September 26, 2018
Re: Appeal of Final Local Determination
Taxpayer: *****
Locality: *****
Business, Professional and Occupational License (BPOL) tax
Dear *****:
This final state determination is issued upon the application for correction filed by you on behalf of ***** (the “Taxpayer”), with the Department of Taxation. You request a refund of Business, Professional and Occupational License (BPOL) taxes paid by the Taxpayer to the ***** (the “City”) for the 2011 through 2013 tax years.
The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL tax assessment is deemed prima facie correct, i.e., the local assessment will stand unless the taxpayer proves that it is incorrect.
The following determination is based on the facts presented to the Department summarized below. The Code of Virginia section, regulation and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site.
FACTS
In Public Document (P.D.) 17-93 (6/9/2017), the Department determined that the Taxpayer was only required to show that gross receipts are included in gross income or federal taxable income reported on another state’s return in order to claim the out-of-state deduction. The case was remanded to the City to review the income tax returns the Taxpayer filed in other states for the 2011 through 2013 tax years and then determine the proper amount of the out-of-state deduction.
The City reviewed the Taxpayer’s returns and issued a final local determination adjusting the assessments for the tax years at issue based on payroll apportionment. The Taxpayer filed an appeal with the Department contending that the City erroneously calculated the out-of-state deduction using payroll apportionment and did not deduct all the gross receipts attributable to a business.
ANALYSIS
Situs
The City’s final local determination stated that the Taxpayer sitused its gross receipts utilizing payroll apportionment. The Taxpayer contends that it used the direct labor method to situs gross receipts. As stated in P.D. 17-93, the Taxpayer sitused its gross receipts to out-of-state locations by tracing its labor charges made by each employee located in the City. It then determined the total labor cost charged to these contracts by its employees nationwide. Utilizing these two calculations, a fraction was then developed with the numerator being the direct labor charges at the City’s definite place of business and the denominator being total direct labor charges. This fraction was multiplied against total receipts from the contracts that the employee working at the City’s definite place of business worked on to determine gross receipts attributable to the City.
It is unclear why the City issued a determination supporting the use of payroll apportionment when the revised assessment appears to have been computed in accordance with direct labor method upheld by the Department in P.D. 17-93. While the use of direct labor resembles payroll apportionment in that both methods make use of employee compensation in the computation of situs, the Department has found the direct labor method more accurately traces gross receipts to labor costs incurred at a particular definite place of business and can be used to situs gross receipts under the statutory method.
In contrast to a direct labor methodology, payroll apportionment provides only a reasonable estimate and has been used only as a method of last resort. Payroll apportionment basically uses the entire payroll of a business to determine situs of gross receipts. When employing a direct labor method, however, a ratio of direct labor charges, as described above, is applied only to the total amount gross receipts resulting from contracts, services or transactions in which employees at a definite place of business participated.
In the Department’s opinion, the use of direct labor to situs gross receipts provides a substantially more accurate measurement than payroll apportionment. The Department further believes today’s technology coupled with cost accounting methodologies could allow many businesses, like the Taxpayer in this case, to situs gross receipts much more accurately than the use of payroll apportionment without adding a significant administrative burden.
Out-of-State Deduction
The Taxpayer argues the deduction is available for all gross receipts attributable to business conducted in another state or foreign country. As such, it claimed an out-of-state deduction for all gross receipts sitused to other states in which its employees located in the City participated.
The Department disagrees that the out-of-state deduction is available for any gross receipts attributable to business conducted in another state or foreign country. See P.D. 17-159 (9/8/2017). Statutory construction clearly establishes that the taxable measure of gross receipts must first be determined before any deduction is granted. In other words, receipts must first be assigned or sitused to a definite place of business. Then, from those assigned receipts to a definite place of business within a Virginia locality, a business may take a deduction under Virginia Code § 58.1-3732 B 2, provided that it can identify receipts attributable to business conducted in another state in which it filed an income tax return and income tax was paid. Gross receipts attributable to business conducted in another state or foreign country are some portion assigned to the definite place of business that employees from the Virginia definite place of business earn, or participate in earning. See P.D. 17-159. Pursuant to P.D. 05-53 (4/8/2005), the out-of-state deduction is limited to the extent a taxpayer at a Virginia definite place of business does business in other states or countries in which the taxpayer is liable for an income or income or income like tax.
The Taxpayer asserts example B 1 in Title 23 of the Virginia Administrative Code 10-500-80 directly addresses its circumstances. In that example, a merchant is permitted to deduct all gross receipts from the sale of goods to a North Carolina resident because the merchant filed a North Carolina income tax return. It is apparent in this example that all gross receipts from the sale of goods are attributable to the merchant located in the definite place of business in Virginia. No portion of the gross receipts was attributable to employees located outside the Virginia definite place of business.
The City determined the out-of-state deduction by multiplying gross receipts sitused outside of the City by the direct labor percentage. The City’s rationale for using this method is unclear because its final local determination erroneously stated that it utilized payroll apportionment to calculate the deduction.
DETERMINATION
The Taxpayer’s method of situsing gross receipts by direct labor meets the statutory requirement of Virginia Code §§ 58.1-3703.1 A 3 a 4. This method was accepted by the City in its original audit. As such, the situsing of the Taxpayer’s gross receipts by payroll apportionment was not proper.
In light of the City’s determination, it is unclear whether the City’s calculations of the out-of-state deduction were made in accordance with P.D. 17-93. As such, I am remanding this case back to the City in order for it to recalculate the Taxpayer’s out-of-state deduction for the 2011 through 2013 tax years in accordance with P.D. 17-93 and this determination. The City must then issue another final local determination letter reflecting its calculations. If the Taxpayer disagrees with the City’s determination, it may appeal to the Department pursuant to Virginia Code § 58.1-3703.1.
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/1695.B