Could a multistate partnership use separate accounting for Virginia real-estate investments instead of the statutory apportionment formula?

Plain-English summary

Virginia denied the partnership's request to allocate each real-estate investment by separate accounting instead of using the statutory apportionment formula. Pass-through entities doing business in Virginia and another state generally apportioned income like corporations.

Apportionment was an approximation. A taxpayer needed clear and cogent evidence that the statutory formula assigned income out of all appropriate proportion, produced a grossly distorted result, or caused qualifying double taxation attributable to Virginia.

The partnership showed only that separate accounting produced a different result. It did not prove unconstitutional distortion or Virginia-caused double taxation.

It also skipped the established claim process. The taxpayer first had to file under the statutory method and pay, then submit a timely amended return with the alternative, supporting records, and an explanation of the inequity.

What this means for you

• A more favorable separate-accounting result is not enough.
• Quantify distortion or double taxation with records.
• Identify whether Virginia—not another state's unique rule—caused the inequity.
• Follow the file-pay-amend procedure for alternative-method relief.

Common questions

Q: Does Virginia favor separate accounting?
A: No. The ruling described a longstanding policy disfavoring it.

Q: What evidence was missing?
A: Proof of unconstitutional distortion or Virginia-caused double taxation.

Q: What procedure should have been used?
A: File and pay under the statutory method, then submit a timely amended-return claim.

Citations and references

• Va. Code §§ 58.1-408 through 58.1-421.
• 23 VAC 10-120-280.
• Moorman Manufacturing Co. v. G.D. Bair, 437 U.S. 267 (1978).
• Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123 (1931).
• Norfolk & Western Railway Co. v. Missouri State Tax Commission, 390 U.S. 317 (1968).
• Department of Taxation v. Lucky Stores, Inc., 217 Va. 121, 225 S.E.2d 870 (1976).
• Virginia Public Document 07-150 (September 21, 2007).

Subject

Taxpayer's request to use an alternative method of allocating and apportioning income denied.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-138

Original ruling text

July 28, 2011

Re: Ruling Request: Allocation and Apportionment of Income

Dear *:

This will respond to your request that * (the "Taxpayer") be permitted to use an alternative method of apportionment for Virginia income tax purposes.

FACTS

The Taxpayer, a partnership headquartered in * (State A), invests in real estate entities throughout the United States including Virginia. The Taxpayer states the information concerning the income or loss of each entity is readily available. Because the Taxpayer believes that this information allows it to allocate the income or loss from its interests in Virginia, it requests permission allocate income to Virginia based on separate accounting for the 2010 taxable year and thereafter.

RULING

If the entire business of the pass-through entity is not deemed to have been transacted or conducted within the Commonwealth, then such pass-through entity's income from Virginia sources is the portion of income allocated and apportioned to Virginia in the same manner as corporations. See Public Document (P.D.) 07-150 (9/21/2007). Accordingly, partnerships that have income that is subject to tax in Virginia and at least one other state are required to apportion income as provided in Va. Code §§ 58.1-408 through 58.1-421.

The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state's method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Manufacturing Company v. G. D. Bair, etc. , 437 U.S. 267 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.

An apportionment formula used as an approximation of a corporation's income reasonably related to the activities conducted within a taxing state will only be disturbed when the taxpayer has proved by "clear and cogent evidence" that the income attributed to the state is in fact " out of all appropriate proportion to the business transacted . . . in that state," Hans Rees' Sons, Inc. v. North Carolina , 283 U.S. 123, 135 (1931), or has "led to a grossly distorted result," Norfolk & Western Railroad Company v. Missouri State Tax Commission , 390 U.S. 317, 326 (1968).

Title 23 of the Virginia Administrative Code (VAC) 10-120-280 provides that the statutory method of allocation and apportionment is inequitable if: 1) it results in double taxation of the income, or a class of income, of the taxpayer; and 2) the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.

The Department's long-standing policy holds the use of separate accounting in disfavor. See Department of Taxation v. Lucky Stores, Inc. , 217 Va. 121, 225 S.E.2d 870 (1976). The Taxpayer has not provided any evidence that demonstrates the statutory apportionment method is inequitable. The fact that separate accounting produces a different result from the statutory method is not sufficient to show the statutory apportionment method is inequitable.

In addition, the Taxpayer has not followed the established procedure for requesting an alternative apportionment method. 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 due. 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: (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 the context of a ruling request, when a taxpayer does not provide the Department with the opportunity to examine the records underlying the claim, the taxpayer cannot demonstrate that Virginia's factor formula produces an unreasonable or distorted result. Further, because constitutional apportionment is designed to approximate income from business transactions within a state and not result in actual income from business transactions within a state, a taxpayer's argument that Virginia's statutory method does not reflect actual income in Virginia cannot be accepted.

The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Based on the facts presented, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer. Furthermore, the Taxpayer's request is not in accordance with the procedure for requesting an alternative method of allocation and apportionment outlined ins Title 23 VAC 10-120-280. Based on the foregoing, I must deny the Taxpayer's request to use an alternative method of allocating and apportioning income.

The Code of Virginia and regulation sections 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, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4793524384.o