Could a Virginia corporation allocate outside the state income from a 50%-owned partnership operating only in another state?

Subject

Corporation did not prove out-of-state partnership income was allocable

Plain-English summary

Virginia upheld inclusion of the corporation's share of an out-of-state partnership's income in its apportionable tax base. The corporation owned 50% of a partnership operating only in another state and had allocated that income entirely outside Virginia.

Virginia generally allowed allocation only for specified dividends. Partnership income retained its operational character, and partners were treated as participating in the partnership business. The auditor therefore included the income and the corporation's share of partnership property, payroll, and sales in the apportionment computation.

The corporation could seek alternative treatment by proving that the investment was nonunitary and passive or that the statutory method was unconstitutional or inequitable. It did not supply the Department's requested records on functional integration, management, economies of scale, or investment function. With the assessment presumed correct, Virginia upheld it but allowed one final 30-day chance to provide the documentation.

What this means for you

• Out-of-state partnership operations do not automatically make partnership income allocable outside Virginia.
• Expect operational-income treatment unless records establish a passive, nonunitary investment or qualifying alternative method.
• Include and support the partner's share of partnership apportionment factors when required.
• Respond fully to information requests; unsupported assertions will not overcome the assessment presumption.

Common questions

Did the partnership's lack of Virginia activity decide the issue?

No. Virginia analyzed the partner's apportionable income and operational relationship.

What evidence was missing?

Records bearing on unitary-business factors and whether the investment served a passive rather than operational function.

Was the taxpayer given another chance?

Yes, a final 30-day period to provide the requested documentation.

Citations and references

• Va. Code §§ 58.1-402, 58.1-403, 58.1-407, 58.1-421, 58.1-391(B), 58.1-219, and 58.1-205.
• 23 VAC 10-120-280.
• Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992).
• Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425 (1980).
• F. W. Woolworth Co. v. Taxation & Revenue Department, 458 U.S. 352 (1982).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-199

Original ruling text

December 19, 2008

Re: § 58.1-1821 Application: Corporate Income Tai:

Dear *:

This will reply to your letter in which you seek correction of the corporate income tax assessments issued to * (the "Taxpayer") for the taxable years ended December 31, 2003 and 2004.

FACTS

The Taxpayer, headquartered in Virginia, owned 50% of * (Partnership A), a joint venture that operated exclusively in *** (State A). The Taxpayer allocated the income generated by Partnership A to State A on its Virginia corporate income tax returns for the taxable years at issue.

Pursuant to an audit, the Department disallowed the allocation of Partnership A's income. The auditor also included the Taxpayer's prorata share of Partnership A's property, payroll, and sales in the denominator of the Taxpayer's apportionment formula. The Taxpayer paid the assessments and filed an appeal contending that Partnership A conducted no activities in Virginia and did not have a unitary relationship with the Taxpayer.

DETERMINATION

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 anal 58.1-403, less dividends allocable pursuant to Va. Code § 58.1-407, is subject to apportionment. The Taxpayer's allocation of Partnership A's income has been treated as a request for an alternative method of allocation and apportionment in accordance with Va. Code § 58.1 -421.

The policies that apply to requests for an alternative method of allocation and apportionment under Va. Code § 58.1-421 are well established. In order for a taxpayer to request an alternative method of allocation and apportionment, the taxpayer must file the return using the statutory method and pay any tax clue. Next, the taxpayer is required to file an amended return proposing an alternative method within the time prescribed for filing amended returns claiming refunds. The amended return must include a statement of why the statutory method is inapplicable or inequitable and an explanation of the proposed method of allocation and apportionment. The Department will not grant an alternative method of allocation and apportionment unless it determines that: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer's situation; or (2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state's method of apportionment. See Title 23 VAC 10-120-280.

In any proceeding with the Department, the Taxpayer bears the burden of showing that the imposition of Virginia's statute is in violation of the standards enunciated by the United States Supreme Court in Allied-Signal, Inc. v. Director, Division of Taxation , 504 U.S. 768 (1992). In this matter, the Taxpayer must demonstrate that its investments are not operational assets involved in a unitary business. 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 .)

The decision of the United States Supreme Court in Allied-Signal also 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.

Moreover, Va. Code § 58.1-391 B (as in effect during the taxable years at issue) provides, "Each item of partnership income, gain, loss or deduction shall have the same character for a partner under this chapter as for federal income tax purposes." For Virginia income tax purposes, income retains its character as income from the operations of a partnership in computing Virginia taxable income and is properly included in the apportionable income of the partner. This means that the partners are considered to be operating in the business conducted by the partnership. As such, the Department generally presumes that the income passed through from a partnership to be operational.

In order to ascertain the facts in this case and the nature of the relationship between the Taxpayer and Partnership A, the Department requested additional information. The Taxpayer did not provide the requested information or documentation to substantiate that the Taxpayer did not have a unitary, relationship with Partnership A or that the Taxpayer's income generated by Partnership A was investment income.

The Department has the authority to investigate any books and records of a taxpayer in order to ascertain the proper tax liability. See Va. Code § 58.1-219. Further, Va. Code § 58.1-205 provides that in any proceeding relating to the interpretation of the tax laws of Virginia, an "assessment of a tax by the Department shall be deemed prima facie correct." As such, the burden of proof is on the Taxpayer to show that the assessment is incorrect.

Because the Taxpayer has failed to furnish information required by law, I must uphold the Department's assessments of tax and interest issued to the Taxpayer for the 2003 and 2004 taxable years. I will, however, grant the Taxpayer, one final opportunity to provide the information requested to substantiate his claim. The documentation must be provided within 30 days from the date of this letter. Otherwise, the assessments will be deemed correct and collection action will resume.

The Code of Virginia sections cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2177746345.B