Document Number
86-128
Tax Type
Individual Income Tax
Description
Foreign Source Income
Topic
Taxable Income
Date Issued
07-11-1986
July 11, 1986


Re: Virginia Code §58.1-1821 Application
Individual Income Tax

Dear ****************

This is in response to your letters in which you make application, on behalf of your clients, for the correction of individual income tax assessments issued by the Department of Taxation for taxable years 1981, 1982 and 1983. Because the same central issue is involved in each of the separate applications that you submitted, this determination will be applicable to all of the above taxpayers. Any differences, unique to a particular individual, will be addressed in the appendices to this determination.
FACTS

During the years in question, the taxpayers as partners, received income from *********** (Partnership). Part of the income allocated to the taxpayers by Partnership was derived from foreign countries (Allocated Foreign Income) This income from foreign countries consisted of four different categories of income:
    • 1. Income from investments in foreign partnerships
      2. Fees earned outside of the United States
      3. Foreign interest and dividends
      4. Foreign royalties (for use of Partnership's name)
On the basis of their interpretation of Virginia Code §58.1-322 C 7, the taxpayers excluded all of this Allocated Foreign Income when computing their Virginia Taxable Income for the taxable years in question. This section allows a subtraction from federal adjusted gross income for foreign source income as defined in Virginia Code §58.1-302 in computing Virginia Taxable Income.

Virginia Code §58.1-322 C 7, provides a subtraction from federal adjusted gross income in computing Virginia Taxable Income for "any amount included therein which is foreign source income as defined in §58.1-302." Virginia Code §58.1-302 defines foreign source income as:
    • 1. Interest, other than interest derived from sources within the United States;
      2. Dividends, other than dividends derived from sources within the United States;
      3. Rents, royalties, license, and technical fees from property located or services performed without the United States or from any interest in such property, including rents, royalties or fees for the use of or the privilege of using without the United States any patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like properties; and
      4. Gains, profits, or other income from the sale of intangible or real property located without the United States.
      In determining the source of "foreign source income," the provisions of §§861, 862, and 863 of the Internal Revenue Code shall be applied.
During a subsequent examination of the taxpayers' returns, the Department of Taxation disallowed a portion of this subtraction. The department allowed the portion of the subtraction that relates to categories 3 and 4 of the Allocated Foreign Income. Those two categories of foreign source income (foreign interest and dividends and foreign royalties for the use of Partnership's name) are clearly included in the definition of foreign source income as defined under Virginia Code §58.1-302. What is contested is the income in the remaining two categories of Allocated Foreign Income These two categories of Allocated Foreign Income consist of: (1) Income from investments in foreign partnerships and (2) Fees earned outside of the United States. It is the assessments that arose from the disallowance of this portion of the subtraction that you protest on behalf of your clients.

Income from investments in foreign partnerships represents income resulting from investments made by Partnership in foreign accounting firms. These firms provide accounting services for a fee and net profit realized is allocated to the partners, including the partnership in which your clients are partners. Fees earned outside of the United States represents fees received by the partnership for accounting services it provides in foreign countries. You contend that these two categories of Allocated Foreign Income are properly subtracted under the definition of foreign source income provided under Virginia Code §58. 1-302.

Your position is based upon the language in Virginia Code §58. 1-302 which defines foreign source income to include, "technical fees from property located or services performed without the United States."
Determination

In your application for correction, you contend that since there is no statutory definition of the phrase "technical fees", that the rule of construction set forth by the Virginia Supreme Court in Orange v Department of Taxation, 220 Va., 655 (1980) is applicable The court stated that:

In the absence of a statutory definition, as here, a statutory term is given its ordinary meaning, given the context in which it is used.

You cite the definition of "technical" contained in Webster's New World Dictionary (1976); furthermore, you deduce that accounting is a "technical profession. You then contend that since accounting is a "technical" profession, the fees received must be "technical fees".

We agree that there is no "statutory definition" in the Code of Virginia for the phrase "technical fees"; however, we must point out that this particular phrase is defined by regulation in the Virginia Individual Income Tax Regulations. To understand our regulation, a review of the legislative history surrounding the passage of the legislation that enacted the foreign source income subtraction (1981 Acts of Assembly, Chapter 402, Senate Bill 641) must be undertaken to reveal its purpose.

As stated in the department's impact statement prepared at the request of the Secretary of Finance during the time that the bill was under consideration by the 1981 session of the General Assembly, its purpose was to react to the Supreme Court's decision in Commonwealth of Virginia v Champion International Corp., 220 Va 981 (1981). In drafting the foreign source income portion of Senate Bill 641, its authors relied heavily upon the intent and language of §358 of the Mathias bill (Senate Bill 983), then under consideration by the 96th Congress. Mathias bill was intended to deal entirely with corporations in interstate commerce and with the problems associated with allocation and apportionment of income from intangibles and real estate was the target of both §358 of the Mathias bill and the foreign source income subtraction contained in Senate Bill 641. In fact, the types of income classified as foreign source income are identical in both the Mathias bill and in Senate Bill 641.

