from Virginia apportionable income for allocable non-business income, net of related expenses.
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 department has treated the Taxpayer’s amended returns as a request for an alternative method of allocation and apportionment pursuant to Code of Virginia § 58.1-421.
The Taxpayer, relying on a court decision which defined transactions and activities comprising the Taxpayer's business, contends income received from certain activities are not a part of its business operations. These activities include management and investment portfolios; real estate rentals; and dispositions of business interests, securities, real estate used in the business, and rental real estate. The Taxpayer believes that this income is not subject to tax by Virginia.
The Taxpayer has not furnished any substantive documentation to refute the statutory method other than general statements that a state court has declared certain activities of the Taxpayer are not considered business activities in accordance with the interpretations of the Taxpayer.
The Taxpayer must bear the burden of showing 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 this matter, the Taxpayer has not demonstrated that its investments are not operational assets involved in a unitary business. In considering the existence of unitary relationship, the Supreme Court has focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. (See Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S., 425 (1980); F.W. Woolworth Co. v. Taxation and Revenue Dept. of N.M., 458 U.S., 352 (1982); and Allied-Signal.) The Taxpayer presented no evidence regarding these factors. Even so, it appears likely that income from rental of real estate operations, sales or dispositions of business interests, sales of rental real estate, and sales of real estate used in the business would meet the Supreme Court’s Standards for the existence of a unitary relationship.
The decision of the U.S. Supreme Court in Allied-Signal also 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 the test is fact sensitive. Accordingly, the Taxpayer must do more than show that the payors are unrelated third parties. 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 Corporation says as much. What is required instead is that the capital transaction serve as an operational rather than an investment function.
The question, therefore, is whether the investment income arises from an operational function. Most of the income in question arises from the utilization of cash generated through normal operations (i.e., proceeds from real estate rental activities, royalties, sales of property used in the Taxpayer's business), that generally constitute operational assets. In addition, the Taxpayer has not demonstrated that the proceeds from the management and investment portfolio, including the sale of securities, were unrelated to the Taxpayer's operational activities carried on in Virginia. To the contrary, the evidence reveals that the Taxpayer had a cash deficit at the end of each taxable year indicating the proceeds were an indispensable component of the Taxpayer's operations, including those in Virginia.
In any proceeding relating to the interpretation of the tax laws of the Commonwealth of Virginia, the burden of proof is on the taxpayer. As such, the Taxpayer must prove by clear and cogent evidence that Virginia's statutory method of allocation and apportionment would result in a tax on income derived from a discrete investment function having no connection with Virginia in violation of the principles set forth in Allied-Signal. Based upon the information provided, the Taxpayer has not met the burden of proof. Accordingly, permission to use an alternative method of allocation and apportionment cannot be granted.
As a result, we cannot issue the refunds you requested. The department requested additional information to substantiate your claim that the income in question represents income generated from nonunitary business activities and/or resulting from a separate investment function by letter on November 22, 1996. In as much as you have not responded to our inquiry, we have made this determination based on the best information at hand. The department will, however, review any additional information you can provide which substantiates your claim, providing we receive it within 60 days of the date of this letter. Please send this additional information to ******** at Office of Tax Policy, Department of Taxation, P. O. Box 1880, Richmond, Virginia 23218--1880.
Please be aware that this denial does not prevent the Taxpayer from filing suit in circuit court pursuant to Code of Virginia § 58.1-1825; however, the suit must be filed within three years of the date of this letter. If you have any additional questions, please call******** in the Office of Tax Policy at **************.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7848O
Rulings of the Tax Commissioner