Did affiliated bankruptcy-remote receivables companies have Virginia corporate-income-tax nexus or Virginia-source income?

Subject

Manufactures and sells products to third party retailers throughout the United States,

Plain-English summary

Affiliated bankruptcy-remote companies that acquired revolving pools of receivables did not appear to have Virginia corporate-income-tax nexus on the facts presented. The operating finance company continued servicing the receivables for a market-rate fee, while the bankruptcy-remote companies transferred receivable income to trusts that issued investor notes and certificates.

Even if nexus existed, the companies had no Virginia property or payroll. Under Virginia's regulatory cost-of-performance method, they also incurred no direct costs in Virginia, so they would have no positive Virginia sales factor or Virginia-source income.

The answer was not unconditional. Under the Virginia Supreme Court's General Motors decision, indirect costs and independent-contractor activities could not automatically be excluded. Collection work performed in Virginia by the finance affiliate could create a positive sales factor if it was more than de minimis.

Virginia also reserved authority to adjust commonly owned corporations' taxable income when related-party transactions improperly reduced Virginia income. Because that inquiry depended heavily on facts and circumstances, the Department would not issue an advance ruling on the receivables-factoring arrangement.

What this means for you

• Nexus and Virginia-source income are separate questions; either analysis can affect liability.
• Receivables companies with no Virginia property, payroll, or direct costs may have no positive apportionment factor under the regulation.
• Virginia collection activity can matter under a broader cost-of-performance analysis.
• Related-party factoring can be adjusted if it lacks economic substance, is not arm's length, or distorts Virginia taxable income.

Common questions

Did Virginia definitively rule that the companies could never be taxed?

No. It found no apparent nexus on the stated facts and described circumstances in which Virginia activity could produce a positive sales factor.

Why could collection activity change the result?

The General Motors decision required a broader cost analysis that could include the affiliate's Virginia collection work.

Did Virginia approve the related-party factoring structure?

No. It declined an advance ruling and reserved its adjustment authority under Va. Code § 58.1-446.

Citations and references

• Va. Code §§ 58.1-400, 58.1-416, and 58.1-446.
• P.L. 86-272, 15 U.S.C. §§ 381-384.
• 23 VAC 10-120-230.
• Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992).
• General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S.E.2d 123 (2004).
• Commonwealth v. General Electric Company, 236 Va. 54 (1988).
• Virginia Tax Bulletin 05-3 and Virginia Public Document 03-56.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-163

Original ruling text

August 6, 2010

Re: Ruling Request: Corporate Income Tax

Dear *:

This is in response to your letter submitted on behalf of your client (the "Taxpayer"), in which you request a ruling regarding corporate income tax nexus. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer manufactures and sells products to third party retailers throughout the United States, including Virginia. The parent company of the Taxpayer ("Finance") extend, credit and makes direct advances to the retailers. Finance also purchases loans from the retailers originated when selling property to customers.

Finance's credit rating restricts the amount of capital it may raise and its cost of funds. In order to increase available credit, Finance established bankruptcy remote companies (BRCs) to secure the receivables generated by the operating affiliates. Finance designates certain receivables and sells its rights, title and interest in the revolving pool to the BRCs. Finance continues to service the receivables for a standard market rate fee.

The BRCs transfer the income from the receivable to Trusts. The Trusts issue notes and certificates to the BRCs' investors. The Taxpayer requests a ruling that the BRCs' activities in Virginia are insufficient to create nexus. If it is determined that the BRCs have nexus, then the Taxpayer requests a ruling that they have no apportionable income to Virginia.

RULING

Nexus

Virginia Code § 58.1- 400 imposes income tax "on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources." Generally, a corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. The existence of positive Virginia apportionment factors establishes income from Virginia sources.

Public Law (P.L.) 86-272, as codified at 15 U.S.C. §§ 381-384, however, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. The Department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr., Co. , 505 U.S. 214 (1992). Although P.L. 86-272 applies to tangible property, the Department's policy has been to extend the "solicitation test" of P.L. 86-272 to situations involving sales other than tangible personal property. The Department has a longstanding policy of narrowly interpreting the provisions of P.L. 86-272. Based on the facts presented, the BRCs do not appear to have nexus with Virginia for income tax purposes.

Apportionment

Even if the BRCs were to, establish nexus with Virginia, the facts provided raise the question as to whether the BRCs have any Virginia source income. The BRCs have no property or payroll in Virginia. In addition, it is possible that the BRCs would not have a positive sales factor. Virginia Code § 58.1-416 provides that sales, other than sales of tangible personal property, are deemed in Virginia if:

The income producing activity is performed in Virginia; or

The income producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines "cost of performance" as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. "Income producing activity" is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.

In General Motors Corporation v. Commonwealth of Virginia , 268 Va. 289, 602 S. E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Va. Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining "cost of performance" and "income producing activity" in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.

In response to the General Motors decision, the Department issued Tax Bulletin (VTB) 05-3 (4/18/2005). The bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department's adoption of policies in response to the General Motors decision. Because the Department administers Va. Code § 58.1-416 in a manner similar to Va. Code § 58.1-418, taxpayers with sales other than tangible personal property may also elect to file returns prepared in accordance with Title 23 VAC 10-120-230 pending the adoption of policies in response to the General Motors decision.

Based on facts presented in your letter, the BRCs would incur no direct costs in Virginia in accordance with Title 23 VAC 10-120-230. Thus, the BRCs would not have a positive sales factor and have no income from Virginia sources. In other words, if the BRCs follow Virginia's regulation, they would not be subject to Virginia income tax even if it did have nexus.

Under the General Motors decision, the cost Finance's collections actions within Virginia would need to be included in the BRCs' computation as to whether the proceeds from an applicable account receivable are deemed to have occurred in Virginia for purposes of its Virginia sales factor. Under this scenario, the BRCs could have a positive sales factor and be subject to Virginia income tax if Finance's collection activities are not de minimis in nature.

Intercompany Transactions

It should be noted that the Department has the authority to adjust the taxable income of two or more corporations in accordance with Va. Code § 58.1-446. In the event that the Department finds that transactions between commonly owned businesses improperly reflect Virginia taxable income from business done in Virginia, the Department can, and if necessary will, seek remedies that may include consolidating the accounts of one or more of the corporations.

The Virginia Supreme Court's opinion in Commonwealth v. General Electric Company , 236 Va. 54 (1988), upheld the Department's authority to equitably adjust the tax of a corporation pursuant to Va. Code § 58.1-446 (or its predecessor) where two commonly-owned corporations structure an arrangement in such a manner as to reflect improperly, inaccurately, or incorrectly the business done in Virginia or the Virginia taxable income. Generally, the Department will exercise its authority if it finds that a transaction or a party to a transaction, lacks economic substance or transactions between the parties are not at arm's length. The Department has exercised its authority under Va. Code § 58.1-446 in situations involving the factoring of receivables. See Public Document (P.D). 03-56 (8/8/2003).

In the instant case, Finance's receivables are being factored to the BRCs. Because Finance is subject to Virginia income tax, and the BRCs may not be subject to Virginia income tax, such a transaction effectively decreases Finance's Virginia taxable income. Because the application of Va. Code § 58.1-446 is highly dependent on the facts and circumstances, the Department cannot issue an advance ruling with respect to these transactions.

This ruling is based on the facts presented summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections, regulations, tax bulletin, and public document cited 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 regarding this ruling, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely

Linda Foster

Deputy Tax Commissioner

AR/1-3326182653.D