Tax Type
Corporation Income Tax
Description
Sales factor; Interest income; Assessment and payment of deficiency
Topic
Allocation and Apportionment
Collection of Tax
Date Issued
08-15-1991
August 15, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear*****************
This will reply to your letter of December 10, 1990, in which you seek correction of corporation income tax assessments for***************(the "Taxpayer").
FACTS
The taxpayer filed its federal and Virginia corporation income tax returns on a consolidated basis. The returns were audited and numerous adjustments were made, resulting in the assessment of additional tax.
The issues you raise will be addressed separately.
DETERMINATION
Sales factor: The auditor removed all interest income from the denominator of the sales factor for FY 89, on the grounds that all the interest was foreign source income. You contend that only a portion of the interest should have been removed from the sales factor.
The term "sales" means all gross receipts of the corporation except dividends allocated under Va. Code §58.1-407. "Sales" (gross receipts) are included in the sales factor if they are included in Virginia taxable income and are connected with the conduct of the taxpayer's trade or business within the United States. Interest subtracted from federal taxable income as foreign source income under Va. Code §58.1-302 C.8. is excluded from Virginia taxable income and, therefore, is not included in the sales factor.
A review of the taxpayer's federal Form 1120 (U.S. Corporation Income Tax Return) and federal Form 1118 (Computation of Foreign Tax Credit) reveals that foreign source interest constitutes only a portion of the total interest reported on line 5. Consequently, there is some interest sourced within the United States which is included in Virginia taxable income and is connected with the taxpayer's trade or business within the United States. This interest should be included in the sales factor.
The audit report will be revised and the sales factor will be recalculated to include interest included in Virginia taxable income.
ACRS addition: For FY 87, the taxpayer calculated an ACRS addition in accordance with Va. Code §58.1-323. The auditor increased the amount of the addition to include depreciation computed under the Modified Accelerated Cost Recovery System (MACRS).
Va. Code §58.1-323 (repealed effective for taxable years beginning on and after January 1, 1988) required taxpayers to add back 30% of the total deduction claimed for federal income tax purposes under the Accelerated Cost Recovery System for taxable years prior to January 1, 1988. The taxpayer's computation failed to include amounts of depreciation calculated under MACRS and reported on federal Form 4562-A. These amounts are required to be included in the depreciation modification, as MACRS is part of the Accelerated Cost Recovery System. The auditor correctly increased the ACRS addition to include 30% of the depreciation calculated under MACRS.
Addition to Virginia taxable income - Taxes: on its FY 87 and FY 89 returns, the taxpayer increased its Virginia taxable income by net income taxes deducted on its federal return. The auditor increased the income by adding back additional taxes deducted on the federal return. You claim that these taxes should not have been added back because they were not based on net income; furthermore, you assert that the original addition should be reduced.
Va. Code §58.1-402 B.4. provides that any net income taxes or other taxes which are based on, measured by, or computed with reference to net income, imposed by Virginia or any other taxing jurisdiction, and deducted in determining federal taxable income shall be added to Virginia taxable income.
For FY 87 and FY 89, the auditor reconciled to amounts reported as state and local income taxes on the supporting schedule for taxes deducted on the federal return. For FY 87, you contend that a portion of the amount reported as state and local income taxes represents interest expense from a tax assessment and should not be included in the addback for state and local income taxes. For FY 89, you claim an adjustment to the state and local income tax figure is necessary.
Virginia relies on the amount and character of items reported on the federal return and supporting schedules. When a taxpayer alleges an item should be treated differently on a Virginia return than it was on a federal return, the taxpayer must clearly show why different treatment is required.
You have not provided sufficient detail with your computations to warrant different treatment. For FY 87, there is no documentation to substantiate your claim that a portion of the state and local income taxes was, indeed, interest expense. For FY 89, supplemental information provided with your application shows an adjustment to the state and local income tax figure reported on the federal return "per attached analysis"; however, no analysis is included. Without more detail, the department cannot determine if the amount is properly subtracted as a tax not based on net income. Because the items were reported on the federal return as state and local income taxes, and there is nothing provided to substantiate your position of different treatment, the audit adjustment for both years is upheld.
Foreign source income subtraction: The taxpayer reported a subtraction for foreign source income equal to the total net foreign source income shown on federal Form 1118. The auditor disallowed the subtraction on the basis that the income did not qualify as foreign source income as defined in Va. Code §58.1-302.
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 qualify. See Va. Code §58.1-302 (copy enclosed). The federal sourcing rules are applied to determine if the source of each item of the specified types of income is "foreign."
Income from the performance of services in the taxpayer's regular course of business is not one of the qualifying types of income under Virginia's definition of foreign source income. Therefore, the auditor properly disallowed that portion of the subtraction.
A review of the taxpayer's return reveals that a portion of the foreign source income subtraction reported by the taxpayer consisted of foreign interest and royalties. These types of income qualify under Virginia's definition of foreign source income and should be subtracted. Therefore, an adjustment will be made to exclude the foreign interest and royalties, net of expenses, from Virginia taxable income.
Accordingly, the audit report will be revised to reflect the principles set forth above. You will receive an updated bill with interest accrued to date. The bill should be paid within 30 days to avoid the accrual of additional interest.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner