Tax Type
Corporation Income Tax
Description
Apportionment of Income of Financial Corporations;Rental Income and Costs of Performance
Topic
Allocation and Apportionment
Date Issued
12-23-1986
December 23, 1985
Dear *************
This is in response to your letters of November 11, 1985 and December 11, 1985 requesting a ruling on the treatment of certain types of income and expense for purposes of § 58.1-418. That section defines a financial corporation as one which receives 70% or more of its gross income from specified types of income and requires a financial corporation to apportion its income according to costs of performance.
FACTS
The taxpayer receives a substantial portion of its income in the form of interest. As a result, the treatment of certain rental income for purposes of the 70% test in § 58.1-418 will determine whether the taxpayer is a financial corporation required to use the single "costs of performance' apportionment factor or a regular corporation required to use the three factor apportionment formula.
The property owned by the taxpayer is depreciated in accordance with I.R.C. § 168 and ACRS adjustments are made for Virginia tax purposes under Regulation § 630-3-323. The taxpayer requests a ruling as to whether the ACRS depreciation and Virginia modification are considered to be "costs of performance' under Va. Code § 58.1-418.
The taxpayer contracts with its parent and other corporations for certain necessary services including tax advice, tax return preparation, and legal advice relative to contracts. Services performed are conducted at arms-length pricing consistent with I.R.C. § 482. The taxpayer requests a ruling as to whether amounts paid for these services are considered to be "costs of performance.'
DETERMINATION
Operating leases.
The taxpayer receives income from the rental of property to affiliated corporations and states that: "This lease is a true operating lease and is treated as such for federal income tax purposes as well as for financial statements . . .'
The federal law, regulations, Revenue Rulings and Revenue Procedures contain a number of conditions which a lease transaction must satisfy to be treated as a lease for federal income tax purposes. If a lease satisfies these conditions, and is treated as a lease for federal income tax purposes, then the rental income received by the taxpayer will not be treated as fees, commissions, or other compensation for financial services for purposes of the 70% test in § 58.1-418.
Safe harbor lease.
The taxpayer receives income from a number of transactions for which it has elected safe harbor lease treatment under § 168(f)(8) I.R.C. Because this income is treated as rental income for federal purposes it will not be treated as income from fees, commissions, or other compensation for financial services for purposes of the 70% test in § 58.1-418.
In a letter dated June 25, 1982, (which may be found at paragraph 200-762 of the CCH Virginia Tax Reports) the department stated that rental income received from safe harbor leases would be treated in the same manner as for federal income tax purposes. Thus the income would be included in the sales factor and the cost of the leased property would be included in the property factor based on the location of the property leased.
Costs of performance.
The taxpayer requests a ruling on whether the apportionment of its income depends on the location where the leasing contract is executed or on the location of the costs of performance for each taxable year in which income is received.
Both the financial corporation apportionment factor and the inclusion of intangible income in the sales factor depend on the costs of performance related to the income for the taxable year. Thus, if the corporation moves some of its operations into or out of Virginia after a lease is executed, the inclusion of the rental income in the financial corporation apportionment factor would depend on the location of the costs of performance for the taxable year in which the rental income is received. The place where the lease is executed is relevant only to the costs of performance for the year in which the lease is executed.
The taxpayer will still be subject to Virginia Income tax even if it moves its entire operation out of Virginia as long as any property which it owns is located in Virginia, even though the property may be leased to others. In the case of a three factor corporation the cost of the property would be included in the property factor. In the case of a financial corporation any maintenance or other expenses incurred for property located in Virginia would be included in the costs of performance.
Depreciation expense.
The term "costs of performance' means all costs directly related to income producing activity, to the extent that the location of the costs can be ascertained. Regulation § 630-3-418 states that the location of a cost is the place where property or employees are located.
Depreciation is a cost directly associated with the ownership of property. Both tax law and generally accepted accounting principles require the recognition of depreciation expense over the life of an asset. Therefore depreciation expense is included in costs of performance based on the location of the property.
Although the Virginia ACRS modification is directly related to the federal ACRS depreciation deduction, it is not considered a direct expense. One of the purposes for the manner in which the ACRS modification is made is to avoid the necessity of preparing separate depreciation schedules and basis adjustments for Virginia income tax purposes. Therefore the Virginia ACRS modification is not included in costs of performance.
Independent contractors.
Regulation § 630-3-418 states that services performed by independent contractors are not included in costs of performance. Although the parent is not truly independent, the contract pricing is consistent with the arms-length standard of IRC § 482.
To the extent that the services are performed by unrelated parties or by affiliated corporations under IRC § 482 pricing standards, the costs for such services are not included in costs of performance.
Rulings of the Tax Commissioner