April 11, 2016
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the corporate income tax assessment issued to ***** (the "Taxpayer") for the taxable year ended June 30, 2012.
FACTS
The Taxpayer, an out-of-state corporation that participated in a joint venture (the "Joint Venture"), filed a Virginia corporate income tax return for the taxable year at issue. A portion of the Taxpayer's distributive share of income from the Joint Venture consisted of royalties paid for the use of intellectual property by certain foreign subsidiaries of another partner in the Joint Venture.
Under audit, the Department removed the royalties from the denominator of the Taxpayer's sales factor and issued an assessment. The Taxpayer appealed, contending that such income was properly included in the sales factor denominator because it was part of the Taxpayer's total sales everywhere during the taxable year at issue.
DETERMINATION
Income from a Joint Venture
The Joint Venture was a partnership for federal income tax purposes. Virginia generally conforms to the federal treatment of partnerships. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners. Internal Revenue Code (IRC) § 702(b) states, "The character of any item of income gain, loss, deduction, or credit included in a partner's distributive share . . . shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership." Each item of partnership income, gain, loss or deduction has the same character for a partner for Virginia income tax purposes as for federal income tax purposes. See Va. Code § 58.1-391 B. In this case, a portion of the income received by the Taxpayer from the Joint Venture included royalties from foreign subsidiaries of another partner in the Joint Venture. Such income retained its character as royalties for purposes of calculating the Taxpayer's Virginia sales factor.
Sales Factor
In general, the sales factor is a fraction, the numerator of which is total sales in Virginia during the taxable year, and the denominator of which is total sales of the corporation everywhere during the taxable year. See Title 23 of the Virginia Administrative Code (VAC) 10-120-120 A. "Sales" is defined as all gross receipts of the corporation except dividends allocated under Va. Code § 58.1-407. See Va. Code § 58.1-302; Title 23 VAC 10-120-120 B. Generally, royalty income from the licensing of intellectual property is included in the sales factor. See Public Document (P.D.) 02-52 (4/16/2002).
The property, payroll and sales of a corporation that are used to produce income qualifying for the subtraction for foreign dividend gross up, subpart F income and foreign source income is not included in the denominator of the fractions. See Title 23 VAC 10-120-150 B 2 b.
Foreign Source Income
Virginia Code § 58.1-402 C 8 permits a taxpayer to subtract foreign source income from federal taxable income (FTI) to the extent it is included in and not otherwise subtracted from FTI. Under Va. Code § 58.1-302, "foreign source income" is defined as:
Rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property, including rents, royalties or fees for the use of or the privilege of using without the United States any patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises or like properties.
In this case, the royalties were received for the use of intellectual property by foreign business entities operating overseas. As such, the royalties qualified for the foreign source income subtraction. See P.D. 03-65 (8/19/2003). Therefore, pursuant to Title 23 VAC 10-120-150 B 2 b, the royalties were properly excluded from the Virginia sales factor denominator.
CONCLUSION
Because it appears the royalties qualified for the foreign source income subtraction under Virginia Code § 58.1-402 C 8, they were properly excluded from the Taxpayer's sales factor. The computation of the Virginia foreign source income subtraction (considering expenses related to the income) is determined in accordance with IRC §§ 861 through 863. See 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.
If the Taxpayer chooses to claim the foreign source income subtraction, it must file an amended return within 60 days of the date of this letter. The Taxpayer should send the return to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23218-7203, Attention: *****. The return will be processed, and the assessment will be adjusted and a refund issued, as warranted. If the return is not received within the time allotted, the assessment will be deemed to be correct and collection action will begin.
The Code of Virginia sections, regulations, 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 Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-6119056891.M