Tax Type
Corporation Income Tax
Description
Apportionment of passive income
Topic
Allocation and Apportionment
Date Issued
08-11-1994
August 11, 1994
Re: §58.1-1821 Application: Corporate income taxes
Dear****************
This will reply to your letters of July 25, 1994 and November 4, 1993 in which you apply for a correction of an assessment of income taxes to*************(the "Taxpayer") for the 1989 and 1991 taxable years. I apologize for the delay in responding.
FACTS
The Taxpayer was the subject of an office audit, and adjustments were made to the 1989 taxable year. On January 7, 1992, you contested this assessment. The Taxpayer was later the subject of a field audit, and numerous adjustments were made. As part of the field audit, the original office audit assessment for 1989 was abated, and a new assessment was issued on August 9, 1993. The Taxpayer has filed an application pursuant to Va. Code § 58.1-1821 for 1989 and 1991, contesting the department's right to apportion and tax certain passive income.
RULING
The Code of Virginia does not provide for the allocation of income other than certain dividends. The Taxpayer's claim has been treated as a request for an alternative method of allocation and apportionment pursuant to Va. Code §58.1-421. The Taxpayer has contested several items of income, which will be addressed separately.
Stock sale: Between 1982 and 1984, the Taxpayer acquired shares of common stock of Company A, a publicly held company. The Taxpayer's total ownership interest in Company A never exceeded 6.5%. The Taxpayer sold the Company A stock over an extended period, including sales in 1989 and 1991.
Sale of second tier investment: During 1985, one of the Taxpayer's 100% owned subsidiaries ("S1") invested in Company B. S1 acquired 50% of the stock of Company B, and an unrelated third party acquired the remaining 50%. Company B was headquartered in a state other than the Taxpayer's state of domicile, and outside of Virginia. The shareholders' agreement signed upon the creation of Company B provided that Company B's "field of activity" would be in a specific' limited area. Neither the Taxpayer nor S1 was engaged in Company B's field of activity.
In 1989, S1 sold its investment in Company B. As part of that transaction, the Taxpayer received a cash payment in exchange for its agreement not to enter into Company B's field of activity for a five year period. This agreement implies that the Taxpayer does not have operations like Company B's, and agrees for a fee not to enter into such field for 5 years. S1 is not required to file Virginia income tax returns, and if S1 had received the cash payment directly it would not have been taxable in Virginia.
The Taxpayer has provided evidence from administrative hearings of another state regarding this income whereby such state found "no connection with the working capital or operational activities and the income was not part of the taxpayers unitary business."
Partnership distribution: The Taxpayer was a 22% limited partner in a venture capital partnership. In 1990 the partnership distributed shares of stock in a publicly traded corporation to the Taxpayer. The Taxpayer never had anything to do with this company whatsoever. Taxpayer sold this stock at a gain in 1991.
The Taxpayer believes that the gains resulting from the sale of Company A, the sale of the second tier investment, and the partnership distribution ("investment gains") should be allocated to its state of commercial domicile.
The Taxpayer owned minority interests in the companies resulting in the investment gains. The Taxpayer has provided ample evidence indicating that its only relationship with the companies was as a minority stockholder. The Taxpayer and the companies were unrelated in every other respect. During the period of its ownership of the companies, there were no transactions of any type between the Taxpayer and the companies.
The facts and circumstances surrounding the Taxpayer's investment in the companies producing the investment gains closely resemble those described in Public Document 94-93 (3/29/94), copy attached.
The decision of the U. S. Supreme Court in Allied-Signal. Inc. v. Director. Div. of Taxation, 112 S. Ct. 2551 (1992) made it clear that the payee and payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. In the absence of a unitary relationship, apportionment is permitted when the investment serves an operational rather than a passive investment function. The Court also made it clear that the test is fact sensitive.
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and the companies, and to determine if the Taxpayer's activities related to its investments in the companies were in any way connected to the Taxpayer's operational activities.
In considering the existence of a unitary relationship, the Supreme Court has focused on three objective factors: (1) functional integration; (2) centralization of management; and (3) economies of scale. (See Mobil Oil Corp. v Commissioner of Taxes, 445 U.S., 425 (1980); F. W. Woolworth Co. v. Taxation and Revenue Dept. of N.M., 458 U.S., 352 (1982); and Allied-Signal. Inc. v. Director. Div. of Taxation, 112 S Ct. 2551 (1992).) Evidence regarding these factors was presented by the Taxpayer in clear and objective terms. There was no indication of a flow of goods or of a flow of values between the Taxpayer and the companies. Based on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and the companies producing the investment gains.
In considering the operational aspects of the investment, the department considered the evidence provided to support the Taxpayer's position. The evidence indicated that: the investment in the companies did not complement the Taxpayer's operational activities; no economies were achieved; and, the management of the companies was at all times separate and distinct from the general management of the Taxpayer.
In light of the substantial evidence provided, it is possible to conclude that the Taxpayer's investments in the companies producing the investment gains constitute passive investments that are not of an operational nature. Based upon the information provided, the department finds that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Accordingly, permission is hereby granted to allocate the investment gains recognized by the Taxpayer out of Virginia apportionable income.
Interest income from other notes receivable: The Taxpayer received interest income from various notes receivable from affiliated companies. Other than general statements regarding the nature of these notes, the Taxpayer has not provided objective evidence indicating that the income arises in the absence of a unitary relationship, or that the income was not operational in nature or did not arise from an operational rather than a passive investment function.
In this particular matter, the Taxpayer must bear the heavy burden of demonstrating that the imposition of Virginia's statute is a violation of the standards enunciated by the United States Supreme Court in Allied-Signal. In Allied-Signal, the court stated:
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- "We agree that the payee and the payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. Container Corp. says as much. What is required instead is that the capital transaction serve an operational rather than an investment function."
- "We agree that the payee and the payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. Container Corp. says as much. What is required instead is that the capital transaction serve an operational rather than an investment function."
other items: On its tax return and in its protest, various other items of capital gain have been claimed as allocable income. The Taxpayer has not met the burden of proof with respect to these items. Accordingly, permission to use an alternative method of allocation and apportionment for such income must be denied.
Limitation: There is another limitation which will apply to the Taxpayer's allocable income. The gross amount of income which may be considered as allocable income pursuant to this ruling and Va. Code §58.1-407 exceeds the Taxpayer's Virginia taxable income. However, because there is no express authority in the Code of Virginia for a Virginia net operating loss, neither the adjustments required in determining Virginia taxable income nor allocable income may be used to create a Virginia net operating loss. The amount of income which the Taxpayer may allocate out of Virginia is therefore limited to the sum of its federal taxable income and the adjustments required by Va. Code §58.1-402. Because there is no provision for a Virginia net operating loss, allocable income from the 1989 taxable year cannot be utilized to reduce Virginia taxable income in any other taxable year.
The protective claim will be adjusted as provided herein, and as reflected on the attached schedules. The apportionment factors will also be adjusted to remove items attributable to allocable income from the denominator of the respective factors. All other aspects of the Taxpayer's allocation and apportionment shall be determined in accordance with Va. Code §§58.1-406 through 58.1-420. A refund will be paid as soon as practicable with interest at statutory rates.
This ruling is limited to the taxable years identified herein, and further limited to the activity described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7771M
Rulings of the Tax Commissioner