Tax Type
Corporation Income Tax
Description
Audit adjustments
Topic
Assessment
Date Issued
03-14-1994
March 14, 1994
Re: §58.1-1821 Application; Corporate Income Taxes
Dear**********
This will reply to your letter dated May 28, 1992, and to a letter dated November 30, 1993 by***** in which an application has been made for correction of the assessments for additional corporate income taxes to ***************(the "Taxpayer") for the fiscal years ending December 31, 1988, 1989 and 1990 .
FACTS
The Taxpayer was field audited by the department, and numerous adjustments were proposed. The Taxpayer has protested twelve different issues on various grounds, and has made application to the department for a correction of these issues.
RULING
Environmental Tax: The department's auditor made an adjustment for the environmental tax deducted by the Taxpayer pursuant to Internal Revenue Code (IRC) §59A. The department has previously ruled that this tax must be added back to federal taxable income in accordance with Va. Code §58.1-402(B) (4) (see Public Document (P.D.) 91-87 (5/29/91), copy attached). Accordingly, the adjustment made by the department's auditor for these taxes is upheld.
Franchise Taxes: An adjustment was made to limit the deduction claimed for Indiana "franchise" type taxes. Indiana imposes an Adjusted Gross Income Tax (AGIT), and a Gross Income Tax (GIT).
The AGIT is based on net income, and therefore must be added back for Virginia purposes in accordance with Va. Code §58.1-402(B) (4). The GIT is based on gross income, and is not required to be added back in determining Virginia taxable income. The GIT is paid only if it exceeds the AGIT. The GIT is actually an addition to the AGIT, as a taxpayer will always pay at least the AGIT. Accordingly, Virginia will only consider the overall Indiana "tax" to be GIT to the extent that the GIT exceeds the AGIT. Because the Taxpayer has failed to provide evidence of the amount of GIT actually paid, the adjustment made by the department's auditor is upheld.
(Note: In making the 1988 adjustment, the department's auditor incorrectly used the Taxpayer's total of franchise taxes instead of the Taxpayer's total of Indiana Gross Income tax. The audit report will be corrected to reflect the proper amount of 1988 Indiana tax added back for Virginia purposes.)
Dividends from more than 50% owned Subsidiaries: The Taxpayer claimed a subtraction for dividends received from subsidiaries in which the Taxpayer owns 50% or more of the voting stock in accordance with Va. Code §58.1-402(C) (10). An audit adjustment was proposed to include these dividends in foreign source income, which is allowed as a subtraction pursuant to Va. Code §58.1-402(C) (9). The department has previously ruled in P.D. 91-229 (9/30/91), copy attached, that because dividends are subject to a separate subtraction, they are not required to be included in the foreign source income subtraction. Accordingly, the adjustment will be reversed, and all dividends received from 50% or more owned subsidiaries shall be allowed as a separate subtraction.
Foreign Source Income and Expenses: An audit adjustment was made to reduce the subtraction allowed pursuant to Va. Code §58.1-402(C)(8), (Foreign Source Income) by expenses allocable and apportionable to such income. You contend that expenses that cannot be definitely allocated to any item or class of income should be excluded from the amount of expenses used in determining foreign source income.
The statutory requirement that the subtraction for foreign source income be computed net of related expenses is found in Va. Code §58.1-402(C), which provides:
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- "[There] shall be subtracted to the extent included in and not otherwise subtracted from federal taxable income: ...
[8.] Any amount included therein which is foreign source income as defined in §58.1-302." (emphasis added)
Virginia Regulation (VR) 630-3-302 provides:
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- [The] federal procedure in Treasury Reg. §1.861-8 is applied to allocate and apportion expenses to income derived from U.S. and foreign sources."
Previous rulings of the department require the Virginia subtraction for foreign source income to be reduced by expenses, determined in accordance with IRC §861 et seq. (see P.D. 91-229 (9/30/91)). The department's policy in this area has been clearly defined. Virginia law requires the use of the federal sourcing rules of IRC §§861, 862 and 863 whether or not the taxpayer believes that certain expenses have any connection to income from foreign sources and regardless of what expenses would be under generally accepted accounting principles.
Therefore, in accordance with the U. S. Treasury Regulations under IRC §861, expenses that are not definitely allocable are to be apportioned ratably among the statutory groupings of gross income and the residual groupings.
The department has previously ruled that the proper method of computing nonallocable expenses attributable to foreign source income is to multiply total nonallocable expenses by a ratio, the numerator of which is total Virginia foreign source gross income and the denominator of which is total gross income from without the United States per the Form 1118 (P.D. 91-229). Items which qualify for separate subtractions under other provisions of the Virginia code, such as IRC §78 gross-up, Subpart F income, and dividends from corporations in which the taxpaying corporation owns 50% or more of the voting stock are not subtracted again as foreign source income. Accordingly, they are not included in the numerator of the ratio, but are included in the denominator to the extent included on Form 1118. Allocable expenses, if any, should be applied directly to the category of income to which they relate.
The department considers federal Form 1118 an appropriate starting point to determine foreign source income and expenses. However, the department realizes that U. S. Treasury regulations do not require a high degree of precision in allocating and apportioning expenses on Form 1118 when federal tax liability will not be affected. The Taxpayer has submitted additional information, which shows foreign source income and the expenses related to foreign source income with more precision than that shown on Form 1118. In accordance with P.D. 87-149 (6/8/87), copy attached, the department has considered this new information.
Property Under Construction: The department's auditor made no change to the Taxpayer's apportionment percentage with respect to construction in progress. However, the Taxpayer has provided new information regarding the amount of property under construction. Because the new information is consistent with other information used by the department, the denominator of the property apportionment factor shall be determined using the new information.
Fully Depreciated Assets: The department's auditor adjusted the property factor in accordance with schedules provided by the Taxpayer. VR 630-3-409 provides that property is considered in the property factor if it is owned or rented by the taxpayer, used by the taxpayer, and effectively connected with the taxpayer's trade or business within the United States and the income from such trade or business is includable in both Virginia taxable income and federal taxable income. Once used or available for use, property shall remain in the property factor until its withdrawal is established by an identifiable event. The fact that property is no longer used by the taxpayer does not necessarily mean that the property should be removed from the property factor.
The auditor appropriately relied on the Taxpayer's schedules as a starting point. However, the Taxpayer has now presented new information regarding fully depreciated assets. These assets have been written off the Taxpayer's books, but are still owned and in use. The Taxpayer has provided evidence such as property tax return schedules which demonstrate that property is still owned by the Taxpayer. Accordingly, the property factor shall be adjusted to include this property in 1988 and 1989.
Virginia Payroll Factor: The Taxpayer has protested the adjustments made to the payroll factor by the department's auditor. VR §630-3-412 provides:
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- "[C.] Compensation within Virginia. The total wages reported to Virginia for unemployment compensation purposes are presumed to be compensation paid in Virginia. "
Because the Taxpayer has not provided evidence which supports its position, the amounts reported for Virginia Unemployment Compensation purposes shall be presumed to fairly represent the numerator of the payroll factor.
The denominator of the payroll apportionment factor is total compensation paid everywhere. The department's auditor made no adjustments to the Taxpayer's payroll factor denominator. However, pursuant to your protest, the total amounts shown on federal Form 940 will be accepted as total payroll everywhere, in accordance with P.D. 91-87 (5/29/91).
Sales Factor: Your protest states that other income items should be included in the denominator of the sales factor. Because no documentation as the nature of the "other income" was provided, the department's auditor excluded these receipts from the sales factor. In accordance with P.D. 92-45 (4/27/92), copy attached, the department cannot allow a taxpayer to include in the denominator of the sales factor receipts from an unknown or unidentified source. In administrative and judicial proceedings to correct an assessment, Virginia law presumes that the assessment is correct and the burden is on the taxpayer to prove what the correct tax should be. In the absence of adequate documentation supporting the Taxpayer's computation of the correct tax, I will not disturb the judgment of the auditor.
