Tax Type
Corporation Income Tax
Description
DISC income;Employee stock ownership plan; Safe harbor lease income
Topic
Subtractions and Exclusions
Taxable Income
Date Issued
02-27-1987
February 27, 1987
Dear ************************
This is in response to your letter of December 6, 1984, applying for correction of assessments dated September 13, 1984, for the taxable years 1981 and 1982 and to your letter of November 24, 1986, applying for correction of assessments dated September 3, 1986, for the taxable years 1983 and 1984. The original of the December 6, 1984, letter was apparently not received by the department. Because the issues involved in both applications are similar they will be resolved together.
Domestic International Sales Corporation
You object to the adjustment made under §58.1-446 (formerly §58-151.083) to include the income of a Domestic International Sales Corporation (DISC). You claim that there is no justification for applying this policy to a "commission" DISC.
When the taxpayer sold merchandise to a third party, it was able to deduct a "commission" to the DISC even though the DISC took no part in the sale. This distorts Virginia taxable income by shifting some of the taxpayer's income from the sale to another corporation in a transaction not subject to the transfer pricing rules of I.R.C. §482. If the DISC is subject to Virginia income tax, the apportionment factors will be different. When the DISC's income is returned to the parent it will be in the form of allocable dividends instead of apportionable income.
Accordingly, the adjustment for the DISC income is correct. This issue is presently in litigation. I suggest that you pay the assessment and file a protective claim for refund under
§58.1-1824 within three years from September 13, 1984 (1981 & 1982) and September 3, 1986 (1983 & 1984). Your claim will be held without action until a final decision is rendered in the case currently before the Virginia Supreme Court styled Commonwealth of Virginia v. General Electric.
Foreign Source Expenses
You object to the audit adjustment which reduced the subtraction for foreign source income by the expenses related to such income. Virginia has never allowed the subtraction or allocation of gross income. All of the subtractions in the law are prefaced by the language "There shall be subtracted to the extent included in and not otherwise subtracted from federal taxable income." (§58.1-402 C. Emphasis supplied. Comparable language is included in §58.1-322 and former §§58-151.013 and 58-151.032.)
Since the law requires that I.R.C. §§861-863 be used to determine the source of the income it is also used to determine the source of the expenses. Enclosed is a copy of a recent ruling dated September 14, 1986, P.D. No. 86-154, in which this issue is reviewed in detail.
Foreign Source Income
You also object to the audit adjustment which excluded certain items from the foreign source income subtraction. These items are: (1) fees charged to subsidiaries for technical and support services performed outside the U. S. and, (2) income from foreign exchange gain related to royalty income.
The department has previously ruled that the reference to technical fees in the definition of foreign source income refers to fees related to a contract producing rent or royalty income. Enclosed is a copy of the ruling dated November 3, 1986, P. D. No. 86-209.
Although the foreign exchange gain may be related to the royalty income, it is not characterized as royalty income under federal law or under the Virginia definition of foreign source income. Terms are required to have the same meaning for Virginia purposes as under federal law. §58.1-301.
Accordingly, the subsidiary fees and foreign exchange gain were properly excluded from the subtraction for foreign source income.
Employee Stock ownership Plan
You claim that the taxpayer should be allowed a deduction for contributions to an Employee Stock ownership Plan (ESOP) which were not deducted in the federal return because a credit was allowed. They were not subtracted in the Virginia returns for 1981 and 1982 nor were they allowed in the audit.
Although the subtractions are allowable, and the department would revise the audit to allow them, the copies of the federal returns do not contain any reference to ESOP contributions or credits in Schedule M-1 adjustments or elsewhere in the returns.
Accordingly, the subtractions will not be allowed at this time. You may, however, submit appropriate documentation to **************** Supervisor, Technical Services Section, Office Services Division, Department of Taxation, P. O. Box 6-L, Richmond, VA 23282, and the audit will be revised accordingly.
Safe Harbor Lease Income
In both audits certain rental income from safe harbor leases was included in apportionable income. However, in the second audit for 1983 and 1984 this income was removed from the sales factor for apportionment purposes. The income should have been included in the sales factor and the audit report will be revised accordingly.
Determination
You will shortly receive a revised audit report for 1983 and 1984 and updated bills for all four taxable years which should be paid within thirty days to avoid the accrual of additional interest. If you have any questions about the revisions to either audit report they should be addressed to the Technical Services Section.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner