Tax Type
Corporation Income Tax
Description
Foreign source income subtraction/Consolidated corporate income tax returns
Topic
Accounting Periods and Methods
Subtractions and Exclusions
Date Issued
08-13-2013
August 13, 2013
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you seek a refund of corporate income tax paid by ***** (the "Taxpayer") for the taxable years ended December 31, 2008 and 2009, and for the correction of the corporate income tax assessment issued for the taxable year ended December 31, 2010. I apologize for the delay in responding to your request.
FACTS
The Taxpayer filed consolidated Virginia corporate income tax returns for each taxable year at issue. The Department audited the Taxpayer for the 2007 through 2010 taxable years and adjusted the expenses applied to the foreign source income subtraction. Assessments were issued for the 2007 through 2010 taxable years. Because of other adjustments, the audit reports for the 2008 and 2009 taxable years resulted in overpayments.
The Taxpayer appeals the auditor's adjustments for the 2008 through 2010 taxable years, contending that the Department erroneously reduced the foreign source income subtraction by expenses attributable to both passive and general subpart F and foreign dividend gross-up income. The Taxpayer also asserts that the auditor did not use non-allocable expenses attributable to passive activity income in computing the subtractions for the 2007 taxable year and was, therefore, inconsistent in the application of Virginia tax policy.
DETERMINATION
Virginia Code § 58.1-402 C 8 provides a subtraction for foreign source income as defined in Va. Code § 58.1-302, to the extent included in federal taxable income. The computation of the Virginia foreign source income subtraction (considering expenses related to the income) is determined in accordance with Internal Revenue Code (IRC) §§ 861 through 863. See Public Document ("P.D.") 86-154 (8/14/1986). Virginia law requires the use of the federal sourcing rules of IRC § 861 et seq., whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and regardless of what expenses would be under generally accepted accounting principles.
The provisions of IRC § 861 et seq., contain detailed rules for assigning income and deductions to particular sources. The provisions differentiate between deductions that are definitely allocable and deductions that are not definitely allocable. First, definitely allocable deductions that are directly related to a class of income are allocated and then apportioned between foreign and domestic source income. If a deduction is not definitely related to any gross income, the deduction must be apportioned ratably between each class of foreign and domestic source income.
The Department has previously ruled that the proper method of computing non-allocable expenses attributable to foreign source income is to multiply total non-allocable expenses by a ratio, the numerator of which is gross Virginia foreign source income and the denominator of which is gross income from without the United States per the Form 1118. See P.D. 91-229 (9/30/1991). Items that qualify for separate subtractions under other provisions of the Virginia Code, such as IRC § 78 gross-up, Subpart F income, and dividends from corporations in which the taxpaying corporation owns 50% or more of the voting stock, are not subtracted again as foreign source income. Accordingly, they are not included in the numerator of the ratio, but are included in the denominator to the extent included on Form 1118.
The Taxpayer argues the exception made for assigning expenses related to Subpart F income and foreign dividend gross-up income means no expenses related to these items should be used in computing the foreign source income subtraction.
Internal Revenue Code (IRC) § 904(d)(1) provides for the separate application of the limitation of the foreign tax credit with respect to certain categories of income (commonly called "baskets"), including passive income, financial services income, and dividends from each non-controlled IRC § 902 corporation (IRC § 78 gross-up). Consequently, income is separated into various baskets, and a separate federal Form 1118 is prepared for each basket for the purpose of calculating the federal limitation.
In this case, the Taxpayer prepared a separate Form 1118 for its passive activity income. The Taxpayer agrees that the income reported on Form 1118 should be included in the computation of the expenses related to foreign source income. However, it asserts that the not definitely allocable deductions reported in the separate Form 1118 should not be included in the computation pursuant to P.D. 86-154.
According to P.D. 86-154, Subpart F and foreign dividend gross-up income are not included in the foreign source income subtraction and as such, no related expense would be included in the foreign source income subtraction calculation because Virginia law allows a separate subtraction for these items of income. In many cases, however, deductions not definitely allocable cannot be distinguished between items of income eligible for the Virginia foreign source subtraction and those items of income that do not qualify for the subtraction. As such, the Department developed the computation in P.D. 91-229 in order to attribute non-allocable expenses to income from foreign sources eligible for the subtraction. Under the Department's computation, only those deductions not definitely allocable apportioned to Virginia foreign source income are used to offset eligible income resulting in a subtraction pursuant to Va. Code § 58.1-402 C 8.
Under the Taxpayer's position, non-allocable expenses attributed to Subpart F dividends and foreign source gross-up as reported on the separate Form 1118 would be removed from the computation while the income would remain in the denominator. Under this reasoning, 100% of foreign source income would be used to apportion less than 100% of deductions not definitely allocable. This method contradicts the federal rules for assigning income and deductions to particular sources.
In P.D. 91-59 (3/29/1991), the Department ruled all foreign source income reported on Form 1118 is considered for purposes of the foreign source income subtraction regardless of the federal basket limitations of IRC § 904. As such, the computation of the subtraction for Virginia foreign source income includes all deductions not definitely allocable without regard to the limitations contained in IRC § 904.
A review of the audit indicates that the auditor properly applied expenses to Subpart F income and foreign dividend gross-up income. Accordingly, the Taxpayer's request for a refund of income tax paid for the 2008 and 2009 taxable years and the abatement of the 2010 assessment cannot be granted. A bill with updated interest will be issued to the Taxpayer. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit payment to: Virginia Department of Taxation, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attn: *****. If you have any questions concerning payment of the assessments, you may contact ***** at *****.
The Taxpayer states that the auditor failed to take into account non-allocable expenses attributable to Subpart F dividends and foreign source gross-up in computing the foreign source income subtraction for the 2007 taxable year. As such, the audit will be returned to the audit staff in order to review the foreign source income subtraction and make any necessary adjustments in accordance with this determination. Once the adjustments are complete, the Taxpayer will receive a revised audit report. If the revised audit reduces the original assessment, it will be adjusted accordingly and an updated bill, if any, will be issued including interest accrued to date.
The Code of Virginia sections, regulation, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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Craig M. Burns
Tax Commissioner
AR/1-5215749688.B
Rulings of the Tax Commissioner