Tax Type
Corporation Income Tax
Description
Subtractions from apportionable income
Topic
Allocation and Apportionment
Subtractions and Exclusions
Date Issued
03-29-1994
March 29, 1994
Re: §58.1-1821 Application: Corporate income taxes
Dear********************
This will reply to your letters dated June 2, 1993, and May 20, 1993, in which you made an application for correction of an assessment for additional corporate income taxes to********** (the "Taxpayer") for the 1989 taxable year.
PROCEDURAL HISTORY
On its 1989 Virginia tax return, the Taxpayer claimed a subtraction from Virginia apportionable income equal to the amount of a capital gain recognized on the sale of the stock of another corporation ("Company A"). The Taxpayer was audited by the department, and the subtraction was disallowed on the basis that the Code of Virginia does not provide for such a subtraction. You protest this adjustment, and aver that this capital gain is not properly subject to apportioned taxation in Virginia.
The Code of Virginia does not provide for the allocation of income other than certain dividends. Accordingly, a taxpayer's entire federal taxable income, adjusted and modified as provided in Va. Code §§58.1-402 and 58.1-403, less dividends allocable pursuant to Va. Code §58.1-407 is subject to apportionment. The Taxpayer's subtraction of the capital gain has been treated as a request for an alternative method of allocation and apportionment in accordance with Va. Code §58.1-421.
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.
FACTS
The Taxpayer is a large multi-national corporation, headquartered outside of Virginia. In 1981, the Taxpayer acquired 21% of the stock of Company A. In 1986 the Taxpayer sold a portion of its stock in Company A, reducing its holdings to 17%. In 1989 the Taxpayer sold the remainder of its investment in Company A. For state income tax purposes, the gain from the sale of Company A was allocated to the Taxpayer's state of commercial domicile.
Company A is one of the largest companies in its particular industry in the United States. The Taxpayer and Company A are not engaged in the same industry. From the time it purchased Company A stock in 1981 to the first sale of stock in 1986, the Taxpayer had two representatives on Company A's twelve member board of directors. Upon selling the shares in 1986, both of the Taxpayer's representatives resigned from Company A's board. Other than in its capacity as a minority shareholder, the Taxpayer did not have any authority to elect or place members on Company A's board of directors. The Taxpayer's board of directors did not have the authority to control or compel dividend payments by Company A.
During the period that the Taxpayer held Company A's stock, there were no common or shared managers, accounting or administrative staff or EDP staff. There were no transfers of personnel or staff between the companies. There were no common transportation services or resources, pension or profit sharing plans, policy or other operating guidelines. There was no common ownership in investments, use of trademarks, patents, licenses, trade secrets, copyrights, brand names, or company names. There was no-common or shared manufacturing technology, or research and development. There was no common marketing or advertising, computer hardware or software. There was no common manufacturing, or distribution services and resources. There were no common purchasing, selling, or marketing activities.
There were no intercompany loans made or secured between the Taxpayer and Company A, and the Taxpayer did not obtain or negotiate terms for loans obtained by Company A. The Taxpayer did not provide any collateral for loans made to Company A by unrelated third parties.
The Taxpayer did not control the price of any corporate service or product of Company A, and the Taxpayer had no control over the day to day operations of Company A. There were no agreements, contracts, or memorandums of understanding between the Taxpayer and Company A establishing cost or reimbursements for shared services or products as there were no shared services or products between these two companies.
Employees of the two companies did not belong to the same common collective bargaining unit or union. There were no common or joint management or employee training programs. There were no common life, health, annuity, or survivor benefit programs for employees or management personnel. There were no common or joint goals or plans for acquisition, diversification, or extension of the businesses conducted by the Taxpayer and Company A. There were no common bonus or incentive plans for management or employees. There were no common technical services or products that were provided in the ordinary course of business by the companies.
There were no royalty payments for patents, trademarks, manufacturing processes, or similar items between the Taxpayer and Company A. The companies had independent banking accounts, financing arrangements, and financial advisors. There were no shared offices, warehouses, data processing facilities, machinery or equipment, transportation facilities, or services. There was no property rented between the Taxpayer and Company A.
The Taxpayer did not have any approval authority, or review function, over the operating budget, capital expenditure budget, individual contracts, or capital expenditures of Company A. There were no common policies or procedures for capital investments or repair projects.
Prior to the 1986 sale of Company A stock, when the Taxpayer owned a greater than 20% interest in Company A, Company A provided the Taxpayer with financial information on a quarterly basis which was incorporated into the Taxpayer's financial statements using the equity method of accounting for investments. After the 1986 sale, the Taxpayer no longer received any special reports from Company A. The Taxpayer did receive annual reports for each year it was a shareholder, as did all shareholders.
