Tax Type
Corporation Income Tax
Description
Multiple member LLC; consolidated returns.
Topic
Taxability of Persons and Transactions
Date Issued
03-24-1999
March 24, 1999
Re: Ruling Request: Corporation Income Taxes
Dear ****************
This will reply to your letters in which you request a ruling concerning the taxability of a number of affiliates of your client ******************** (the "Taxpayer") resulting from a corporate restructuring. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer is a corporation incorporated under the laws of Virginia and files consolidated federal and Virginia income tax returns. The Virginia consolidated return includes those subsidiaries included in the federal return which own real or tangible personal property in Virginia, or have employees who regularly work in Virginia. The Taxpayer has implemented a restructuring plan which will affect several of its existing subsidiaries, and will create several new affiliated entities.
As a result of the restructuring, the Taxpayer created a single member limited liability company (LLC1) that holds interests in a number of entities including one 100%owned subsidiary (S1) and a single member limited liability company (LLC2). LLC2 owns 100% of two subsidiaries (S2 and S3) and a single member limited liability company (LLC3). LLC3 and S3 are general partners in a partnership (P1).
Also, a new multiple member limited liability company (LLC4) was organized as a partnership between S1 and P1. Two contractors were also converted to single member limited liability companies (LLC5 and LLC6) owned by LLC4. None of the entities own real property or tangible personal property in Virginia, have payroll in Virginia, and/or have sales in Virginia (with the exception of LLC4).
Approximately 5% to 15% of LLC4's sales are to Virginia customers. LLC4's sales are made through a related corporation (the "Sales Agent"), located in Virginia, to whom LLC4 pays a commission. The relationship between the Sales Agent and the Taxpayer is such that both corporations could be included in the same Virginia consolidated corporate income tax return. The Sales Agent serves only members of the affiliated group.
You have requested a ruling as to whether any or all of the subsidiaries, P1, and LLCs (with the exception of the Sales Agent) in question would be subject to the Virginia income tax as a result of the corporation restructuring. In a addition, you have asked several questions concerning certain activities conducted in Virginia. Each of these questions will be answered separately.
RULING
1. Is a company subject to Virginia income taxation just because it incorporates under Virginia law?
Code of Virginia § 58.1-400 imposes income tax "on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources." Thus, every corporation, whether incorporated in Virginia or elsewhere, that has Virginia taxable income is subject to the tax. Because the tax is imposed on the income of the corporation and not the corporation itself, a corporation, whether incorporated in Virginia or elsewhere, having no Virginia taxable income cannot be subject to the tax.
Because the Taxpayer files a consolidated return, the proposed restructuring plan would affect the eligibility of several members of the affiliated group to continue to be included in the consolidated return. Pursuant to Code of Virginia § 58.1-442, an affiliated group of corporations may elect to file a consolidated Virginia income tax return. Title 23 of the Virginia Administrative Code (VAC) 10-120-322 provides that a corporation cannot be included in a consolidated return if it is exempt from Virginia income tax under Code of Virginia § 58.1-401, exempt from Virginia income tax under U.S. Public Law (P.L.) 86-272, not affiliated as defined by § 58.1-302 of the Code of Virginia, not subject to Virginia income tax if separate returns were to be filed, or using different taxable years. (Emphasis added.)
Generally, corporations organized under Virginia law and foreign corporations having income from Virginia sources are subject to Virginia tax. A corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. The existence of positive Virginia apportionment factors clearly establishes income from Virginia sources. This would be the case whether or not a corporation is incorporated in Virginia.
Code of Virginia § 58.1-441 does require every corporation organized under the laws of the Commonwealth to file an income tax return annually with the department. However, a filing requirement does not subject a corporation to the Virginia tax on its income. Public Document (P.D.) 94-368, (12/12/94), copy attached, states that a corporation registered to do business in Virginia, but has not conducted any business in Virginia is not subject to tax in Virginia and is not eligible to be included in a consolidated Virginia return pursuant to VAC 10-120-322 (formerly Virginia Regulation 630-3-442) even though it filed separate Virginia returns. Thus, it is reasonable to surmise that though a business incorporated under the laws of Virginia may be required to file a Virginia return, it may not be subject to the Virginia tax on its income.
The mere fact that a corporation is incorporated under the laws of Virginia does not subject it to the tax imposed by Virginia on its income and may not be included in an affiliated group for the purposes of filing a Virginia consolidated corporation income tax return.
2. When a parent holding company or other affiliate located in Virginia performs services for the affiliated group, will these activities make all members of the group subject to taxation in Virginia?
After the restructuring, the Taxpayer will render certain administrative and oversight services to the subsidiaries, P1, and LLCs. An inter-company fee will be charged for the services.
As stated above, the department has held that a corporation with no property, payroll or sales in Virginia is not subject to Virginia income taxation. The purchase of administrative and management services would not create a positive Virginia property, payroll or sales factor for any subsidiaries, P1, LLCs, or any subsidiaries that have an income passed through from P1 or the LLCs.
Nonetheless, LLC4 makes sales in Virginia. As such, it will have a positive sales factor and income from Virginia sources. The implications of LLC4's activities are addressed in detail in the next question.
In any case, the department does maintain the authority to adjust the taxable income of a corporation and/or other entity in accordance with Code of Virginia § 58.1-445 which provides:
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- In any case of two or more related trades or businesses liable to taxation under this chapter owned or controlled directly or indirectly by the same interests, the Department may, and at the request of the taxpayer shall, if necessary in order to make an accurate distribution or apportionment of gains, profits, income, deductions or capital between or among such related trades or businesses, consolidate the accounts of such related trades or businesses.
- In any case of two or more related trades or businesses liable to taxation under this chapter owned or controlled directly or indirectly by the same interests, the Department may, and at the request of the taxpayer shall, if necessary in order to make an accurate distribution or apportionment of gains, profits, income, deductions or capital between or among such related trades or businesses, consolidate the accounts of such related trades or businesses.
3. When a Virginia company performs sales activities for multiple members of the affiliated group with no other Virginia presence except sales, does that local activity make the out-of-state affiliate taxable in Virginia? Will that sales agent be treated as an independent contractor or as a "representative" for purposes of P.L. 86-272?
As explained above, a taxpayer that has a positive Virginia property, payroll or sales factor is considered to have income from Virginia sources. When Virginia source income is present, the department must make a determination as to whether the income is subject to Virginia tax. P.L. 86-272 provides an exemption from a state's income tax if a taxpayer's activities in such state do not exceed a narrowly defined range of activities constituting solicitation.
In this case, LLC4 is making sales in Virginia and has Virginia source income. In such a case, the department will examine the activities of LLC4 within Virginia to determine if they exceed the protection afforded under P.L. 86-272. In this case, LLC4'S activities consist of sales through the Sales Agent located in Virginia.
Unlike the administrative and oversight services provided by the Taxpayer, the Sales Agent is providing a service by which LLC4 is directing its business toward Virginia. Even though the Sales Agent would not directly create a positive Virginia apportionment factor, its activities of selling LLC4's products have facilitated LLC4'S positive sales factor. Thus, the determining factor as to whether or not LLC4 is subject to the Virginia tax on its income hinges on whether or not the Sales Agent is an independent contractor or LLC4's representative.
Pursuant to this federal law, there are different standards which apply to the activities of a taxpayer's representative verses the activities of an independent contractor. A taxpayer is not protected from taxation by a state pursuant to P.L. 86-272 if its representatives maintain an office in such state or accept orders for sales. However, a taxpayer is not subject to taxation merely by reason of the maintenance of an office in a state by one or more independent contractors whose activities on behalf of such taxpayer consist solely of making sales, or soliciting orders for sales of tangible personal property.
An independent contractor is defined in P.L. 86-272 as:
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- commission agent, broker, or other independent contractor who is engaged in selling, or soliciting orders for the sale of, tangible personal property for more than one principal and who holds himself out as such in the regular course of his business activities. . . (emphasis added.)
- commission agent, broker, or other independent contractor who is engaged in selling, or soliciting orders for the sale of, tangible personal property for more than one principal and who holds himself out as such in the regular course of his business activities. . . (emphasis added.)
In the same manner, a corporation not otherwise liable to taxation will be deemed to be doing business in a state through the agency of a representative that exceeds the mere solicitation of orders. The maintenance of an office and the acceptance of sales by a representative (be it individual, a corporation, or other legal entity) clearly exceed activities protected by P.L. 86-272.
The P.L. 86-272 definition sets forth a three part test, all three of which must be met, in order for an agent to be considered an independent contractor. The agent must represent two or more principals, the agent must be in fact independent from the principals, and the agent must hold himself out to the general public as such. The Sales Agent, in this case, will represent two or more members of the affiliated group. However, these principals' relationship with the Sales Agent representing them is such that there is 100% direct or indirect common ownership.
