Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Passive investment
Topic
Allocation and Apportionment
Date Issued
12-22-1997
December 22, 1997
Re: § 58.1-1821 Application: Corporate Income Taxes
Dear***************
This will reply to your letter of March 15, 1996, in which you apply for the correction of an assessment of additional corporate income taxes to **** (the "Taxpayer") for the 1993 and 1994 taxable years. I apologize for the delay in responding.
FACTS
The Taxpayer claimed a subtraction for certain "nonbusiness income" on its 1993 and 1994 Virginia corporate tax returns. The Taxpayer was the subject of an audit, and an adjustment was made to disallow the subtraction for this income. You contest the adjustment and believe that such income is allocable investment function income and should be removed from Virginia apportionable income. Further, you state that an incorrect amount was used in the calculation of the payroll factor.
DETERMINATION
Virginia law does not require or permit the subtraction or allocation of "nonbusiness income." The Code of Virginia only provides for the allocation of 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 in accordance with 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 Taxpayer is a publicly held corporation, headquartered outside of Virginia, whose principle business activity is the development, marketing and support of various software products and application tools. During 1993, the Taxpayer sold a significant amount of common stock in a public offering. The proceeds of this offering were segregated into a separate investment account. It is the income from this investment account which the Taxpayer seeks to allocate.
The Taxpayer maintains the investment account at its corporate headquarters outside of Virginia. Prior to the public stock offering, the Taxpayer was profitable, and had sufficient operational working capital and cash flow. After the offering, the Taxpayer's financial statements demonstrate that the Taxpayer had sufficient cash flow from its operations to support its operational activities without reliance on, or utilization of, the separate investment fund.
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and the payors of the investment income, and to determine if the Taxpayer's activities related to the investment activity were in any way connected to the Taxpayer's operational activities.
In the existence of a unitary relationship, the department looks to three factors favored by the courts: (1) functional integration; (2) centralization of management; and (3) economies of scale. Evidence regarding these factors was presented by the Taxpayer in clear and objective terms. There was no indication of a flow of goods or a flow of values between the Taxpayer and the investments. Based on the information provided to the department, it does not appear that a unitary relationship existed.
In considering the operational aspects of the investment, the department considered the evidence provided to support the Taxpayer's position. The evidence indicated that: the investment activity did not complement the Taxpayer's operational activities; and, no economies were achieved. The passive investments which produced the investment income were financed directly by the issuance of common stock. These funds were separate and distinct from other working capital balances. Given the unique circumstances surrounding the source of the funds, the segregation of the funds, and the fact that the Taxpayer's operations did not rely on these funds, it is clear that the activity was conducted independently from the management and investment of necessary operational working capital balances.
In light of the evidence provided, it does not appear that the Taxpayer's investment activities were related to its operational activities. Accordingly, it is possible to conclude that the Taxpayer's investment activities constitute a separate passive investment function that is not of an operational nature. As the Taxpayer's headquarters and management of its investment function were located outside of Virginia, the passive investment income did not relate to the Taxpayer's operational business carried on 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. In this particular matter, 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 department finds that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Because of the extraordinary circumstances surrounding the relationship between the Taxpayer and the aforementioned investments, permission is hereby granted to allocate the investment interest income out of Virginia apportionable income for tax years 1993 and 1994. The sales factor for both years will also be adjusted to remove the allocable income from the denominator.
In addition, the Taxpayer has stated that an incorrect value for compensation was used to calculate the payroll factor on the 1993 return as filed. Based on the new information provided to the department, the audit assessment for 1993 will be adjusted to reflect the change as requested by the Taxpayer.
Accordingly, your request for relief has been granted. All other aspects of the Taxpayer's 1993 and 1994 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 schedules. The resulting refund amounts will be credited to the Taxpayer's 1996 estimated tax payments as requested. Should you have any questions, please contact **** of my staff at ******* .
This determination is limited to the taxable years identified herein, and further limited to the activity described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/11077M
Rulings of the Tax Commissioner