Tax Type
Corporation Income Tax
Description
Capital loss and gross receipts on combined return
Topic
Allocation and Apportionment
Date Issued
03-19-1991
March 19, 1991
Re: §58.1-1821 Application; Corporation Income Tax
Dear**************
This will reply to your letter of October 27, 1989, in which you seek correction of a corporation income tax assessment for *********************(the "Taxpayer").
FACTS
During 1983 and 1984, the taxpayer filed a combined Virginia corporation income tax return with its subsidiaries doing business in Virginia. 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
Use of Capital Loss on Combined Return: The taxpayer sold the stock of two of its subsidiaries. The sales resulted in a net capital loss that was not allowed in the taxable year because of the Internal Revenue Code (IRC) §1211 limitation. You claim that the taxpayer is entitled to use the capital loss to offset capital gains of the taxpayer's affiliate on the combined return.
Va. Code §58.1-442 provides that, in a combined return, the Virginia taxable income or loss is computed, allocated and apportioned separately for each corporation. The combination of income or loss from Virginia sources does not occur until after apportionment. The situation you propose would not satisfy these requirements because, in computing the taxable amounts of the affiliated group, federal taxable income or loss would not be computed separately for each corporation. Instead, you seek to combine elements of federal taxable income of two corporations.
Therefore, the auditor properly disallowed use of the capital loss to offset the capital gain of the taxpayer's subsidiary.
Inclusion of Gross Receipts in Sales Factor Denominator: The auditor included the gross receipts from the sales of the stock in the numerator and the denominator of the taxpayer's sales factor. You contend that these receipts should be removed from the sales factor because the sales resulted in a partial return of capital that was not includable in federal taxable income. In the alternative, if the sales are included in the sales factor, they should not be included in the numerator.
The department has previously ruled that gross receipts producing capital gains and losses are included in the sales factor. P.D. 88-172 (6/29/88) (copy enclosed). I find that the auditor properly included the gross receipts from the sale of the operating divisions in the sales factor.
Please note that House Bill 916 (1990 Acts of Assembly, chapter 294) changed the law for taxable years beginning on or after January 1, 1990, and only the net gain from the sale or other disposition of intangible property is included in the sales factor. A disposition of intangible property resulting in a loss is ignored in computing the sales factor.
Inclusion of Gross Receipts in Sales Factor Numerator: In your letter, you state that the purpose of the transactions was to sell the assets of two divisions. However, the transactions were structured as the sale of stock in two subsidiary corporations. The sale of stock is the sale of an intangible asset. Virginia Regulation (VR) 630-3-416 provides that the sale of intangible property is included in the numerator of the sales factor if a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.
You contend that the income producing activities of the subsidiaries were located outside of Virginia; therefore, the gross receipts from the sale should not be included in the numerator of the sales factor. However, the location of the subsidiaries' income producing activities is irrelevant. The regulations state that income producing activity means the acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. VR 630-3-416(B). Because the taxpayer's corporate headquarters was located in Virginia, and the decisions and record keeping occurred there, that is where the income producing activity occurred for purposes of the sale of stock. There is no indication that any income producing activity associated with the receipts from the stock sales occurred at any place other than the commercial domicile of the taxpayer in Virginia.
Therefore, the receipts were properly included in the numerator and the denominator of the sales factor.
Excess Cost Recovery: After restructuring its operations, the taxpayer sold the stock of a subsidiary corporation that had added back 30% of the ACRS deduction it had taken on its federal return, in accordance with Virginia law in effect at that time. The assets subject to ACRS depreciation were transferred to a new subsidiary and retained by the taxpayer. After the stock of the subsidiary that reported the additions was sold, the taxpayer continued to claim the ACRS subtractions associated with those additions because a new subsidiary held the assets. The auditor disallowed the subtraction.
Generally, a taxpayer may claim a subtraction for only those ACRS additions made by the taxpayer. VR 630-3-323 D.2. (copy enclosed). An exception exists for a corporation involved in merger or other form of reorganization. It is clear from the regulations that the ACRS subtractions do not follow the assets but rather remain with the taxpayer that claimed the additions, unless it is the subject of a merger or reorganization. In this case the corporation which claimed the ACRS additions was not part of a merger or reorganization; its stock was sold to an unrelated party.
Therefore, the auditor properly removed the subtraction from the taxpayer's return.
Adjustments for DISC Income: The taxpayer had a wholly owned subsidiary (the "DISC"), operated outside Virginia for the purposes of qualifying as a domestic international sales corporation. The taxpayer and five of its subsidiaries paid commissions to the DISC on their sales to the extent that the commissions qualified for preferential tax treatment under federal law. Three of the subsidiaries did no business in Virginia and were not subject to Virginia income tax.
The auditor increased the taxable income of the taxpayer by the commission income paid to the DISC by the taxpayer's affiliated corporations not taxable in Virginia and by interest income paid by the taxpayer. The auditor also included the commissions in. the numerator and denominator of the sales factor.
Under Va. Code §58.1-446, the department can require consolidation of the income of a corporation and its affiliates if it determines that the income earned from business done in Virginia has been distorted. The department may then equitably adjust the tax of the parent corporation. See Rulings of the Tax Commissioner dated January 16, 1980 and February 17, 1984 (copies enclosed).
Inspection of the DISC tax return indicates that the DISC incurred negligible expenses. You have supplied additional information indicating that the DISC's expenses were not borne entirely by the taxpayer, but that each affiliate bore all expenses relating to the commissions it paid to the DISC. Under these circumstances the statutory consolidation under Va. Code §58.1-446 may be adjusted to remove from the taxpayer's income and sales factor the commissions paid by affiliates which are not subject to Virginia tax. The commissions paid by affiliates subject to Virginia income tax will not be removed.
You also claim that interest on producer's loans should not be included in the taxpayer's income because the interest rate charged was an arm's-length rate. This portion of the DISC income represents interest on accumulated income from prior commissions. The adjustments are based on the fact that the DISC did not earn the commissions paid to it; therefore, the DISC does not have any accumulated income to earn interest in subsequent years.
The auditor included the DISC commissions in the numerator and denominator of the sales factor. You claim that only the denominator should be adjusted because all income producing activity occurred at the place outside Virginia where the DISC was administered. Although the mechanics of the adjustment appear as additions to the taxpayer's income, the adjustments are more properly characterized under Va. Code §58.1-446 as consolidating the DISC and the taxpayer by eliminating the taxpayer's deductions for items paid to the DISC and the DISC's income for items paid by the taxpayer. only the DISC commission income remaining after these adjustments represent "sales" for purposes of the sales factor (all of the producer's loan interest was paid by the taxpayer). Based on the information supplied, it appears that the income producing activity of the taxpayer related to these items occurred at the place where the DISC was administered.
Accordingly, the audit will be revised to remove from taxable income and the sales factor the commissions paid to the DISC by affiliates which are not subject to Virginia income tax; to remove from the numerator and denominator of the sales factor any items of DISC income derived from payments by the taxpayer; and to include in the denominator but not the numerator of the sales factor any remaining items of DISC income added to the taxpayer's income. 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. 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