Tax Type
Corporation Income Tax
Description
Loan to affiliate; Certificates of deposit and money market accounts
Topic
Allocation and Apportionment
Computation of Income
Subtractions and Exclusions
Date Issued
12-13-2000
December 13, 2000
Re: § 58.1-1821 Application: Corporate Income Tax
Dear ****
This will reply to your letter in which you request a correction of the assessment of corporate income tax against * * * (the "Taxpayer") for the taxable year ended September 30, 1995. I apologize for the delay in response.
FACTS
The Taxpayer claimed a subtraction from Virginia apportionable income for allocable non-business income on its 1994 Virginia corporate income tax return. This income was derived from interest on a loan with an affiliated corporation (the "Affiliate"), certificate of deposits, and dividends from a money market account (which is treated as interest for income tax purposes). Pursuant to an audit, the subtraction was disallowed because the income was derived from the Taxpayer's operations and was related to its Virginia business. The Taxpayer contends that the interest income is separate from operations and is unrelated to its Virginia business.
DETERMINATION
The Code of Virginia does not provide for the allocation of income other than 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). Thus, the department has treated the Taxpayer's amended returns as a request for an alternative method of allocation and apportionment pursuant to Code of Virginia § 58.1-421.
In any proceeding with the department, the Taxpayer must bear the burden of showing that the imposition of Virginia's statute is in violation of the standards enunciated by the United States Supreme court in Allied-Signal, Inc. v. Director, Division of Taxation, 112 S.Ct. 2251 (1992). In this matter, the Taxpayer must demonstrate that its investments are not operational assets involved in a unitary business. In considering the existence of unitary relationship, the Supreme Court has focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. (See Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S., 425 (1980); F.W. Woolworth Co. v. Taxation and Revenue Dept. of N.M., 458 U.S., 352 (1982); and Allied-Signal.)
With regard to the Affiliate, the Taxpayer presented complete and clear evidence regarding these factors. The Taxpayer and the Affiliate share the same parent (the "Parent"), but are otherwise independent companies which operate separately from each other. Both the Taxpayer and the Affiliate have their own officers and directors. An analysis of the Taxpayer and the Affiliate demonstrates that their operations are not functionally integrated, management is not centralized, and do not benefit from economies of scale. In fact, their only other relationship is that the Taxpayer purchases less than one percent of one particular raw material at fair market prices from the Affiliate. As such, the Taxpayer and the Affiliate are not engaged in unitary business.
The nature of the Taxpayer's certificates of deposit and money market accounts preclude the presence of a unitary relationship between the Taxpayer and issuer. The question, therefore, is whether the interest income from the loan to the Affiliate, the certificates of deposit, and the money market accounts fulfill an investment or operational function.
The decision of the U.S. Supreme Court in Allied-Signal also held 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. Accordingly, the Taxpayer must do more than show that the payors are unrelated third parties. In Allied-Signal, the Court stated:
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- The existence of a unitary relation between payee and payor is one justification for apportionment, but not the only one. Hence, for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms a part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank.
- The existence of a unitary relation between payee and payor is one justification for apportionment, but not the only one. Hence, for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms a part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank.
The department will examine levels of long-term debt on the premise that significant amounts of debt create a strong presumption that cash reserves or investments fulfill an integral operational function. This operational function can be achieved by either contributing to debt retirement or maintaining a strong financial position to facilitate operational relationships involving banking and credit. The department will also examine the function of the investment within the context of normal working capital requirements. See Public Document ("P.D.") 94-58 (3/15/94)(copy enclosed).
In the instant case, the Taxpayer had no long-term debt. Cash (excluding investments) and accounts receivable at the conclusion of the fiscal years ended September 30, 1994 and 1995 were sufficient to cover total current liabilities. In addition, fiscal 1995 operating cash flow was significantly positive.
Certificates of Deposit and Money Market Accounts
The evidence provided by the Taxpayer supports the contention that the interest income on certificates of deposit and money market accounts was generated through a passive investment with non-unitary payors. All earnings resulting from the certificates of deposit and money market accounts were reinvested into the accounts and were kept separate from the Taxpayer's operating cash. The Taxpayer has shown that the certificates of deposit and money market accounts were funded with cash in excess of funds needed for operations. Based on the information provided, the Taxpayer has demonstrated by clear and convincing evidence that an alternative method of allocation and apportionment is appropriate for the interest income derived from the certificate of deposits and money market accounts.
Loan to Affiliate
The Taxpayer and the Affiliate are owned by the Parent. Although the Taxpayer and the Affiliate do not have any common officers or directors, both share officers and directors with the Parent. Based on the information provided, both the Taxpayer and the Affiliate did benefit from centralized management through the Parent. As evidence of this, the Taxpayer has stated that the loan was set up as a matter of convenience for both the Taxpayer and the Affiliate. Presumably, without centralized management, the Affiliate may not have known that the Taxpayer had the funds available to make the loan.
In addition, while the Taxpayer indicates that the funds loaned to the Affiliate could have been invested elsewhere, no documentation has been presented to show that these funds had been set aside for investment purposes, or that the Taxpayer was even looking to invest the funds outside of its normal operations. Further, no evidence has been provided to indicate that the Taxpayer had a separate investment function for the purpose of investing and maintaining these funds. The Taxpayer has indicated that its investment function is handled by its Controller. The evidence indicates that the Controller is also responsible for the capital needed for operations.
The Affiliate has been paying off the loan with additional borrowing from a bank. The loan was not maintained as part of a separate investment function by the Taxpayer. The loan payments that the Taxpayer received on the loan was commingled with its operating funds. As such, the department has determined that the loan between the Taxpayer and the Affiliate served an operational, rather than an investment.
Accordingly, permission to use an alternative method of allocation and apportionment can be granted for the income derived from the certificates of deposit and money market accounts, but not for the interest income derived from the loan to the Affiliate. This ruling is limited to the activity described herein for taxable year ended September 30, 1995, and shall not be considered as pertaining to any other taxable year or transaction.
The audit assessment has been adjusted to reflect this determination. Please remit payment of tax and interest according to the enclosed schedule to * * * Office of Tax Policy, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23218-1880 within 30 days to prevent the accrual of additional interest. If you have any questions regarding this determination, you may contact * * * at * * *
Danny M. Payne
Tax Commissioner
Related Documents
Rulings of the Tax Commissioner