The Taxpayer never controlled any aspect of Company A's operations. There no joint meetings of management personnel or supervisors. There were no shared administrative manuals or general instructions for management or employees of the companies. There is no flow chart showing the relationship of the Taxpayer to Company A. The Taxpayer did not eliminate, or cause to be eliminated, any marginal or unprofitable operations of Company A.
The total amount of intercompany sales during the period that the Taxpayer owned Company A stock was clearly immaterial with respect to both companies. There was no consumer recognition of the Taxpayer's ownership of its stock interest in Company A.
There were no changes in Company A's management personnel resulting from the Taxpayer's investment in Company A stock. The location of Company A's headquarters and support operations did not change as a result of the Taxpayer's investment in Company A's stock. There were no changes in Company A's external auditors, outside legal counsel, advertising firms or any other service company as the result of the Taxpayer's investment in Company A.
All decisions concerning the investment in Company A were made by the Taxpayer's board of directors. The Taxpayer's Treasurer's department is responsible for the day to day investment and borrowing needs of the Taxpayer. Except for activities related to the purchase or sale of Company A, the Treasurer's department did not spend any time managing this investment.
Company A's management wanted to prevent diminution of control and, to confine the Taxpayer's status solely to that of an investor. Consequently, as a condition of the sale of stock to the Taxpayer, Company A obtained from the Taxpayer a stipulation which precluded the Taxpayer from acquiring any additional shares without Company A board approval. Moreover, the Taxpayer agreed to a restriction that it would not pledge or encumber the Company A shares, or solicit proxies.
The Taxpayer's board of directors was interested in investing in Company A as it believed that the industry in which Company was engaged offered an opportunity to provide a better then average return on investment. During the nine years that the Taxpayer owned stock in Company A, Company A never paid a dividend. The Taxpayer its interest in 1989 as it afforded them an opportunity to realize a substantial return on its investment. This decision was made by the Taxpayer's board of directors. The sale price was negotiated directly between the Taxpayer and the buyer, as this stock is not publicly traded.
During the entire period of the Taxpayer's ownership of Company A stock, the only connection between the companies was the Taxpayer's minority representation on Company A's board of directors, and an immaterial amount of intercompany sales.
DETERMINATION
The department has examined the evidence provided by the Taxpayer in order to determine if a unitary relationship existed between the Taxpayer and Company A, and to determine if the Taxpayer's activities related to the investment in Company A 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.) Elements affecting these factors were addressed in depth 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 Company A. Based on the information provided to the department it does not appear that a unitary relationship existed between the Taxpayer and Company A.
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 business did not complement the Taxpayer's operational activities before or after the acquisition; no integration of the two businesses ever occurred; no economies were achieved; the two companies were physically separated at all times; the management of Company A was at all times separate and distinct from the Taxpayer; there was no intent to create consumer awareness of the common ownership; there was no attempt to take advantage of the fact that common ownership existed; and with few immaterial exceptions, no business transactions of any type occurred between the companies. In light of the substantial evidence provided, it does not appear that the Taxpayer used its own operational activities to enhance the value of its investment in Company A, nor does it appear that the ownership of the Company A enhanced the operational activity of the Taxpayer. Accordingly, I conclude that the Taxpayer made a passive investment in the Company A that was not of an operational nature. As the Taxpayer's headquarters and management of its investment function was located outside of Virginia, the gain recognized by the Taxpayer on the sale of Company A did not relate to the Taxpayer' 9 operational business carried on in Virginia.
In any proceeding relating to the interpretation of the tax laws of the Commonwealth of Virginia, the burden of proof is on the taxpayer. In this particular matter, the Taxpayer must prove by clear and cogent evidence that Virginia's statutory method of allocation and apportionment would result in a tax on income derived from a discrete investment function having no connection with Virginia in violation of the principles set forth in Allied-Signal. Based upon the information provided, I find that the Taxpayer has demonstrated that an alternative method of allocation and apportionment is appropriate. Because of the extraordinary circumstances surrounding the relationship between the Taxpayer and Company A, permission is hereby granted to allocate the capital gain recognized by the Taxpayer on the sale of the Company A stock in 1989 out of Virginia apportionable income. The sales factor for 1989 will also be adjusted to remove allocable income from the denominator.
All other aspects of the Taxpayer's 1989 allocation and apportionment shall be determined in accordance with §§58.1-406 through 58.1-420. The audit report will be revised in accordance with this ruling and the attached schedules, and a refund will be issued in due course with interest at statutory rates.
This ruling is limited to the 1989 taxable year, and further limited to the transaction described herein, and shall not be considered as pertaining to any other taxable year or transaction.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/6777M
Rulings of the Tax Commissioner