November 7, 2018
Re: § 58.1-1824 Protective Claim: 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 year ended October 31, 2012. I apologize for the delay in responding to your request.
FACTS
The Taxpayer was in the business of providing information technology (IT) services, including infrastructure technology outsourcing. The Taxpayer provided the management, procurement and planning, as well as related services for security, legal compliance and emergency and disaster response for unrelated third parties. The Taxpayer also provided application and business services that included the upgrading, customization, maintenance and protection of business customer software. In addition, the Taxpayer provided technology services that included consulting and support services.
The Taxpayer submitted a claim for a refund, contending that it overstated the amount of income reported in the numerator of its sales factor based on cost of performance. It also asserts that it underreported the amount of sales in the denominator of the sales factor. Finally, it argues that it did not carry over a net operating loss (NOL) that was reported on an amended Virginia corporate income tax return filed for a prior taxable year.
DETERMINATION
Protective Claim
Virginia Code § 58.1-1824 permits taxpayers to file a protective claim for refund within three years of the date of an assessment. Pursuant to the authority granted the Department under Virginia Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Virginia Code § 58.1-1821. As permitted by statute, the Taxpayer’s request has been treated as an appeal under Virginia Code § 58.1-1821.
Net Operating Loss Carryover
Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia. For corporate income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income with federal taxable income (FTI). Income properly included in the FTI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Virginia Code § 58.1-402.
Generally, Virginia income tax law does not address NOLs. Because Virginia starts its computation of corporate income tax with FTI, the Department allows an NOL to the extent it is allowable in computing FTI as calculated for Virginia income tax purposes. Title 23 of the Virginia Administrative Code (VAC) 10-120 325 provides the methodology that a corporation must use to calculate the net operating loss deduction (NOLD) carrybacks and carryforwards for purposes corporate income tax. Under this regulation, a Virginia NOLD modification must be determined for the taxable year in which an NOL occurred. This Virginia NOLD modification must be carried back and forward in the same manner as the NOLD.
Fixed date conformity additions and subtractions are not considered Virginia modifications. Rather, these exceptions identified in Virginia Code § 58.1-301 are added to or subtracted from FTI as computed under the IRC in order to determine a corporation's FTI for Virginia income tax purposes. A corporation's Virginia FTI is calculated by starting with FTI as reported on the federal income tax return, adding the fixed date conformity addition (FDCA), and then subtracting any fixed date conformity subtraction (FDCS). The formula for determining Virginia FTI would be as follows:
FTI + FDCA - FDCS = Virginia FTI
For Virginia income tax purposes, a corporation will have an NOL only if the formula results in a number that is less than zero. If FDCA exceeds the total of a loss reported on a federal return plus FDCS, the corporation will not have an NOL for Virginia income tax purposes. Conversely, if FDCS exceeds FTI plus FDCA, the taxpayer will have NOL for Virginia even if it does not report an NOL on its federal return. Such an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2.
The Taxpayer believes it is eligible to carry forward an NOL from the 2011 to the 2012 taxable year. A review of the 2011 amended return indicates the Taxpayer reported negative FTI. The return also includes fixed date conformity additions and subtractions. The additions for fixed dated conformity exceed the total of FTI and the FDCS. Thus, the Taxpayer had a positive FTI in 2011 for Virginia income tax purposes.
Cost of Performance
The Taxpayer contends that no sales should be assigned to the numerator of its sales factor because the majority of its costs are attributable to states outside of Virginia. Under Virginia Code § 58.1-416, sales, other than sales of tangible personal property, are deemed in Virginia if:
- The income-producing activity is performed in Virginia; or
- 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 of the Virginia Administrative Code (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 Virginia 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. 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 be 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.
In this case, the Taxpayer generates fees from leveraging its various IT services through multiple customers. The Taxpayer has provided documentation showing that it attributed a smaller percentage of its payroll and property expenses to Virginia then to other states. A taxpayer, however, would be required to show that such costs were attributable to each sales transaction that was performed both within and without Virginia and document which of those costs occurred in Virginia. Employees who have their offices in other states may perform a preponderance of the work on a particular contract in Virginia. The costs incurred for such employees would be attributed to Virginia even though their salary would be attributed to the other states for payroll apportionment purposes. Likewise, Virginia based employees that perform a preponderance of work on a contract out-of-state may have costs attributed out-of-state but would be considered Virginia based employees for apportionment purposes.
Sales Factor
The Taxpayer did not include certain markup income, currency remeasurement income and other income in the denominator of its sales factor that was reported on its federal return as other income. It contends that these items are required to be included in the sales factor because there were includable in federal taxable income (FTI).
Virginia Code § 58.1-414 addresses the computation of the sales factor and provides:
the sales factor is a fraction, the numerator of which is the total sales of the corporation in the Commonwealth during the taxable year, and the denominator of which is the total sales of the corporation everywhere during the taxable year, to the extent that such sales are used to produce Virginia taxable income and are effectively connected with the conduct of a trade or business within the United States and income therefrom is includable in federal taxable income.
Virginia Code § 58.1-302 defines the term “sales” as the gross receipts of the corporation from all sources (except dividends, which are allocated), whether or not such gross receipts are generally considered sales. The sales factor includes all gross receipts that are included in Virginia taxable income and are connected with the conduct of the taxpayer’s trade or business within the United States only the net gain from the transactions are included. See Title 23 VAC 10-120-210.
Currency remeasurement is the reporting method used to report foreign currency into the currency of the reporting entity. The spot exchange rate is the price paid to sell one currency for another for delivery on the earliest possible value date. The conversion of one currency into another is not a transaction producing gross receipts, but rather a mere change in the form of the money involved. See Public Document (P.D.) 85-1 (1/7/1985) and P.D. 92-21 (4/14/1992). As such, amounts reported as currency remeasurement or as adjustment to the spot adjustment rate would not be included in the sales factor.
The Department has determined that receipts of an unknown or unspecified nature may not be included in the denominator of the sales factor. See P.D. 92-45 (4/27/1992) and P.D. 03-60 (8/8/2003). The Taxpayer has provided no evidence regarding amounts included in markup income and other income on the federal return that would demonstrate that they constitute receipts within the meaning of Title 23 VAC 10-120-210.
CONCLUSION
Because the Taxpayer did not have an FTI of less than zero after accounting for the fixed date conformity additions and subtractions, it would not have had an NOL for Virginia income tax purposes for the 2011 taxable year. Accordingly, it was not eligible to carry forward the NOL to the 2012 taxable year.
Virginia Code § 58.1-205 provides that in any proceeding relating to the interpretation of the tax laws of Virginia, an “assessment of a tax by the Department shall be deemed prima facie correct. As such, the burden of proof is on the Taxpayer to show its sales show that a greater proportion of the income producing activity occurred outside of Virginia. The Taxpayer has not provided sufficient evidence that its income producing activity occurred outside of Virginia. In addition, certain items of income relating to currency exchange and unspecified other income would not be included in the denominator of the sales factor.
I will allow the Taxpayer an opportunity to provide the information requested to substantiate its claim regarding its income producing activity and to show that markup income and other income on the federal return constitute receipts for purposes of the sales factor. The documentation must be provided within 45 days from the date of this letter. Please send the requested information to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *****. At the conclusion of the 45-day period, the case will be remanded to the Department’s Compliance Unit to make the adjustments, if any, in accordance with this determination and the information provided. A refund will then be issued if warranted.
The Code of Virginia sections, regulations, Tax Bulletin, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and 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/1024.B