Document Number
10-285
Tax Type
Corporation Income Tax
Description
Taxpayer's factoring and loan transactions prior to January 1, 2004 are subject to the addback requirements
Topic
Accounting Periods and Methods
Property Subject to Tax
Records/Returns/Payments
Taxable Transactions
Date Issued
12-22-2010


December 22, 2010




Re: Ruling Request: Addback of factoring

Dear *****:

This is in response to your letter requesting a ruling on whether the intercompany transactions detailed below will be respected for Virginia corporate income tax purposes.

FACTS


The parent company ("Parent" or "Taxpayer") is a corporation legally and commercially domiciled outside of Virginia. Parent's principal operating activity is the manufacture and sale of tangible personal property. Parent is engaged in business within the Commonwealth and files a Virginia corporate income tax return on a separate company basis. Parent is able to obtain lines of credit with third-party financial institutions ("Lenders") at beneficial rates by collateralizing certain account receivables. Under the terms of the financing, the Lenders require that the secured receivables be held in a bankruptcy-remote entity.

In order to establish a bankruptcy-remote entity and to meet the requirements of Lenders, Parent created a wholly-owned subsidiary ("SUB 1 "), to which it sells all of its domestic receivables on a non-recourse basis at an arm's-length discount. Additionally, Parent transferred its accounts receivables function to SUB 1. SUB 1 employs 23 employees, who are responsible for the collection of all factored receivables.

Because a small portion of the receivables are not of sufficient quality to be collateralized, SUB 1 created a wholly-owned subsidiary ("SUB 2").

SUB 1 sells the high-quality receivables to SUB 2 to be used as collateral. The high-quality receivables sold to SUB 2 represent virtually all of the receivables. By using the high-quality receivables as collateral, SUB 2 maintains lines of credit with the Lenders at favorable rates. Using cash obtained from the collection of receivables, as well as from the lines of credit, SUB 2 lends to SUB 1, which subsequently lends to Parent.

SUB 1 and SUB 2 ("Financial Companies") do not have income from Virginia sources and therefore do not file Virginia tax returns. The Financial Companies pay state income tax in the state of domicile as well as in one other state.

Taxpayer contends that the intercompany factoring and loan transactions should be respected for Virginia income tax purposes for taxable years beginning prior to January 1, 2004. Taxpayer also contends that the intercompany factoring losses for taxable years beginning on or after January 1, 2004, should be excluded from the addback requirement under Va. Code § 58.1-402(B)(8) because the intercompany transactions had a valid business purpose other than the avoidance or reduction of tax. Finally, Taxpayer contends that, for taxable years on or after January 1, 2004, the intercompany interest expense paid to SUB 1 and deducted by Parent should also be exempt from the addback requirement.

DETERMINATION


Treatment of Intercompany Factoring and Loan Transactions Prior to January 1, 2004

Virginia Code § 58.1-402(B)(8)(a) requires that intangible expenses and costs between related members be added back to the extent they were excluded from federal taxable income. Similarly, Va. Code § 58.1-402(B)(9)(a) requires that interest expenses and costs between related members be added back to federal taxable income for Virginia purposes, to the extent they were excluded from federal income.

These provisions are effective for taxable years beginning on or after January 1, 2004. Prior to January 1, 2004, there was no addback requirement for intercompany factoring and loan transactions. Accordingly, any factoring and loan transactions for taxable years beginning prior to January 1, 2004, are not subject to the addback requirements of Va. Code §§ 58.1-402(B)(8) and 58.1-402(B)(9).

Treatment of Intercompany Factoring Transactions On or After January 1, 2004

Virginia Code § 58.1-402(B)(8)(a) provides that there shall be added back to the extent excluded from federal taxable income:
    • [T]he amount of any intangible expenses and costs directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with one or more members to the extent that such expenses and costs were deductible or deducted in computing federal taxable income for Virginia purposes.

Virginia Code § 58.1-302 specifically defines "intangible expenses and costs" to include losses related to or incurred in connection with factoring transactions.

Several exceptions to the addback requirement are detailed in Va. Code § 58.1­402(B)(8)(a). Based on the facts provided, it does not appear that the Taxpayer qualifies for any of these exceptions.

An additional exception to the addback statute is permitted under Va. Code § 58.1-402(B)(8)(b) when the intangible intercompany expenses were incurred through a valid business purpose other than the avoidance or reduction of tax. To qualify for this exception, the Taxpayer must demonstrate to the Tax Commissioner's sole satisfaction, by clear and convincing evidence, that the transaction or transactions between the corporation and a related member resulting in the increase in taxable income had a valid business purpose other than the avoidance or reduction of tax due. Va. Code § 58.1-402(B)(8)(b).

