Tax Type
Corporation Income Tax
Description
Foreign source income
Topic
Computation of Income
Date Issued
01-14-1988
January 14, 1988
Re: §58.1-1821 Application; Corporation Income Tax
§58.1-402 Foreign Source Income
Dear*****************
This is in response to your letter of July 14, 1987, in which you applied for correction of an assessment of corporation income tax for the taxable years 1983, 1984 and 1985.
Facts
The taxpayer claimed a subtraction for foreign source income which included income which is classified as income from without the United States under I.R.C. §863(b). The auditor adjusted the foreign source income subtraction by removing the 863(b) income and applying the expenses related to the remaining foreign source income. A number of other adjustments were made which are not in dispute.I.R.C. 863(b) Income
You protest the removal of 863(b) income on the grounds that the definition of foreign source income provides that the federal sourcing rules, I.R.C. §861-863, shall be used to determine the source of the income and 863(b) income qualifies as income from without the United States under federal sourcing rules.
Virginia's subtraction for foreign source income does not apply to all income from without the United States under the federal sourcing rules. only specified types of income (interest, dividends, etc.) qualify. The federal sourcing rules are applied to determine if the source of each item of the specified types of income is "foreign."
The income in question, 863(b) income, is not one of the qualifying types of income under Virginia's definition of foreign source income. The Internal Revenue Code defines 863(b) income as other income which is from sources partly within and partly without the United States. It includes, for example, income from goods manufactured in the United States and exported. The income in question is included in Virginia taxable income and apportioned based on the property, payroll and sales factors. The apportionment factors will reflect any foreign property, payroll, or sales connected with 863(b) income.
Therefore the auditor properly excluded 863(b) income from the subtraction for foreign source income.
Expenses
All subtractions are allowable only to the extent that they are included in federal taxable income and are net of related expenses. This applies to the subtractions for I.R.C. §78 dividend gross up and subpart F income. However, these two subtractions are separate from the subtraction for foreign source income even though they are treated as dividends from without the United States under federal sourcing rules.
Dividend gross up and subpart F income may only be subtracted once even though they also qualify for the foreign source income subtraction. The difference is that the federal sourcing rules must be used to determine the related expenses for the foreign source income subtraction while generally accepted accounting principles determine the expenses related to dividend gross up and subpart F income. In most cases there will be no related expenses because dividend gross up is not income actually received but merely deemed to be received for purposes of computing the federal foreign tax credit, and subpart F income is the net income of certain subsidiaries.
The auditor used the expenses shown on federal form 1118 as the starting point for computing the expenses related to the subtraction for foreign source income. Expenses which are definitely allocable to a type of income qualifying for the Virginia subtraction for foreign source income should be allocated to such income. Expenses which are not definitely allocable to any class of income must be computed by means of a ratio.
In computing the expenses not definitely allocable to any class of income for purposes of federal form 1118 the taxpayer is required to include dividend gross up and subpart F income in the ratios which increases the amount of expenses. When starting with this figure to compute the expenses related to Virginia's foreign source income subtraction, an adjustment must be made to exclude expenses attributable to dividend gross up and subpart F income. It appears that this was not done by the auditor.
Determination
Accordingly, the assessment will be revised to adjust the expenses related to Virginia's foreign source income subtraction. You will shortly receive an updated bill with interest accrued to date. The bill should be paid within thirty days to avoid the accrual of additional interest.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner