Tax Type
Corporation Income Tax
Description
Allocation of Income
Topic
Allocation and Apportionment
Royalties
Date Issued
10-23-1998
October 23, 1998
Re: Sec. 58.1-1821 Application: Corporate Income Tax
Dear *****
This will reply to your letter in which you request the correction of an assessment of additional corporate income tax against ***** (the "Taxpayer') for the taxable year ended October 19, 1988. I apologize for the delay in responding.
FACTS
The department audited the Taxpayer and made several adjustments. On its Virginia return for the taxable year in question, the Taxpayer claimed a subtraction for foreign source income. On audit, the department reduced the subtraction for expenses related to the amount claimed as a subtraction. Because the auditor was not able to calculate the related expenses from the information provided by the Taxpayer, expenses equal to 25% of the subtraction were added back.
The Taxpayer contends that the foreign source income was entirely derived from royalties and there was no expenses related to these foreign source royalties.
DETERMINATION
The provision permitting the subtraction for foreign source income is Code of Virginia Sec. 58.1-402(C), copy enclosed, which states:
Virginia Regulation 23 VAC 10-120-20, copy enclosed, provides that the "federal procedure in Treasury Reg. Sec.1.861-8 is applied to allocate and apportion expenses to income derived from U.S. and foreign sources.' Because Code of Virginia Sec. 58.1-302, copy enclosed, explicitly requires the use of the federal provisions in determining the source of "foreign source income', both the gross income and the expenses included in federal taxable income are used when computing the Virginia subtraction. Thus, both definitely allocable and not definitely allocable expenses are used to reduce gross income from sources without the United States.
Previous rulings of the department require the reduction of the Virginia subtraction for foreign source income by related expenses, in accordance with Internal Revenue Code (IRC) Sec. 861, 862 and 863. See Public Document (P.D.) 91-229, (9/30/91), and P.D. 86-154, (8/18/86), copies enclosed. The department has clearly defined its policy in this area. Virginia law requires the use of the federal sourcing rules of IRC Sec.861 et seq. whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and no matter what expenses would be under generally accepted accounting principles.
The provisions under IRC Sec.861 et seq. contain elaborate detail on assigning income and expense to particular sources. The provisions differentiate between expenses that are definitely allocable and expenses that are not definitely allocable. The latter, such as legal and accounting fees of a taxpayer, are apportioned to items of income on the basis of a percentage of a taxpayer's total receipts.
The department considers federal Form 1118 an appropriate starting point to determine foreign source income and expenses. The department realizes, however, that U. S. Treasury regulations do not require a high degree of precision in allocating and apportioning expenses on Form 1118 when federal tax liability will not be affected. In this case, the Taxpayer did not allocate any expenses, either definitely allocable or not definitely allocable, to its foreign source income on its Form 1118 required by IRC Sec.861 et seq.
In addition, the Taxpayer failed to provide information to determine reasonable expenses related to the foreign source income. As such, the auditor estimated the related expenses to be used in computing the foreign source income subtraction.
Accordingly, the auditor's adjustment is correct and your claim for a refund cannot be granted. Please send ***** tax and ***** interest) to *****, Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218 within 30 days to prevent the accrual of additional interest. If you have any questions about this determination, you may contact ***** at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10536B
Re: Sec. 58.1-1821 Application: Corporate Income Tax
Dear *****
This will reply to your letter in which you request the correction of an assessment of additional corporate income tax against ***** (the "Taxpayer') for the taxable year ended October 19, 1988. I apologize for the delay in responding.
FACTS
The department audited the Taxpayer and made several adjustments. On its Virginia return for the taxable year in question, the Taxpayer claimed a subtraction for foreign source income. On audit, the department reduced the subtraction for expenses related to the amount claimed as a subtraction. Because the auditor was not able to calculate the related expenses from the information provided by the Taxpayer, expenses equal to 25% of the subtraction were added back.
The Taxpayer contends that the foreign source income was entirely derived from royalties and there was no expenses related to these foreign source royalties.
DETERMINATION
The provision permitting the subtraction for foreign source income is Code of Virginia Sec. 58.1-402(C), copy enclosed, which states:
-
- "[There] shall be subtracted to the extent included in and not otherwise subtracted from federal taxable income:...
-
- [8.] Any amount included therein which is foreign source income as defined in Sec. 58.1-302.' (Emphasis added).
- [8.] Any amount included therein which is foreign source income as defined in Sec. 58.1-302.' (Emphasis added).
Virginia Regulation 23 VAC 10-120-20, copy enclosed, provides that the "federal procedure in Treasury Reg. Sec.1.861-8 is applied to allocate and apportion expenses to income derived from U.S. and foreign sources.' Because Code of Virginia Sec. 58.1-302, copy enclosed, explicitly requires the use of the federal provisions in determining the source of "foreign source income', both the gross income and the expenses included in federal taxable income are used when computing the Virginia subtraction. Thus, both definitely allocable and not definitely allocable expenses are used to reduce gross income from sources without the United States.
Previous rulings of the department require the reduction of the Virginia subtraction for foreign source income by related expenses, in accordance with Internal Revenue Code (IRC) Sec. 861, 862 and 863. See Public Document (P.D.) 91-229, (9/30/91), and P.D. 86-154, (8/18/86), copies enclosed. The department has clearly defined its policy in this area. Virginia law requires the use of the federal sourcing rules of IRC Sec.861 et seq. whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and no matter what expenses would be under generally accepted accounting principles.
The provisions under IRC Sec.861 et seq. contain elaborate detail on assigning income and expense to particular sources. The provisions differentiate between expenses that are definitely allocable and expenses that are not definitely allocable. The latter, such as legal and accounting fees of a taxpayer, are apportioned to items of income on the basis of a percentage of a taxpayer's total receipts.
The department considers federal Form 1118 an appropriate starting point to determine foreign source income and expenses. The department realizes, however, that U. S. Treasury regulations do not require a high degree of precision in allocating and apportioning expenses on Form 1118 when federal tax liability will not be affected. In this case, the Taxpayer did not allocate any expenses, either definitely allocable or not definitely allocable, to its foreign source income on its Form 1118 required by IRC Sec.861 et seq.
In addition, the Taxpayer failed to provide information to determine reasonable expenses related to the foreign source income. As such, the auditor estimated the related expenses to be used in computing the foreign source income subtraction.
Accordingly, the auditor's adjustment is correct and your claim for a refund cannot be granted. Please send ***** tax and ***** interest) to *****, Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218 within 30 days to prevent the accrual of additional interest. If you have any questions about this determination, you may contact ***** at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/10536B
Rulings of the Tax Commissioner