Tax Type
Corporation Income Tax
Description
Consolidation of taxpayer and DISC.
Topic
Accounting Periods and Methods
Corporate Distributions and Adjustments
Date Issued
07-23-1982
July 23, 1982
Re: Application For Correction of
Corporation Income Tax Assessments
For the Years 1976 and 1977
Dear *****:
This is in reply to your letter of December 31, 1980, in which you applied pursuant to §58-1118 of the Code of Virginia for relief from corporation income taxes assessed for the years 1976 and 1977.
In my letter to you dated January 8, 1981, I informed you that I would discuss the matter in question with my staff and advise you accordingly. As a result of that discussion, I have come to the conclusion below.
You seek relief only in regard to the department's treatment of DISC income, an issue presently in litigation before the Circuit Court of the City of Richmond in the case of the General Electric Company v. Commonwealth of Virginia. You requested a hearing, but postponed that request unless there were questions that we needed to discuss and requested I proceed with a determination on the information submitted. This determination has been rendered without a conference with Taxpayer. If a conference is desired you must request one within 30 days.
FACTS
Taxpayer owns a subsidiary which is a Domestic International Sales Corporation (DISC) qualified under §991 et. seq. of the Internal Revenue Code. DISC is a separate operating company with substantial property, payroll, activity and identity of its own. DISC purchases goods from Taxpayer and other subsidiaries of Taxpayer and resells them abroad. DISC does not do business in Virginia.
Taxpayer is subject to tax in Virginia. After audit of its returns for calendar years 1976 and 1977 the Department of Taxation invoked §58-151.083 to equitably adjust the tax of taxpayer based upon consolidation of taxpayer and DISC.
DISC filed federal form 1120-DISC for 1976 and 1977 in which it used the § 482 method of pricing to determine DISC's taxable income. Taxpayer and the I.R.S. have agreed on a formula for determining the transfer price for purposes of the § 482 pricing method.
All transactions between Taxpayer and DISC were subject to § 482 market pricing rules except:
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- 1. Engineering services performed by taxpayer for foreign subsidiaries and billed at cost through DISC.
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- 2. Sales to one entity made at market price, the profit divided 50/50 between Taxpayer and DISC.
The sales not subject to § 482 pricing are a small portion of DISC's sales.
DETERMINATION
Historically virtually all Domestic International Sales Corporations encountered by the Department have been "paper" corporations using either the 4% or 50/50 pricing method. The pricing method used to determine the income of such corporations bears no relationship to the business done by such corporations. While this is a permissible method of deferring federal taxes on certain income, the effect is to artificially shift income to a "paper" corporation, convert the income from apportionable income to allocable dividends and permanently remove the income from Virginia taxable income.
When all transactions between affiliates are subject to § 482 I.R.C., the income of each affiliate should reasonably reflect the business done by that affiliate. Therefore the income from Virginia sources of those affiliates subject to Virginia income tax will, reasonably reflect the income from Virginia sources of the entire affiliated group and no adjustments are necessary.
Although not all of the transactions between Taxpayer and DISC were subject to § 482 market pricing rules, substantially all of them were.
After consideration of all of the facts and circumstances, I conclude that an equitable adjustment to Taxpayer's tax is necessary under §58-151.083. However the adjustment should not be based upon consolidation of Taxpayer and DISC. In this case I conclude that the appropriate remedy is to equitably adjust Taxpayer's tax as if all transactions between Taxpayer and DISC had been subject to § 482. This requires the following information and adjustments.
1. Engineering Services. These services were rendered at "cost" and Taxpayer asserts that no gain or less was realized by Taxpayer or DISC. However the property and payroll utilized to provide these services is included in the apportionment factors of Taxpayer, yet no income or profit from the rendering of these services is included in Taxpayer's Virginia taxable income. If the § 482 method is applied to these services the transfer price must be at least 15% higher to allow for overhead and profit.
Accordingly Taxpayer's Virginia Taxable income must be increased by 15% of the "cost" billed to or through DISC for engineering services.
2. Certain Sales. Certain sales were made direct from Taxpayer to a partnership in which Taxpayer is a partner. The transfer price was the fair market value. The profit on these sales was arbitrarily divided between Taxpayer and DISC using the 50/50 pricing method even though DISC did not actively participate in the sales.
If the § 482 method is applied to these sales none of the profit can be attributed to DISC. Accordingly Taxpayer's Virginia taxable income must be increased by the amount of profit on these sales attributed to DISC.
It should be noted that it may also be necessary to adjust the sales factor to the extent these amounts were not included in gross receipts.
Upon Taxpayer furnishing the information required the assessments will be adjusted in accordance with this determination.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner