Tax Type
Corporation Income Tax
Description
Alternate Method of Allocation and Apportionment
Topic
Allocation and Apportionment
Date Issued
07-21-1999
July 21, 1999
Re: § 58.1-1821 Application: Corporate Income Tax
Dear***
This will respond to your letter in which you request permission to use an alternative method of allocation and apportionment on behalf of your client, ***** (the "Taxpayer'). I apologize for the delay in responding.
FACTS
The Taxpayer is a lessor of real property and conducts all of its business in Virginia. The Taxpayer is also a member in a limited liability company (LLC) which has elected to be taxed at the federal level as a partnership. The LLC is in the same line of business as the Taxpayer, but does not conduct business within Virginia.
On its Virginia corporation income tax return for the taxable year ending June 30, 1997, the Taxpayer subtracted the lease income passed through from the LLC. On audit, the subtraction was disallowed and all of the Taxpayer's income was apportioned using the standard three factor formula.
This resulted in an assessment of additional tax.
The Taxpayer contests the assessment and requests to be allowed to use an alternative method of allocation and apportionment. Specifically, the Taxpayer requests to be allowed to allocate the lease income from the LLC in lieu of reporting the entire taxable income of the corporation and using the three factor apportionment formula in determining Virginia taxable income.
DETERMINATION
A corporation that has business activities both within and without Virginia must allocate and apportion its income in accordance with Code of Virginia § 58.1-406, et. seq. The department has previously ruled that a corporation which holds a general partnership interest in a partnership must include its proportionate share of partnership property, payroll, and sales in its own factors for purposes of apportioning Virginia taxable income. See Public Document (P.D.) 88-226 (7/29/88), copy enclosed. The Taxpayer's investment in the LLC does not qualify to the exception of this rule provided to limited partners in P.D. 95-19 (2-13-95), copy enclosed.
A corporation that is a member of a LLC that has elected to be treated as a partnership and receives income therefrom is essentially considered a general partner for federal income tax purposes. Accordingly, such a corporation will be required to include its proportionate share of the LLC's property, payroll, and sales in its own factors for allocating and apportioning its income subject to Virginia tax.
You believe that the use of separate accounting more accurately reflects the income subject to Virginia tax than the standard three factor formula. You propose that partnership rental income which is required to be directly allocated to other states be allowed as a subtraction on the Virginia return.
The polices which apply to requests for an alternative method of allocation and apportionment under Code of Virginia § 58.1-421 are well established. See Title 23 of the Virginia Administrative Code (VAC) 10-120-280, copy enclosed. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair, 437 U.S. 279 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.
Further, as set forth in 23 VAC 10-120-280, a taxpayer must demonstrate that the use of an alternative method of allocation and apportionment is justified due to disparities being caused by Virginia's method rather that the methods employed by other states. In this instance, although the methods employed by Virginia and the other states differ, it has not been demonstrated that the result of applying the varying methods Is caused by Virginia, as opposed to the other states.
Additionally, your remedy to resolve the alleged inequity is to allocate business income out of the state of Virginia. Your method is essentially a form of separate or geographical accounting. This method has been wholly discounted for "basic theoretical weaknesses' by the United States Supreme Court in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, (1983).
The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. After considering the facts set forth, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it applies to the Taxpayer, or that the circumstances justify granting your request.
As to your statement that the C corporation and the S corporation are being treated differently, it should be noted S corporations are required to apportion income for purposes of determining Virginia income of nonresident shareholders. Nonresident shareholders of an S corporation which conducts its business within and without Virginia must include in their income from Virginia sources the portion of their pro rata share of the S corporation's income which is allocated and apportioned in Virginia.
Virginia resident shareholders of an S corporation which conducts its business within and without Virginia include 100% of their pro rata share of the S corporation's income in their Virginia taxable income. In lieu of allocation and apportionment, the Virginia residents may claim a credit for income taxes paid to other states pursuant to Code of Virginia § 58.1-332.
The department fully recognizes that the income of an S corporation can be taxed differently from that of a C corporation. In fact, the S corporation election was instituted at the federal level in order to allow corporations an alternate method of taxation. The difference is attributable to the inherent differences between the ways federal and state governments can tax individuals versus corporations. Thus, the difference between the taxation of S corporations and C corporations is not a valid argument for an alternative method of allocation and apportionment.
Accordingly, there is no basis upon which to grant your request. However, information provided at the time of the audit was not sufficient to accurately adjust the apportionment factor. As such, the Taxpayer's apportionment factor has been adjusted in accordance with the information furnished in your letter. A refund will be issued with applicable interest in accordance with the enclosed schedule.
