Document Number
99-140
Tax Type
Corporation Income Tax
Description
Returns of Affiliated Corporations
Topic
Returns and Payments
Date Issued
06-11-1999

June 11, 1999


Re: § 58.1-1821 Application: Corporation Income Taxes

Dear************************

This will respond to your letter in which you seek correction of assessment of additional corporate income taxes against ***** (the "Taxpayer') and ***** ("S') for the taxable years ended December 31, 1993 and 1994. I apologize for the delay in responding.

FACTS

The Taxpayer filed a combined return with S for the taxable years ended December 31, 1993 and 1994. The department performed an audit on the returns for the 1993 and 1994 taxable years, and made a number adjustments resulting in an assessment of additional corporation income tax. You have contested a number of the adjustments, each of which will be addressed separately.

DETERMINATION

Foreign Source Income Subtraction

The auditor eliminated the foreign source income subtraction for S. Because S did not file a Form 1118 with the federal income tax returns for the 1993 and 1994 taxable years, the auditor requested documentation to show how expenses would be allocated to the foreign source income pursuant to Internal Revenue Code (IRC) §§861, 862 and 863. In response, S indicated that foreign source expenses based on the provisions in IRC §861 et. seq. exceeded foreign source income for both 1993 and 1994.

You assert that the auditor eliminated the subtraction because S failed to file Form 1118. You further contend that, while Virginia law requires the provisions of IRC §§861 et. seq. be applied in determining the source of foreign source income, and that the federal procedure in Treasury Regulation (Treas. Reg.) §1.861-8 be applied to allocate and apportion expenses, there is no statutory mandate requiring the filing of federal Form 1118 as a prerequisite or condition precedent to the subtraction of foreign source income, less expenses, from federal taxable income in arriving at Virginia taxable income.

Many taxpayers who claim a Virginia subtraction for foreign source income will also have claimed a federal credit for income taxes paid to foreign countries. Thus, the department considers federal Form 1118 an appropriate starting point to determine foreign source income and expenses. However, Virginia law does not follow federal law in all respects regarding income from sources without the United States because, federal Form 1118 includes many types of income that do not qualify for the Virginia subtraction. Thus, the fact that a taxpayer does not complete a federal Form 1118 does not preclude the taxpayer from making a foreign source income subtraction, net of expenses pursuant to Treas. Reg. §1.861-8 et. seq., on its Virginia income tax return.

Because no federal Form 1118 was filed, the auditor properly requested information to show foreign source expenses allocated against foreign source income as required by 23 VAC 10-120-20. S has clearly stated in a letter to the auditor dated March 27, 1997 (copy enclosed) that expense allocated pursuant to the Virginia regulation would exceed foreign source income. As such, the auditor was correct in eliminating the foreign source income subtraction.

Net income and other taxes based on income

The auditor adjusted the addition for income taxes to include foreign withholding taxes on royalty, interest, and dividend income. You contend such foreign withholding does not fall within the add back provisions of Code of Virginia § 58.1-402.
    • Code of Virginia § 58.1-402(B) provides, in pertinent part:
      B. There shall be added to the extent excluded from federal taxable income:...
      4. The amount of any net income taxes and other taxes, including franchise and excise taxes. which are based on. measured by. or computed with reference to net income, imposed by the Commonwealth or any other taxing jurisdiction, to the extent deducted in determining federal taxable income; (emphasis added)
The tax was withheld to satisfy foreign tax on dividend, interest and royalty income. The tax was clearly withheld on income earned by S. The department, therefore, must conclude the foreign withholdings are a payment of a tax based on income. Accordingly, the auditor's adjustment is proper unless S can demonstrate that the foreign withholding taxes were not used to determine federal taxable income.

Property Factor

The auditor reduced inventory in the denominator of the property factor to reflect the LIFO valuation to match the value used in the federal income tax return. The Taxpayer contends that the Virginia inventories in the numerator are listed at cost. The Taxpayer, therefore, submits that the Virginia inventories should be adjusted to reflect LIFO value so that inventories within Virginia and inventories everywhere are on a comparable basis.

Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-120-170(B)(2), the inventories included in the property factor must be valued in accordance with the valuation method used on the federal income tax return. As such, the auditor correctly adjusted the denominator to reflect the LIFO inventory valuation. However, the inventory in the numerator must be valued in a manner consistent with the denominator. As such, the numerator have been adjusted to reflect the LIFO valuation method.

United States Obligations

S's subtraction for United States ("U. S.') obligations was disallowed by the department's auditor. The obligations were purchased in connection with S's commodity and futures accounts with several brokers. The auditor concluded the securities were repurchase agreements and do not qualify for the subtraction pursuant to 23 VAC 10-120-102. However, you have provided sufficient documentation to show that the obligations in question were three-month U. S. Treasury notes periodically purchased with excess cash through the brokerage firms in the normal course of business. As such, the obligations satisfy the requirements of 23 VAC 10-120-102. The audit has been adjusted to allow a subtraction for interest earned on U. S. obligations.

The department has made the adjustments as provided in this letter. The assessments have been adjusted as provided on the attached summaries. The balance due should be paid within 30 days to prevent the accrual of additional interest. Your payment may be sent to ***** c/o Office of Tax Policy, Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218-1880. If you have any questions, you may contact ***** at *****.

Sincerely,


Danny M. Payne
Tax Commissioner

OTP/129140



Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46