Tax Type
Corporation Income Tax
Description
Foreign source income
Topic
Computation of Income
Subtractions and Exclusions
Date Issued
08-14-1986
August 14, 1986
Re: §58.1-1821 Application; Corporation Income Tax
§58.1-302 Foreign Source Income
Dear ********************
This is in response to your letter of November 19, 1984, applying for correction of an assessment of tax after a field audit. In this application the taxpayer protests a number of adjustments for taxable years 1981 and 1982 which relate to the subtraction for foreign source income under §58-151.013(c)(9) recently recodified as §§58.1-302 and 58.1-402 C. 8. This application, and others like it, prompted a lengthy review of the department's regulations and policies regarding the Virginia subtraction for foreign source income for individuals and corporations.
Issue
Whether the subtraction for foreign source income is computed by reducing gross income from sources without the United States by the expenses in accordance with federal law and regulations.
Determination
The taxpayer claims that the Virginia subtraction for foreign source income is the amount of gross income which is treated as received from without the United States under federal law. The taxpayer relies on the fact that the language in §58.1-302 Va. Code closely parallels the definition of gross income in §862(a) I.R.C. and that §58.1-301 Va. Code states that terms in the Virginia law shall have the same meaning as in the federal law when used in a comparable context.
Section 58.1-302 is merely a definitional section. The provision of the Virginia Code which actually allows the subtraction for foreign source income is found in §58.1-402 C. That subsection states:
-
- C. There shall be subtracted to the extent included in and not otherwise subtracted from federal taxable income:
-
- 8. Any amount included therein which is foreign source income as defined in §58.1-302." Va. Code §58.1-402 (emphasis added.)
- 8. Any amount included therein which is foreign source income as defined in §58.1-302." Va. Code §58.1-402 (emphasis added.)
In addition, Virginia Regulation §630-3-302, "Foreign Source Income," explicitly states that the subtraction is computed by following the federal procedure for assigning related expenses to gross income from sources without the United States.
The provisions of §§861, 862 and 863 I.R.C. contain elaborate detail on assigning income and expense to particular sources. The provisions differentiate between expenses which are definitely allocable and expenses which are not definitely allocable. The latter, such as legal and accounting fees of the taxpayer, are apportioned to items of income on the basis of a percentage of the taxpayer's total receipts.
Because §58.1-302 explicitly requires the use of the federal provisions in determining the source of "foreign source income" these provisions are used to determine both the gross income and the expenses included in federal taxable income when computing the Virginia subtraction. Thus gross income from sources without the United States must be reduced by definitely allocable expenses and by expenses not definitely allocable, all of which must be computed in the same manner as under federal law.
There are two exceptions to this rule. Virginia law contains separate subtractions for foreign dividend gross up and Sub-part F income, both of which are also included in the federal definitions of income from without the United States. The taxpayer, of course, may not take two subtractions for the same item. Because these items are not actually received by the taxpayer but merely deemed to have been received under federal law, there are generally no expenses directly related to the items. Therefore as a separate subtraction under Virginia law there would be no offsetting expense. By enacting the foreign source income subtraction in addition to the separate subtractions for foreign dividend gross up and sub-part F income the General Assembly did not intend to limit or reduce the separate subtractions. Therefore these two items and their apportioned share of expenses not definitely allocable are ignored in computing the Virginia subtraction for foreign source income.
I.R.S. Form 1118
Many taxpayers who claim a Virginia subtraction for foreign source income will also have claimed a federal credit for income taxes paid to foreign countries. Thus federal form 1118 is often used as a starting point for computing the Virginia subtraction.
Virginia law does not follow federal law in all respects regarding income from sources without the United States. Thus form 1118 may only be used as a starting point for the Virginia subtraction. Federal form 1118 includes many types of income which do not qualify for the Virginia subtraction.
For example, gains, profit and other income arising from the sale of tangible personal property are not included in the list of specified types of income qualifying for the Virginia subtraction. As already noted, foreign dividend gross up and Sub-part F income are not included in computing the Virginia subtraction for foreign source income. Also, amounts reported on form 1118 may be affected by limitations contained in §904 I.R.C. while the Virginia subtraction is computed without regard to such limitations.
§863(b) Income
The taxpayer included in its computation of foreign source income the §863(b) income shown on form 1118. The auditor adjusted the subtraction for the taxes paid with respect to such income. However, §863(b) income is not one of the types of income specified in §58.1-302 Va. Code. Therefore both the income and all expenses associated with the income should have been removed from the foreign source income subtraction.
DISC Dividends
Dividends received from a Domestic International Sales Corporation (DISC) were included in the taxpayer's federal form 1118 and expenses related to the DISC dividends were included in the auditor's adjustment. However, the auditor also made an adjustment under §58.1-446 based on consolidation of the DISC with the taxpayer. Accordingly both the DISC dividends and the expenses should have been removed from the foreign source income subtraction.
Conclusion
Accordingly, I find that the Virginia subtraction for foreign source income must be reduced by expenses allowable in computing federal taxable income and that the source of both the gross income and such expenses shall be determined under the provisions of §§861, 862 and 863 I.R.C.
You will shortly receive a revised audit report reflecting any corrections required to conform the audit to the principles set forth in this letter and a bill including interest to date. In order to prevent the accrual of any further interest the revised bill should be paid within 30 days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner