Tax Type
Corporation Income Tax
Description
Financial corporation apportionment factor
Topic
Allocation and Apportionment
Date Issued
06-26-1987
June 26, 1987
Re: Request for Ruling; Corporation Income Tax
§58.1-418 Financial Corporation; Costs of Performance
Dear *********************
This is in response to your letter of January 5, 1987, in which you request a ruling on whether certain items would be considered costs of performance for purposes of the financial corporation apportionment factor and, if so, whether they would be located in Virginia. These questions were also the subject of a conference held with members of the Tax Policy Division on December 11. 1986.
Facts
The taxpayer is a financial corporation with its only office in Virginia. It is contemplating a corporate reorganization in which an affiliated corporation would be created to perform many of the functions now performed by the financial corporation. The service corporation would remain in Virginia, but the financial corporation would move its only office to another state. The financial corporation would make decisions about assuming credit risks, but virtually all other functions would be performed by the service corporation under a contractual arrangement. You have requested a ruling on the treatment of four types of expenses incurred by the financial corporation.
Credit Committee
A credit committee would be created by the board of directors to establish credit lines with unrelated banks, to establish operational guidelines, to review and authorize the execution of contracts over specified dollar limits, and to direct the employees in the day to day operations of the financial corporation. The committee would be composed of employees of affiliated corporations and outside personnel. Some of the members would be residents of Virginia.
The credit committee would meet at least quarterly in the office of the financial corporation outside of Virginia. The members would be compensated for attending meetings and for travel expenses.
The compensation and travel expense would be considered a cost of performance which is not located in Virginia provided that the direction of day to day operations is not directly supervised by individuals in their capacity as members of the credit committee. The credit committee may establish operational guidelines and general policy, but the direct supervision of day to day operations is a function of the chief executive officer or other designated employee of the finance corporation.
Office
The only office of the financial corporation would be located outside of Virginia. Employees at the office would consist of an officer of the corporation authorized to execute contracts, a secretary, and other supporting staff as needed. All compensation paid to employees located in the office, rent, utilities, supplies and similar expenses would be considered costs of performance not located in Virginia.
Functions Unrelated to Risk Assumption
All functions which are unrelated to risk assumption would be performed by the services corporation under contract. These functions include, but are not limited to:
-
- _ Accounting and servicing accounts.
_ Collection.
_ Treasury services related to negotiating, but not executing, favorable bank borrowing lines of credit. (The method of compensation is not specified.)
_ Brokerage operations related to negotiating, but not executing, loan contracts meeting criteria established by the credit committee. Compensation would be based on a fee for accepted contracts.
- _ Accounting and servicing accounts.
In general, if the contractual relationship, pricing and conduct between affiliated corporations is similar to what would exist between unrelated parties, the affiliated corporations will be treated as independent contractors and payments will be excluded from costs of performance. On the other hand, if the taxpayer exercises sufficient control over the manner in which the contracted function is performed, then the affiliated corporation will not be independent and the payments to the affiliated corporation will be included in costs of performance. In addition, if the payments are not reasonably related to the arm's length price for the services rendered then there may be grounds for finding that an arrangement exists which would be subject to an equitable adjustment of the tax under §58.1-446.
The issue in your examples is whether the services corporation is, in fact, an independent contractor when performing various functions for the financial corporation. The independence of the services corporation is questionable because the two corporations share employees, particularly the president of the financial corporation. In the scenario presented, the functions performed by the services corporation would be performed or supervised by persons who are also employees of the financial corporation. The department presumes that every decision made by a person employed by both corporations would be affected by that person's responsibilities to both employers. This element of shared employees actually performing the contracted services was not present in the facts on which the previous ruling was based.
Therefore the services corporation will not be considered an independent contractor when the contracted services are performed or supervised by individuals who are also employees of the financial corporation.
The President
The president of the financial corporation would be an officer of the services corporation and would spend most of his time in the Virginia office of the services corporation. You state that all of the services that he performs for the financial corporation will be performed in the financial corporation's office outside of Virginia and that this will be documented with a log maintained by the president. You request a ruling that the salary paid by the financial corporation to the president would be treated as a cost of performance not located in Virginia.
Normally, the location of employee wages is established by the same criteria applied to determining the location for the payroll factor in the three factor formula. However, in the proposed situation it appears that virtually all of the president's time would be devoted to performing functions for the financial corporation, either directly as president or indirectly as an officer of the services corporation under contract to the financial corporation.
We cannot accept your statement that the president and chief executive officer of the financial corporation would act as such only in the office of the financial corporation. In his capacity as an officer of the services corporation he will be performing services for the financial corporation. Therefore, we presume that when acting as an officer of the services corporation he will also consider his responsibilities to the financial corporation.
In the facts presented it appears that the president will spend the majority of his working hours in Virginia performing functions directly or indirectly for the financial corporation. Accordingly the salary and other compensation paid to the president would be considered a cost of performance incurred in Virginia for purposes of the financial corporation apportionment factor.
You state that at some time in the future it is anticipated that the president will cease working for the services corporation and work full time for the financial corporation. When that occurs the salary paid to the president will be considered a cost of performance located in whichever state he spends the majority of his working hours.
Conclusion
The opinions expressed in this letter are based on the facts as presented. If, on audit, it is discovered that the facts vary significantly then a different result may be reached.
If you feel that there are additional facts relevant to these issues which were not brought out in your letter of January 5, 1987, or in the conference with members of the Tax Policy Division, I would be willing to arrange a conference to discuss the facts and this ruling.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner