Document Number
12-138
Tax Type
Corporation Income Tax
Description
Virginia source income for income tax purposes
Topic
Clarification
Date Issued
08-28-2012

August 28, 2012




Re: Request for Ruling: Corporate Income Tax

Dear *****:

This will reply to your letter in which you request a ruling concerning corporate income tax on behalf of ***** (the "Taxpayer"). I apologize for the delay in responding to your letter.

FACTS


The Taxpayer, an S corporation headquartered in a state adjoining Virginia, is a law firm that opened an office in Virginia in 2010. The Virginia office is limited to providing administration and support to the law firm, which does not result in any billable time to clients.

Although none of the attorneys in the firm has been admitted to practice law in Virginia, the Taxpayer has several clients with operations in Virginia. The Taxpayer requests a ruling as to whether it would have Virginia source income for income tax purposes.

RULING


Virginia Source Income

Virginia Code § 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." Generally, 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.

Pass-through entities (including S corporations) that have income from business both within and without Virginia are required to compute their Virginia source income in accordance with the corporate statutory formula set forth in Va. Code §§ 58.1-408 through 58.1-421. As such, pass-through entities generally must allocate dividends to the state of commercial domicile and apportion all other income. Income is apportioned using a three-factor formula based on the property, payroll and sales within Virginia. See Public Document (P.D.) 07-150 (9/21/2007). Thus, the Taxpayers income from Virginia sources would be an apportioned amount of its total income for Virginia income tax purposes less dividends.

Under Va. Code § 58.1-408, the apportionment formula is an average of the property factor plus the payroll factor plus the sales factor twice. In other words, the sales factor is weighted 50% in the apportionment formula with payroll and property each getting weighted at 25% for purposes of determining the apportionment factor.

Property Factor

The Taxpayer had property in Virginia. Virginia Code § 58.1-409 provides that the property factor consists of the ratio of the average value of a taxpayer's real and tangible personal property owned or rented and used in Virginia over the like property located everywhere. See Title 23 of the Virginia Administrative Code (VAC) 10-120-160 through 10-120-180.

Payroll Factor

The Taxpayer had an employee working in Virginia. Pursuant to Va. Code § 58.1-412, the payroll factor is a fraction, the numerator being the total amount of compensation paid or accrued within Virginia during the taxable year by a taxpayer and the denominator being the total compensation paid or accrued everywhere during the taxable year. See Title 23 VAC 10-120-190.

Sales Factor

The Taxpayer was engaged in providing services to its customers. Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are deemed in Virginia if:
  • 1. The income-producing activity is performed in Virginia; or
    2. The income-producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

Pursuant to Title 23 VAC 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. "Income producing activity" is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.

In General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S. E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Va. Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining "cost of performance" and "income producing activity" in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.

In response to the General Motors decision, the Department issued Tax Bulletin (VTB) 05-3 (4/18/2005). This bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department's adoption of policies in response to the General Motors decision. Because the Department administers Va. Code § 58.1-416 in a manner similar to Va. Code § 58.1-418, taxpayers, including pass-through entities, with sales other than tangible personal property may also elect to file returns prepared in accordance with Title 23 VAC 10-120-230 pending the adoption of policies in response to the General Motors decision.

Based on facts presented, direct costs for salaries and administration (including depreciation, overhead and taxes) were incurred in Virginia. All of the other costs, including services rendered on behalf of clients, occurred in the adjoining state.

The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct cost associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would not be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.

I hope this information is helpful. This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections, regulations, and tax bulletin cited are available on­line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,


                • Craig M. Burns
                  Tax Commissioner



AR/1-4996462229.o


Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46