After examining the facts provided by the Taxpayer, it appears that the sale of receivables to Taxpayer's wholly-owned, bankruptcy-remote entity may have a valid business purpose other than the avoidance or reduction of tax. Based on the information provided, it appears that the Taxpayer created a bankruptcy-remote entity to facilitate the securitization of its receivables, as required by its Lenders, for the purpose of obtaining more favorable financing. This structure ensures that the collateralized receivables held by SUB 2 will be available to pay the lenders in the event that Parent liquidates.

Virginia Code § 58.1-402(B)(8)(b) outlines very specific procedures a taxpayer must follow in order to claim this exception. To apply to the Tax Commissioner for relief based upon the existence of a valid business purpose, a taxpayer must file its Virginia income tax return reporting the addition in accordance with the statute and remit all taxes, penalties, and interest due for the taxable year. A corporate taxpayer may then petition the Tax Commissioner to consider evidence relating to any transactions between the corporation and related members that resulted in its taxable income being increased. The Tax Commissioner may permit the taxpayer to file an amended return if the application demonstrates by clear and convincing evidence that the transactions resulting in such increase in taxable income had a valid business purpose other than the avoidance or reduction of the tax.

The Taxpayer's request was not made in accordance with the procedure for claiming the valid business purpose exception pursuant to Va. Code § 58.1­-402(B)(8)(b). Accordingly, the Department of Taxation ("TAX") cannot consider the Taxpayer's request to qualify for the valid business purpose exception at this time.

After the statutory procedure set forth above is followed, the Taxpayer may then apply for relief. If the application is granted, the taxpayer may file an amended return that excludes the addition related to the specific transaction or transactions identified in the response. The amended return must be filed within one year of the response. If the Taxpayer applies for and is granted the relief for the first taxable year in question, the Taxpayer may be granted the valid business purpose exception for subsequent years for as long as there is no substantial change in the facts surrounding the arrangement.

After reviewing the facts presented so far, TAX has determined that we will not need to retain outside assistance to review your petition should you follow the statutory procedures to qualify for the exception. Therefore, TAX will not charge a fee for reviewing such a petition at this time.

Treatment of Intercompany Interest Expenses Incurred On or After January 1 2004

Virginia Code § 58.1-402(B)(9) provides that there shall be added back to the extent excluded from federal taxable income:
    • [T]he amount of any interest expenses and costs directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with one or more related members to the extent such expenses and costs were deductible or deducted in computing federal taxable income for Virginia purposes.

For income tax purposes, Va. Code § 58.1-302 defines "interest expenses and costs" as:
    • [A]mounts directly or indirectly allowed as deductions under Section 163 of the Internal Revenue Code for purposes of determining taxable income under the Internal Revenue Code to the extent such expenses and cost are directly or indirectly for, related to, or in connection with the direct or indirect acquisition, use, maintenance, management, ownership, sale, exchange, lease, transfer, or disposition of intangible property. (Emphasis added).

The term "intangible property" is defined in Va. Code § 58.1-302 to mean patents, patent applications, trade names, trademarks, service marks, copyrights and similar types of intangible assets.

Taxpayer contends that Va. Code § 58.1-402(B)(9)(a) does not apply to the interest paid to SUB 1 and deducted by Parent because the interest expense is not in connection with intangible property, but is instead related to loans with Lenders.

The definition of intangible property lists several types of intellectual property "and similar types of intangible assets." While the accounts receivable that are transferred to SUB 1 are intangible assets, they are not sufficiently similar to the types of intellectual property listed in the definition to be included. Therefore, Parent is not required to add back the interest deduction claimed with respect to the transfer of accounts receivable to SUB 1.

Although Parent is not required to add back the interest deduction pursuant to Va. Code § 58.1-402(B)(9)(a), this does not limit or negate TAX's authority to equitably adjust the tax under Va. Code § 58.1-446 if the arrangements improperly reflect the business done or the Virginia taxable income earned from business done in the Commonwealth. Va. Code § 58.1-402(B)(9)(c).

CONCLUSION


Based on the foregoing, none of Taxpayer's factoring and loan transactions for taxable years beginning prior to January 1, 2004 are subject to the addback requirements of Va. Code §§ 58.1-402(B)(8) and 58.1-402(B)(9).

Because the Taxpayer has not followed the procedures set forth in Va. Code § 58.1-402(B)(8)(b), TAX cannot consider whether the Taxpayer qualifies for the valid business purpose exception to the intangible addback statute.

Finally, because factoring does not fall under the definition of "intangible property" set forth in Va. Code § 58.1-302, Taxpayer is not subject to the interest addback requirement of Va. Code § 58.1-402(B)(9).

The Code of Virginia sections and public documents cited are available online at www.tax.virginia.gov in the Tax Policy Library section of the TAX website. If you have additional questions, please contact ***** in the Office of Tax Policy, Policy Development Division, at *****.
                • Sincerely,


                • Craig M. Burns
                  Tax Commissioner




PD/1-2409266886


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46