Tax Type
Corporation Income Tax
Description
Domestic International Sales Corporations
Topic
Computation of Income
Royalties
Date Issued
03-04-1982
March 4, 1982
Re: § 58-1118 Application for Years 1978, 1979
§ 58-151.083 Adjustment for DISC
§ 58-151.038 Allocation. Intangible Royalties
Dear *****************
This ruling is made in response to your application under § 58-1118 dated January 19, 1982. Although you requested a conference, I have made this ruling without one.
FACTS
Taxpayer is the parent of a controlled group of corporations some of which do business in Virginia. Several subsidiaries qualify as Domestic International Sales Corporations (DISC) under §§991-997 of the Internal Revenue Code. The DISCs are so-called "Commission DISCs" and do not actively conduct business. Each subsidiary making foreign sales has its own related DISC to which commissions are attributed. For purposes of this ruling the DISCs associated with subsidiaries not doing business in Virginia will be referred to as the Non-Virginia DISC Group.
After audit the Department assessed additional tax based upon consolidation of all DISCs with Taxpayer under §58-151.083, inclusion of intangible royalties in apportionable income and certain other adjustments not in dispute.
Within 90 days of the assessment Taxpayer applied for correction of an erroneous assessment under §58-1118 protesting the DISC adjustment and the apportionment of intangible royalty income.
DETERMINATION
Royalty income from intangible property located in a foreign country is included in federal taxable income. Virginia law in effect for 1978 and 1979 did not allow a subtraction for such income in computing Virginia taxable income. §58-151.013(c)(9) (Foreign Source Income) is a recent amendment effective for taxable years beginning on or after January 1, 1981. Therefore the royalty income is included in Virginia taxable income.
§58-151.038 requires allocation of net rents and royalties from real and tangible personal property to the state in which the property is located. Royalties from intangible property are not allocated and therefore must be apportioned.
The purpose of the §58-151.083 adjustment is to subject to Virginia income tax income that was earned from business done in Virginia. Federal law allows corporations to shift a portion of their earnings from qualified exports to a DISC and thereby defer federal income taxes. Because this distorts income earned from business done in Virginia the Department requires a § 58-151.083 adjustment.
Taxpayer protested the adjustment with respect to any of its DISCs on the grounds that it was unconstitutional, citing Westinghouse Electric Corporation v. James H. Tully, 440 N.Y.S. 397 (6119/81).
The Westinghouse case was decided by the Appellate Division of the New York Supreme Court and has been appealed to the Court of Appeals (New York's highest court). The Department has reviewed the opinion and is unpersuaded. Compare Administrative Decision 81-9-B of the West Virginia State Tax Department holding to the contrary.
The Department has recently considered this question ant ruled that the adjustment for DISCs is authorized by § 58-151.083 and is not a violation of the U.S. Constitution. A copy of the ruling dated January 13, 1982 is enclosed for your convenience.
However, the major portion of the assessment is due to the consolidation of the Non-Virginia DISC Group. The income attributed to the Non Virginia DISC Group came from subsidiaries which do not do business in Virginia. Expenses associated with these DISCs were borne by the related subsidiaries, not by Taxpayer. Although the Non-Virginia DISC Group distorts the income of its related subsidiaries, it does not appear to distort the income of Taxpayer from business done in Virginia.
Since § 58-151.083 authorizes the Department to equitably adjust the tax in such manner at it may determine, I rule that the assessment shall be corrected to exclude from the §58-151.083 adjustment only the Non-Virginia DISC Group. The adjustment for the remainder of the DISCs is correct. The inclusion of intangible royalty income in apportionable income is correct.
You will shortly receive a corrected assessment which should be paid promptly to avoid further interest charges.
It should be noted that the issue of § 58-151.083 adjustments for DISC income is presently before the Circuit Court of the City of Richmond, Division I, in the case styled General Electric Company v. Commonwealth of Virginia. You may wish to preserve your judicial remedies pending final decision in the General Electric case by filing a protective claim under § 58-1119.1 limited to the DISC issue.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner