February 15, 2022
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you appeal the Department’s denial of amended returns seeking a refund of corporate income tax paid by your client, ***** (the “Taxpayer”) for the taxable years ended June 30, 2015, 2016 and 2017. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer, a nonprofit educational institution domiciled in Virginia and generally exempt from federal income tax under Internal Revenue Code (IRC) § 501(c)(3), was subject to tax only on its unrelated business taxable income (UBTI). The Taxpayer owned less than 10% limited partnership interests in various investment partnerships (the “Partnerships”). The Partnerships issued tax reporting documents that allocated their income among various states. The Taxpayer’s original Virginia returns for the taxable years at issue included all UBTI reported on their federal returns in its Virginia taxable income. The Taxpayer later submitted amended returns requesting refunds of tax paid on income attributable to the Partnerships and not allocated to Virginia. Under review, the Department denied the refunds. The Taxpayer appealed, contending the income from the Partnerships should not be subject to Virginia income tax because it was non-unitary investment function income.
DETERMINATION
The Code of Virginia does not provide for the allocation of income other than certain dividends. A taxpayer’s entire federal taxable income, adjusted and modified as provided in Virginia Code § 58.1-402 and § 58.1-403, less dividends allocated pursuant to Virginia Code § 58.1-407, is subject to apportionment. In the case of a nonprofit, the Virginia corporate income tax applies to the extent of its UBTI. See Virginia Code § 58.1-401 5. Under the plain language of the statute, therefore, the Taxpayer must begin the calculation of Virginia taxable income with its UBTI as reported on its federal return. There is no provision in the law for separate accounting that would exclude from this starting point the Taxpayer’s proportionate share of income allocated to other states by the Partnerships. Accordingly, the Taxpayer’s exclusion of income that was allocated to other states by the Partnerships has been treated as a request for an alternative method of allocation and apportionment in accordance with Virginia Code § 58.1-421.
The Department will not grant an alternative method of allocation and apportionment unless it determines that: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer’s situation; or (2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state’s method of apportionment. See Title 23 of the Virginia Administrative Code (VAC) 10-120-280.
The Taxpayer asserts that the income in question is from a non-unitary investment unrelated to its operational activities within Virginia and, therefore, must be sourced under the principles established in Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 787 (1992). The decision of the United States Supreme Court in Allied-Signal, however, clarified that in order for a state to constitutionally tax a nondomiciliary corporation, certain minimal connections had to exist between the interstate activities and the taxing state. Because the Taxpayer is domiciled in Virginia, the judicial doctrines controlling Allied-Signal and prior cases do not apply to this situation. See Public Document (P.D.) 97-285 (6/25/97) and P.D. 02-67 (4/29/2002). Even if the Department concluded that the Partnerships’ income should be sourced as nonbusiness income under Allied-Signal, the income would still be sourced to Virginia as the Taxpayer’s state of commercial domicile. See P.D. 07-197 (11/30/2007).
The Taxpayer further contends that sourcing the Partnerships’ income to Virginia results in double taxation. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state’s method of allocation and apportionment is rationally related to the business transacted within a state, then each state’s tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair, 437 U.S. 279 (1978).
The Department recognizes that double taxation may result in this case, but as stated above, in order to grant an alternative method of allocation and apportionment, that inequity must be attributable to Virginia, rather than another state’s method of apportionment. Based on the information known about the Taxpayer’s interests in the Partnerships, it appears that such interests would satisfy the conditions set forth in P.D. 95-19 (2/13/1995) and the Taxpayer’s share of the Partnerships’ property, payroll and sales would be excluded from its apportionment factors. See also P.D. 88-235 (8/10/1988).
Under Virginia’s policy, if the Taxpayer had been domiciled elsewhere and was only receiving passive investment income attributable to the Virginia activities of a partnership in which the Taxpayer had a limited partnership interest satisfying the conditions of P.D. 95-19, there would have been no attribution of the partnership’s property, payroll and sales factors to the Taxpayer. With no positive Virginia apportionment factors, the Taxpayer would not have been subject to Virginia income tax in that scenario. As such, the inequity was not attributable to Virginia’s system of taxation, rather to the other states to which the Taxpayer claimed it was liable to pay income tax. Because the application of Virginia law to these facts, if applied by every jurisdiction, would result in no more than all of the Taxpayer’s income being taxed, the policy meets the test of internal consistency. See Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 169 (1983). Further, tax schemes that may result in double taxation only as a result of two different but nondiscriminatory and internally consistent schemes are not constitutionally prohibited. See Comptroller of the Treasury v. Wynne, 575 U.S. 542, 562 (2015).
The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Based on the facts presented, it has not been demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer. Accordingly, I must deny the Taxpayer’s request to use an alternative method of allocating and apportioning income. Therefore, the denial of the requested refunds is upheld.
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 Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/3501.X