The logic behind the Virginia foreign source income subtraction was to allow a subtraction for the classes of income that were allocated under prior corporate law As a general rule, income arising from real estate and intangible property was allocated to foreign countries and not subject to tax by Virginia. Since Senate Bill 641 removed all types of income (except dividends) from the definition of allocable income, an apportioned amount of this income would have become taxable in Virginia without a subtraction for income from foreign sources.

The department could not ignore the intent of the General Assembly in interpreting this section of the Code for the purpose of issuing a regulation. The legislature clearly did not intend to exempt all types of foreign source income from taxation in Virginia. Had it been the intent to exempt all types of foreign source income from taxation in Virginia, for both corporations and individuals, there would have been no need to modify the language in IRC §862, which both the Mathias bill and Senate Bill 641 modified. The provisions of IRC §862, which both our statute and the Mathias bill look to, only to determine the source of different types of income also addresses the treatment of "compensation for labor or personal services performed without the United States." The fact that the legislature did not specifically exempt this type of income cannot be ignored.

Keeping this legislative intent in mind, the Virginia Individual Income Tax Regulations, which were adopted in accordance with the requirements set forth under the Administrative Process Act, sufficiently defines the term "technical fees" and is not unreasonable or plainly inconsistent with the applicable provisions of the law. Section 630-2-302 defines foreign source income and more specifically "technical fees" in the following manner:
    • 1. Generally. As used in these regulations, the term "foreign source income" means income as defined in subsection (2) below. Foreign source income does not include all income from sources outside of the United States, but limited to the types of income enumerated below, and is further limited by the federal definitions in IRC §§861 through 864 and the regulations thereunder in determining the source of a particular item of income
      2. "Foreign source income" defined "Foreign source income is limited to the items enumerated in (a) through (d) below.
      a. Interest. Interest means that derived from sources outside of the United States, subject to the limitations of IRC §§861 through 864.
      b. Dividends. Dividends means those derived from sources outside of the United States, subject to the limitations of IRC §§861 through 864.
      c. Rents, royalties, license and technical fees. Rents, royalties, license and technical fees mean those derived from property located outside of the United States or derived from services performed outside of the U. S. The term "technical fees" shall not include wages salaries, compensation or other "earned income" as defined in IRC §911 (b). Fees for the use outside the U. S. of patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties constitute "license and technical fees.
      d. Gains means those gains and other income derived from the sale of intangible or real property located outside of the United States (Emphasis added.)
IRC §911(b), to which our individual regulation refers to define earned income in the definition of what does not constitute a "technical fee", defines earned income as:

1. Wages
    • 2. Salaries
      3. Professional fees
      4. Other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered.
In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, under regulations prescribed by the Secretary, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income.

Therefore, tho Virginia Individual Income Tax Regulations exclude the following items from "technical fees" and accordingly these same items shall not be allowed as a subtraction as foreign source income:
    • 1. Wages
      2. Salaries
      3. Compensation
      4. Professional fees
      5. Other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered.
In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, under regulations prescribed by the Secretary, a reasonable allowance as compensation for the personal services rendered by tho taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered earned income.

Treasury Reg. §1. 1348 details the fourth and fifth categories above for purposes of the maximum tax on personal service income From the discussion in Treasury Reg §1. 1348 it is clear that as far as accounting firms are concerned; (1) the income received from an accounting firm is considered personal service income; therefore, earned income and (2) there is no need to allocate between personal service income and capital because the practice of accounting "will not as such be treated as a trade or business in which capital is a material income-producing factor. "

Since under the provisions of Virginia Code §58. 1-391 B the character of the income to the partner is the same as it is to the partnership, the income received by the individual partners, to the extent that it is classified as earned income for federal income tax purposes, would not be eligible for the foreign source income subtraction. Therefore, the foreign source income subtraction would only be applicable partially in situations in which the business income would be from a business in which both personal services and capital are income producing factors. In these cases the 30 percent (maximum) of the business income that is considered earned income would not qualify for the subtraction. Only the 70 percent (minimum) that represents income from income-producing capital and is considered unearned, would qualify for the subtraction.

Based upon the information you presented and upon the above discussion, we must reject your applications for correction to the extent that you contest the department's assessments that resulted from the disallowance of the subtraction for income from investments in foreign partnerships and for fees earned outside of the United States.

Please see the attached appendices for any adjustments necessary because of the differences that may be unique to a particular individual that you represent.

Sincerely,



W. H. Forst
Tax Commissioner

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46