Tax Type
Corporation Income Tax
Description
Audit, nonbusiness income disallowed.
Topic
Allocation and Apportionment
Appropriateness of Audit Methodology
Date Issued
11-18-1997
November 18, 1997
Re: § 58.1-1821 Application: Corporate Income Tax
Dear***************
This will reply to your letter in which you make an application for the correction of an assessment for additional corporate income taxes to ****(the "Taxpayer") for the 1992 taxable year. I apologize for the delayed response.
FACTS
The Taxpayer is a national corporation, primarily engaged in the manufacturing and selling of electrical products, and headquartered outside of Virginia. In 1992, the Taxpayer realized a capital gain from its interest in a partnership that invests and trades U.S. Treasury Securities and mortgage pass through certificates. The Taxpayer also realized a capital gain on the sale and exchange of various stocks ("miscellaneous investments") acquired through an investment advisor. The Taxpayer combined these gains with a nonunitary business loss, and subtracted the net gain on its 1992 Virginia corporate income tax return.
The Taxpayer was the subject of an audit, and among other adjustments, the subtraction for nonbusiness income was disallowed. The Taxpayer contests this portion of the assessment based on the belief that the income is allocable investment function income which should be removed from Virginia apportionable income and allocated to the Taxpayer's 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 pursuant to Code of Virginia § 58.1-421.
The decision of the United States Supreme Court in Allied-Signal, Inc. v. Director, Div. of Taxation,112 S. Ct. 2551 (1992) 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.
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and these investments, and to determine if the Taxpayer's activities related to these investments were in any way connected to the Taxpayer's operational activities.
In considering the existence of a 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, lnc. v. Director, Div. of Taxation,112 S. Ct. 2551 (1992).) Evidence regarding these factors was presented by the Taxpayer in clear and objective terms. There was no indication of a flow of goods or of a flow of values between the Taxpayer and any payor of investment income. Based on the information provided to the department, it does not appear that a unitary relationship existed between the Taxpayer and the payors of the investment income.
In considering the operational aspects of the investments, the department considered the evidence provided to support the Taxpayer's position. The evidence indicated that: the taxpayer was profitable and the investments were not used to complement the Taxpayer's operational activities; no integration of the businesses occurred; no economies were achieved; and the management of the investment activities was separate and distinct from the general management of the Taxpayer.
In light of the substantial evidence provided, it is evident that the Taxpayer did not use its own operational activities to enhance the value of its investments nor did the ownership of such investments enhance the operational activity of the Taxpayer. Accordingly, it is possible to conclude that the Taxpayer's investment activities constitute a separate investment function making passive investments that are not of an operational nature.
Based upon the information provided, the department finds that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Accordingly, permission is hereby granted to allocate the net capital gain recognized on the transactions out of Virginia apportionable income. The sales factor will also be adjusted to remove the gross proceeds attributable to the allocable income from the denominator.
All other aspects of the Taxpayer's 1992 allocation and apportionment shall be determined in accordance with Code of Virginia §§ 58.1-406 through 58.1-420. The audit report will be adjusted as provided herein and as reflected on the enclosed schedule. Interest has been accrued through the date of your appeal. The assessment should be paid in full within 30 days to avoid the accrual of additional interest. Please remit your payment to the attention of******** , Virginia Department of Taxation, Office of Tax Policy, P.O. Box 1880, Richmond, Virginia 23218-1880. Should you have any questions, please contact her at ***** .
This ruling is limited to the 1992 taxable year, and further limited to the transaction described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/8013M
Rulings of the Tax Commissioner