Rulings of the Tax Commissioner

March 21, 2024

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 assessments issued to ***** (the “Taxpayer”) for the taxable years ended December 31, 2015, and December 31, 2016. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer filed consolidated federal corporate income tax returns and combined Virginia returns for the 2015 and 2016 taxable years. ***** (the “Parent”) used the modified apportionment method for manufacturing companies. The other affiliates included in the combined returns used the standard three factor formula.

Under audit, the Department disallowed the modified apportionment method and adjusted the returns to reflect the general three factor formula. The Department also increased both the total amount of sales income and the amount of income from services apportioned to Virginia, for purposes of computing the Parent’s sales factor. In addition, the Department disallowed the subtraction claimed on the Taxpayer’s 2016 return for qualified or basic research expenses and wages or salaries eligible for the federal Targeted Jobs Credit. 

The Taxpayer appeals, contending that the Parent met all the requirements to use the modified apportionment method for manufacturing companies. In addition, the Taxpayer asserts that the Department incorrectly adjusted the Parent’s sales factor and improperly disallowed the subtraction for qualified or basic research expenses and wages and salaries eligible for the federal Targeted Jobs Credit. 

DETERMINATION

Manufacturing Apportionment Factor

Virginia Code § 58.1-422 allows manufacturing companies to elect a modified apportionment factor based on sales to determine their Virginia taxable income. For taxable years beginning on or after July 1, 2014, qualifying corporations that elect to use the modified apportionment formula are required to use the single factor apportionment method to apportion Virginia taxable income. Once an election is made, it cannot be revoked for three taxable years. The single factor formula is calculated by multiplying Virginia taxable income less dividend income allocated without Virginia by the sales factor. 

Virginia Code § 58.1-422 D defines a manufacturing company as “a domestic or foreign corporation primarily engaged in activities that, in accordance with the North American Industrial Classification System (NAICS), United States Manual, United States Office of Management and Budget, 1997 Edition, would be included in Sector 11, 31, 32, or 33.”  A business is primarily engaged in manufacturing if either 50% or more of the gross receipts are derived from the sale of goods that are manufactured by the taxpayer, or 50% or more of the employees are engaged in manufacturing activities. See the Single Sales Factor Election for Manufacturers Guidelines (the “Guidelines”), issued as Public Document (P.D.) 13-6 (1/7/2013).

In this case, the audit staff appears to have applied the requirements of the election without regard to any operations that were conducted outside of Virginia. This was incorrect. Although taxpayers are required to maintain at least 90% of their base year full-time employment level in Virginia to remain qualified to use the modified method, the tests to be considered a manufacturing company encompass the company’s entire operations, not just those in Virginia. Based on its activities conducted throughout the United States and an evaluation of the documentation provided, the Parent was a manufacturing company for the taxable years at issue and was eligible to use the modified apportionment method.

Sales Factor

The Taxpayer contests the auditor’s adjustments to the total amount of sales and the amount of sales from services that were sourced to Virginia. The Taxpayer claims that these amounts were properly reported on its Virginia returns for the taxable years at issue. The auditor adjusted the reported sales based in part on trends reported in the Taxpayer’s publicly available financial data. 

The estimated sales amounts were not reconciled to the amounts reported on the federal returns or any other records provided by the Taxpayer. Absent corroborating evidence from the Taxpayer’s records, the denominator of the sales factor cannot be adjusted to exceed the amount reported on its Virginia income tax return.

With regard to the numerator, the audit report provided to the Taxpayer only cites general statutory and regulatory information concerning sales of other than tangible personal property without providing any explanation of the rational for or the documentation used to support the adjustments. Without a supporting explanation or documentation, an audit adjustment cannot be upheld.

Subtractions

Pursuant to Virginia Code § 58.1-402 C 14, corporations are allowed to subtract the amount of qualified research expenses and basic research expenses that were eligible for deduction for federal purposes, but which were not deducted on account of the provisions of § 280C(c) of the Internal Revenue Code (IRC). Similarly, Virginia Code § 58.1-402 C 6 allows corporate employers to subtract the amount of wages or salaries eligible for the federal Targeted Jobs Credit which was not deducted for federal purposes on account of the provisions of IRC § 280C(a).

On its 2016 Virginia income tax return, the Parent claimed subtractions under these code sections for amounts it claims it could not deduct on its federal return on account of IRC § 280C. The subtractions were disallowed in the audit. The audit report fails to explain the reason for these adjustments. Without an explanation for the adjustment, it cannot be upheld.

CONCLUSION

Based on this determination, the Parent was eligible to use the modified manufacturer’s apportionment method to compute its Virginia apportionment factor for the taxable years at issue. Further, the adjustments to the Parent’s sales factor will be reversed. Finally, the Department’s adjustment to the subtractions for the amount of qualified or basic research expenses eligible for deduction for federal purposes and for the amount of wages or salaries eligible for the federal Targeted Jobs Credit, but which were not deducted on account of the provisions of IRC § 280C, is reversed. 

This determination will result in an abatement of most of the amount of the assessments. A portion, however, was not in dispute. The Department will adjust the assessments in accordance with this determination and the attached schedule. The Taxpayer will receive an updated bill that will include accrued interest to date. The Taxpayer should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collection actions. 

The Code of Virginia sections, regulations and public document 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 (804) *****.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/3250.B