The issue then becomes whether the Sales Agent is "independent" from the principal it represents. The few courts and administrative bodies that have considered the P.L. 86-272 definition have looked to the common law definition of an independent contractor. The Oregon Supreme Court applied the common law definition in a case involving an Indiana manufacturer's use of an Oregon corporation's salesmen in the state as they related to Oregon's authority to assess income tax pursuant to P.L. 86272. See Herff Jones Co. v. State Tax Commission, 247 Ore. 404 (1967).
Although the courts in Virginia have not applied the common law definition in a case involving P.L. 86-272, Virginia courts have ascribed to the common law definition in a number of cases. In its analysis as to what is an independent contractor, the Virginia Supreme Court stated "It is not the actual exercise of control, but the right to control - that is to say, the potential power of control . . ." The Texas Company. et al. v. M. Ziegler. Administrator. Etc., 177 Va. 557 (1941). The Court found that a corporation's right to control may be determined by a necessity of obedience to orders or instructions, if given. In this case, the Court determined that a corporation's distributor (an unrelated corporation) was not an independent contractor. Thus, according to the Virginia Supreme Court, the mere potential of an entity to control an agent disqualifies the agent as an independent contractor even if the agent is an unrelated corporation. In a case where a corporation is performing solicitation for a group of affiliated businesses of which it is also a member, there is a strong presumption that the right or potential of control is present at minimum, and that actual control in all likelihood exists as well.
You have stated that LLC4 lacks the right to control because it lacks direct ownership in the Sales Agent and is not an officer or director of the Sales Agent. However, because the Taxpayer ultimately owns and controls both LLC4 and the Sales Agent, LLC4 has a clear avenue of influence over the Sales Agent. In addition, the Sales Agent is clearly dependent on LLC4 and the Taxpayer's other affiliates in order to continue as a going concern. The fact that LLC4 and the affiliated Sales Agent share a common parent indicates that LLC4 has the potential to exercise control as to how its products are sold by the affiliated Sales Agent.
You further assert that the Taxpayer does not have enough control over the Sales Agent such that the Sales Agent would not be an independent contractor. However, the documentation shows that the Taxpayer approves significant sales contracts, business operation plans, across the board pay increases, budgets and budget changes for its affiliates. The Taxpayer also prepares some contracts for its affiliates, manages cash and financing, and audits and inspects records and facilities of its affiliates. These activities clearly show significant control over the affiliated group including the Sales Agent.
Thus, the Sales Agent's affiliation causes it to fail one of the P.L. 86-272 tests of an independent contractor relationship. Even if LLC4 never attempts to interfere, the mere right to interfere is enough to change the status from that of independent contractor to that of a representative.
In addition, the Taxpayer and its affiliates file a consolidated Virginia corporate income tax return which includes the Sales Agent. Allowing a corporation that is affiliated for filing purposes to be considered independent for the purposes of determining its affiliates' nexus with Virginia would be contradictory.
Insufficient evidence has been provided to make a determination as to whether the Sales Agent holds itself out as an independent contractor to the general public. Because the Sales Agent is in fact not an independent contractor under the common law definition, no analysis of this test is needed.
Thus, the Sales Agent would be considered as LLC4'S representative in Virginia and not an independent contractor. Because, the Sales Agent has a place of business in Virginia and accepts sales orders, LLC4'S activities in Virginia would exceed the protection afforded by P.L. 86-272.
Conclusion:
Generally, multiple member limited liability companies can elect to taxed as an entity or pass-through its income and tax attributes to its members. The department has previously ruled that it will accept the federal tax status election of a limited liability company. See P.D. 97-343, (8-28-97), copy enclosed.
As such, LLC4's income will be subject to the Virginia corporation income tax. Because, LLC4 has elected to pass-through its income and tax attributes to its members, Virginia will require the entity which is subject to federal income tax on the income of LLC4 to file and pay income tax on its income apportioned to Virginia.
In this case, LLC4's income and tax attributes (including those of LLC5 and LLC6) would pass-through to S1 and P1. P1, being a pass-through entity, would pass along with its income and tax attributes, the income and income and tax attributes of LLC4 to its partners (LLC3 and S3). As taxable corporations, S1 and S3 would include in their federal taxable income, the income and tax attributes of LLC4. Thus S1 and S3 would be required to file and pay income tax on its income apportioned to Virginia. See P.D. 95-19, (2-13-95), copy attached.
LLC3 will continue to pass the attributes of LLC4 on until they reach a taxable entity. In this case, the attributes would be passed all the way to the Taxpayer through LLC2 and LLC1.
I trust this will answer the questions posed in your letter; however, please contact*************if you have additional questions or if we may be of further assistance.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner