Tax Type
Corporation Income Tax
Description
Foreign source income; Royalties and dividends
Topic
Collection of Tax
Royalties
Date Issued
03-18-1991
March 18, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear******************
This will reply to your letter of November 16, 1989, in which you seek correction of corporation income tax assessments for****************** (the "Taxpayer").
FACTS
The taxpayer was field audited and numerous adjustments were made. The contested adjustments made during the audit that resulted in additional tax were related to the subtraction claimed for foreign source income. Specifically, you object to the disallowance of the subtraction claimed for certain royalties and dividends as foreign source income. I will address each issue separately.
DETERMINATION
Foreign Royalties: The auditor disallowed the subtraction for foreign royalties (including net royalty income received from a limited partnership) on the 1987 and 1988 returns. The foreign royalty income was not included on the royalty income line of the federal return. The auditor relied on this fact to conclude that the royalty income was not included in federal taxable income and, therefore, could not be subtracted in determining Virginia taxable income.
Supplemental information furnished by the taxpayer indicates the royalty income was included on the federal return on the line for "Other Income." The amounts also appear on federal Form 1118 (Computation of Foreign Tax Credit), indicating that the source of the income was "foreign" pursuant to Internal Revenue Code (IRC) 861 et seq. Therefore, the foreign royalty income qualifies for the Virginia foreign source income subtraction.
Foreign Dividends: The auditor disallowed the subtraction for foreign dividends because he found that the dividends were not included in federal taxable income. The auditor based his finding on the fact that the foreign dividend income was not included on Schedule C, line 8 (other dividends from foreign corporations) on federal Form 1120.
Supplemental information provided by the taxpayer and a review of federal Form 1118 indicate that the foreign dividends were included in federal taxable income. The dividends appear on line 1 of Schedule C on Form 1120. Dividends appearing on this line qualify for an IRC §243(a) deduction (in this case, 70% of dividends received were deducted in computing federal taxable income). Consequently, only 30% of the dividends were included in federal taxable income.
The taxpayer claimed a subtraction for 100% of the dividends, which the auditor disallowed. However, the taxpayer is entitled to a subtraction for only those foreign dividends included in federal taxable income. Therefore, the auditor should have added back 70%, instead of 100%, of the foreign dividends included in the subtraction claimed by the taxpayer. Furthermore, allocable income should be reduced by the foreign dividends properly subtracted.
While the income items qualify for the foreign source income subtraction because they were included in federal taxable income, the amount of the subtraction claimed by the taxpayer is excessive. The taxpayer claimed a subtraction for the gross amount of foreign royalty and dividend income. Virginia has never allowed the subtraction of gross foreign source income. See P.D. 86-154 (8/14/86). Therefore, the subtraction for foreign source income will be reduced by expenses allowable in computing federal taxable income, in accordance with IRC §861 et seq.
You will shortly receive a revised audit report reflecting any corrections required to conform the audit to the principles set forth in this letter and an updated bill with interest accrued to date. The bill should be paid within thirty days to avoid the accrual of additional interest. Although you requested a conference, this letter has been issued without one. If you still desire a conference you should request one within thirty days.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner