Bulletin Number
VTB 93-4
Tax Type
Corporation Income Tax
Description
Reporting Nonapportionable Investment Income on Virginia Corporate Income Tax Returns
Topic
Returns/Payments/Records
Date Issued
04-06-1993
Virginia Tax Bulletin
93-4
REPORTING NONAPPORTIONABLE INVESTMENT INCOME
ON VIRGINIA CORPORATE INCOME TAX RETURNS
ON VIRGINIA CORPORATE INCOME TAX RETURNS
GUIDANCE IN PREPARING 1992 CORPORATE TAX RETURNS
New Lines on Form 500: For taxable year 1992, the Virginia Corporation Income Tax Return (Form 500) has been revised to include lines 2(a) and 4(b) on which taxpayers may report nonapportionable investment function net income or loss. The form change was made in response to the decision of the U. S. Supreme Court in Allied-Signal, Inc. v. Director, Division of Taxation, 112 S. Ct. 2251 (1992). Virginia law does not provide for a subtraction of unapportionable investment function income, nor does the law provide for the allocation of any income other than dividends. The new lines were added to Form 500 in recognition that some taxpayers may be entitled to an alternative method of allocation and apportionment under Va. Code § 58.1-421 if they can demonstrate that the application of Virginia's apportionment law to their particular facts for the taxable year is not in accordance with the decision in Allied-Signal.
This adjustment is only available to those multistate corporations that (1) file a Virginia Schedule A to apportion and allocate their income in accordance with Va. Code § 58.1-406, and (2) prove by clear and cogent evidence that the income (a) is derived from an investment function that is unrelated to operational functions and (b) does not arise from a unitary business.
Allied Signal Decision: In Allied-Signal, the Court affirmed that investment income may be included in apportionable income. By refusing to overturn prior cases decided under the unitary business rule the Court reaffirmed the continued validity of apportionment of any income received directly by the taxpayer, including investment income such as capital gains, unless the income is derived from an unrelated business activity constituting a discrete business enterprise. The Court ruled that the taxpayer's gain on the sale of stock could not be excluded from the apportionment formula unless the capital asset sold served an investment function that was completely unrelated to any operational activities carried on in the taxing state. The decision in Allied Signal limits, but does not prohibit in all cases, the ability of states to apportion investment type income. States may continue to apportion such income unless the taxpayer establishes that the income was earned in the course of activities unrelated to those carried out in the taxing state.
Burden of Proof: In order to claim an adjustment on lines 2(a) and 4(b) (which effectively allocates income other than dividends), the taxpayer must provide objective evidence that (1) the capital transaction was separate from its operations, and (2) the taxpayer's unapportionable investment function income was unrelated to its business in Virginia, and (3) the investment function itself was located outside of Virginia. The taxpayer must also demonstrate that the classification of the capital asset and its income for Virginia purposes is consistent with the manner in which the income has been allocated and apportioned with other state tax authorities. For example, in the case of a stock investment in another corporation, the taxpayer could furnish copies of annual reports or other regulatory filings that reflect the asset as a long-term investment separate from other operational assets, copies of a legally binding instrument that prohibit involvement in the management of the other corporation, or copies of a judicial order such as an antitrust ruling, and copies of other state income tax returns filed by the taxpayer. An unsubstantiated statement as to the taxpayer's intent or purpose with respect to the asset will be insufficient to meet the burden of proof.
The department will look closely at any investment that has an operational connection. An investment that complements or expands operations will not be viewed as serving exclusively an investment function. For example, an investment in land with the expectation of building a new plant would be of an operational nature. An acquisition that increases market share, provides a source of raw material or creates other economic advantages would also be considered as operational in nature.
The taxpayer will be under a particularly heavy burden of proof in cases where the asset was clearly operational at any time. The taxpayer must provide objective evidence as to the moment in time that the taxpayer's purpose in holding the investment changed. A mere change in the form of ownership of operating assets does not indicate a change in the purpose for owning the assets. For example, a taxpayer who has decided to sell apart of its operations may transfer the assets to a subsidiary in order to facilitate the sale. As long as the operational relationship continues after the transfer to the subsidiary, ownership of the subsidiary's stock will be viewed as part of the taxpayer's operations regardless of how long a period elapses before a sale is consummated. The presumption will be that an operational function or unitary relationship continues until such time as the taxpayer can clearly demonstrate when and how such relationship has changed. Generally, a brief passage of time between the change of intent and the date of sale will create a presumption that the motivation arose out of the contemplation of the sale and the resulting state tax consequences.
Taxpayers claiming a modification for nonapportionable income on 1992 corporate tax returns should follow the instructions for lines 2(a) and 4(b) provided in the general instructions for Form 500. In addition, taxpayers should attach a statement to their return stating the nature of the deduction or addition and the basis for their position that relief is available under the Allied-Signal decision. Supplemental evidence should be clearly referenced and included with the return. The taxpayer should submit all evidence that they consider necessary to support their position.
AMENDED RETURNS, PROTECTIVE CLAIMS OR § 58.1-1821 APPLICATIONS
Taxpayers that file amended returns or dispute audit adjustments with respect to nonapportionable investment function income should submit all the necessary evidence consistent with the guidance above. It is suggested that claims made with respect to this issue be segregated from other matters to expedite the processing of those portions of a claim that relate to routine types of changes.
Generally, Virginia amended returns may not be filed more than three years after the extended due date of the return, unless such amended return is filed within 90 days of the date of a final determination of federal tax liability made by the IRS. After July 1, 1992, Virginia amended returns filed beyond the 3 year statute of limitations to report changes made by the IRS to federal tax liability may not amend any item that was not adjusted by the IRS. If the federal change affects an item of nonapportionable investment function income then the Virginia amended return will be limited to the decrease in Virginia tax attributable to the amount by which the IRS changed the item.
The department may audit the amended return prior to issuing a refund. The department may also process the amended return as submitted and refund the amount claimed subject to a subsequent audit and assessment of any amount determined to be erroneously refunded. In either case, the assessment of an amount erroneously refunded or the denial of a refund may, be protested by filing an application for correction pursuant to Va. Code § 58.1-1821.
Taxpayers that have claims relating to this issue pending with the department should furnish the department with any additional evidence necessary to support their claim consistent with the guidance provided in this Bulletin.
§ 58.1-1821 Application Procedure
Virginia regulation VR 630-1-1821 requires taxpayers to submit a complete explanation of the disputed issues and supporting documentation with the application. The application is not subject to the Administrative Process Act and hearings are not required or held; however, the department may hold informal conferences. Because of the complex nature of the issues and level of detail required to make a determination as to nonapportionable investment function income, taxpayers who make a substantial showing that the income arose from a separate investment function are likely to be offered a conference to explore the nature of the investment function and the level of evidence necessary to satisfy the department that it is completely separate from operating activities.
However, if a taxpayer submits only unsubstantiated statements without any objective evidence as to the existence of a separate investment function, the department may act without offering a conference. While such action does not preclude the department from reconsidering its action upon submission of adequate evidence within the applicable period of limitations, any amounts collected in the interim will not be refunded until the department has concluded its review and finds that the income in question is nonapportionable investment function income.
ADDITIONAL INFORMATION
For additional information contact the Taxpayer Assistance Section, Office of Taxpayer Services, Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23282, or call (804) 367-8038.
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