If you have any questions regarding this determination please ***** of the Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/13548P
Re: § 58.1-1821 Application: Corporate Income Tax
Dear***
This will respond to your letter in which you request permission to use an alternative method of allocation and apportionment on behalf of your client, ***** (the "Taxpayer'). I apologize for the delay in responding.
FACTS
The Taxpayer is a lessor of real property and conducts all of its business in Virginia. The Taxpayer is also a member in a limited liability company (LLC) which has elected to be taxed at the federal level as a partnership. The LLC is in the same line of business as the Taxpayer, but does not conduct business within Virginia.
On its Virginia corporation income tax return for the taxable year ending June 30, 1997, the Taxpayer subtracted the lease income passed through from the LLC. On audit, the subtraction was disallowed and all of the Taxpayer's income was apportioned using the standard three factor formula.
This resulted in an assessment of additional tax.
The Taxpayer contests the assessment and requests to be allowed to use an alternative method of allocation and apportionment. Specifically, the Taxpayer requests to be allowed to allocate the lease income from the LLC in lieu of reporting the entire taxable income of the corporation and using the three factor apportionment formula in determining Virginia taxable income.
DETERMINATION
A corporation that has business activities both within and without Virginia must allocate and apportion its income in accordance with Code of Virginia § 58.1-406, et. seq. The department has previously ruled that a corporation which holds a general partnership interest in a partnership must include its proportionate share of partnership property, payroll, and sales in its own factors for purposes of apportioning Virginia taxable income. See Public Document (P.D.) 88-226 (7/29/88), copy enclosed. The Taxpayer's investment in the LLC does not qualify to the exception of this rule provided to limited partners in P.D. 95-19 (2-13-95), copy enclosed.
A corporation that is a member of a LLC that has elected to be treated as a partnership and receives income therefrom is essentially considered a general partner for federal income tax purposes. Accordingly, such a corporation will be required to include its proportionate share of the LLC's property, payroll, and sales in its own factors for allocating and apportioning its income subject to Virginia tax.
You believe that the use of separate accounting more accurately reflects the income subject to Virginia tax than the standard three factor formula. You propose that partnership rental income which is required to be directly allocated to other states be allowed as a subtraction on the Virginia return.
The polices which apply to requests for an alternative method of allocation and apportionment under Code of Virginia § 58.1-421 are well established. See Title 23 of the Virginia Administrative Code (VAC) 10-120-280, copy enclosed. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair, 437 U.S. 279 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.
Further, as set forth in 23 VAC 10-120-280, a taxpayer must demonstrate that the use of an alternative method of allocation and apportionment is justified due to disparities being caused by Virginia's method rather that the methods employed by other states. In this instance, although the methods employed by Virginia and the other states differ, it has not been demonstrated that the result of applying the varying methods Is caused by Virginia, as opposed to the other states.
Additionally, your remedy to resolve the alleged inequity is to allocate business income out of the state of Virginia. Your method is essentially a form of separate or geographical accounting. This method has been wholly discounted for "basic theoretical weaknesses' by the United States Supreme Court in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, (1983).
The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. After considering the facts set forth, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it applies to the Taxpayer, or that the circumstances justify granting your request.
As to your statement that the C corporation and the S corporation are being treated differently, it should be noted S corporations are required to apportion income for purposes of determining Virginia income of nonresident shareholders. Nonresident shareholders of an S corporation which conducts its business within and without Virginia must include in their income from Virginia sources the portion of their pro rata share of the S corporation's income which is allocated and apportioned in Virginia.
Virginia resident shareholders of an S corporation which conducts its business within and without Virginia include 100% of their pro rata share of the S corporation's income in their Virginia taxable income. In lieu of allocation and apportionment, the Virginia residents may claim a credit for income taxes paid to other states pursuant to Code of Virginia § 58.1-332.
The department fully recognizes that the income of an S corporation can be taxed differently from that of a C corporation. In fact, the S corporation election was instituted at the federal level in order to allow corporations an alternate method of taxation. The difference is attributable to the inherent differences between the ways federal and state governments can tax individuals versus corporations. Thus, the difference between the taxation of S corporations and C corporations is not a valid argument for an alternative method of allocation and apportionment.
Accordingly, there is no basis upon which to grant your request. However, information provided at the time of the audit was not sufficient to accurately adjust the apportionment factor. As such, the Taxpayer's apportionment factor has been adjusted in accordance with the information furnished in your letter. A refund will be issued with applicable interest in accordance with the enclosed schedule.
If you have any questions regarding this determination please ***** of the Office of Tax Policy at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/13548P
Rulings of the Tax Commissioner