Sales Factor: Your protest states that gross receipts from intangibles should be included in the sales factor in 1988 and 1989, and have provided a statement of these amounts for 1988. The Taxpayer did not include these proceeds in their sales factor in their return as filed, but states that they should be included at this time. Neither federal Form 1120 nor its supporting schedules as filed for 1988 reflected this information as gross proceeds. A review of the documentation provided leads to conclusion that the proceeds relate to short term positions held in various municipal bonds which were held from one day to a week or more. Apparently the Taxpayer purchased these bonds at a discount, and reported the difference as interest income, or as exempt municipal bond interest. The failure of the Taxpayer to report these transactions on its federal return leads to the conclusion that the income realized by the Taxpayer is properly categorized as interest income. In accordance with PD 91-212 (9/6/91), copy attached, no adjustment shall be allowed to the sales factor with respect to this income.
Capital Loss Carryback: The Taxpayer incurred a capital loss on its 1989 federal return, which it carried back to 1988 on federal Form 1139. The Taxpayer has presented evidence that the federal Form 1139 was filed and accepted by the Internal Revenue Service. Accordingly, the capital loss carryback adjustment from 1989 to 1988 will be allowed
Apportionment Factor Adjustments: You have protested the amounts used by the department's auditor as inventory for purposes of the property apportionment factor. However, the amounts used were equal to the amounts per your protest. Based on the information available to us, it is not clear what you are protesting, and does not appear that an adjustment is required.
The department's auditor increased the numerator of the property factor by an apportioned amount of movable personal property in accordance with VR 630-3-410(D). The Taxpayer has not furnished any substantive documentation to refute the auditor's position, other than a general statement that such treatment by Virginia results in double taxation. The Taxpayer has not shown that the statutory method of apportionment produces an unconstitutional result. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Mooreman Manufacturing Company v. Bair, 437 U.S. 279, 98 S.Ct. 2340 (1978).
The Taxpayer has indicated that an adjustment to Virginia inventory is necessary in calculating the Virginia property factor, but has not provided evidence to support its position.
In the absence of adequate documentation supporting the Taxpayer's computation of the correct tax, I will not disturb the judgement of the auditor.
State Income Tax Addition: The department's auditor adjusted the 1990 taxable year to account for Virginia modifications related to a net operating loss carryover in accordance with VR 630-3-402. The modifications relate to state income tax additions reported in preceding loss years by two separate corporations that were merged into the Taxpayer. The net operating losses of these merged corporations are carried over and deducted by the Taxpayer in 1990, therefore the adjustment is appropriate. Based on the copies of the Virginia returns as originally filed for the loss years the amount of the Virginia modifications is correct. However, the Taxpayer has now presented evidence indicating the amount added back as state income tax for one taxable year was incorrect, and that in fact the taxes in question were not net income taxes. Accordingly, the audit adjustment made to the 1990 taxable year shall be adjusted to remove this amount.
ACRS Subtraction: The Taxpayer has protested the failure of the department's auditor to allow an ACRS carryover from a corporation which was merged into the Taxpayer during 1989. The Taxpayer has failed to provide the department with evidence of the amount of ACRS additions and subtractions for the merged corporation for all applicable years. Furthermore, the one Form 302 that was supplied to the department reflects a "0" in all applicable boxes of the form. Accordingly, no adjustment shall be made with respect to this issue.
Summary: As stated above, the audit report will be adjusted for the correct amount of franchise taxes in 1988, a subtraction will be allowed for dividends received from 50% owned corporations, the foreign source income subtraction and expenses related to foreign source income will be determined in the manner described in this letter, the property factor will be adjusted for property under construction and fully depreciated assets, the payroll factor denominator shall be adjusted, a capital loss carryback to 1988 shall be allowed, and the state income tax addition shall be adjusted. The assessments will be adjusted in accordance with the attached schedules. You should pay the balance due as shown on the summary schedule, **** within 30 days to avoid the accrual of additional interest. The 1989 refund and appropriate interest will be paid to you in due course.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/6223
Rulings of the Tax Commissioner