Document Number
95-175
Tax Type
Individual Income Tax
Description
Taxes paid to other states; California franchise taxes
Topic
Credits
Date Issued
06-28-1995
June 28, 1995



Re: §58.1-1821 Application: Individual Income Tax


Dear**************

This will reply to your letter of October 19, 1994, concerning the 1991 Virginia individual income tax assessment of your clients,*****************(the "Taxpayers").
FACTS

The Taxpayers are Virginia residents. The husband was a shareholder in an S Corporation that earned income from doing business in California. For California purposes, the S Corporation elected to be treated as a C Corporation and filed a 1990 California Corporation Franchise or Income Tax Return, which had a fiscal year ending in 1991. When the 1991 Virginia income tax return was filed, an out-of-state credit was claimed for the husband's pro rata portion of the California corporation franchise tax paid by the S Corporation. The department disallowed the portion of the out-of-state credit attributable to the corporation franchise tax, and issued an assessment. The Taxpayers contend that the corporation franchise tax is an income tax that qualifies for the Virginia out-of-state tax credit provided in Code of Virginia §58.1-332 since it is based on income. They also provide the department's Public Document (P.D.) 88-119 (May 27, 1988) to further substantiate that the credit is allowable.
DETERMINATION


Since 1959 the Virginia Department of Taxation has consistently held that Virginia residents were not entitled to an out-of-state credit for taxes paid to another jurisdiction if such taxes were designated as "franchise" taxes. The Virginia Supreme Court overturned this policy by holding that, although designated as a "franchise" tax, the tax imposed by the District of Columbia on entities operating within its jurisdiction was actually an income tax. Llewellyn King v. W.H. Forst, State Tax Comm'r. 239 Va. 557 (1990)

Legislation enacted by the 1991 General Assembly (HB 1734, Chapter 362 and SB 765, Chapter 456), retroactively overturned the Virginia Supreme Court's King decision. Specifically, Code of Virginia §58.1-332 provides that:
    • [N]o franchise tax, license tax, excise tax, unincorporated business tax, occupation tax or any tax characterized as such by the taxing jurisdiction. although applied to earned or business income, shall qualify for the credit under this section. (Emphasis added.)
As indicated in this code section, a tax that is characterized by a taxing jurisdiction as a franchise tax is not allowable in the computation of the Virginia credit. The tax on corporations doing business in California is clearly characterized by Division 2, Part 11, Chapter 2 of the Cal. Rev. & Tax Code as a franchise tax even though the tax is based on income. Consequently, Code of Virginia §58.1-332 does not allow a credit for franchise tax regardless of whether the franchise tax is paid by an S Corporation or an S Corporation electing to be taxed by California as a C Corporation.

P.D. 88-119 simply referred to a credit being allowable for California income tax paid, but did not address the situation where a franchise tax was imposed on a C or S Corporation doing business in California. Therefore, to clarify the department's policy concerning the Virginia out-of-state credit the public document stated:
    • This credit is only applicable to the 2.5% California tax imposed on S Corporations which make the election to be taxed as an S Corporation or the California corporate income tax that is imposed on S Corporations which elect to be taxed as C Corporations. (Emphasis added.)
The California corporate income tax applies to an S Corporation (or S Corporation electing to be taxed as a C Corporation) that receives income from sources within California but which is not doing business in California. The shareholder of such a corporation may claim a credit on the Virginia return for the prorata portion of income taxes paid by such corporation to California. However, if an S Corporation (or S Corporation electing to be taxed as C Corporation) is doing business in California, the corporation is subject to the California franchise tax. In this instance, the California franchise tax is not eligible for the Virginia credit. Therefore, as the tax rates for the income and franchise taxes in California may be identical, the California tax return must be evaluated to determine the type of tax actually paid by a corporation and whether the Virginia credit can be claimed.

In the instant case, the husband's corporation apportioned income to California using the three-factor formula, which included property, payroll, and sales located in California. Therefore, the corporation was clearly doing business in California and was subject to the California franchise tax instead of the income tax. As a result, the franchise tax paid to California was not allowable in the computation of the 1991 Virginia out-of-state credit.

Although I am sympathetic to the Taxpayer's situation, neither Code of Virginia §58.1-332 nor P.D. 88-119 provide basis for the credit claimed. As such, the department has no choice but to deny the relief sought by the Taxpayers. The balance of the updated assessment is
which represents tax of******* and******interest of If you have any questions, please feel free to contact**********.

                        • Sincerely,


                          Danny M. Payne
                          Tax Commissioner

OTP/8594N

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46