Were a Virginia telephone cooperative and its taxable subsidiary exempt from Virginia corporate income tax?

Plain-English summary

Virginia did not find the cooperative exempt on the information supplied, and it held that the wholly owned subsidiary remained taxable. A Virginia-chartered telephone company could qualify under Va. Code § 58.1-401(6) if it operated exclusively as a local mutual association and did not accumulate profits for, or pay dividends to, members.

That state exemption was distinct from the federal IRC § 501(c)(12) rule requiring at least 85% member-source income. A qualifying local mutual could remain state-exempt even in a year it failed the federal test. But the cooperative did not provide documents Virginia requested, and its State Corporation Commission-certified gross receipts appeared inconsistent with the claimed exemption. Virginia therefore did not confirm exempt status.

The subsidiary was a separate communications corporation, was not itself a local mutual association, and did not inherit a parent's possible exemption merely because it joined a federal consolidated return. Virginia required the subsidiary to file and pay corporate income tax.

Common questions

Q: Did federal cooperative status automatically decide the Virginia exemption?
A: No. Virginia applied its own statutory local-mutual-association requirements.

Q: Did a consolidated federal return exempt the subsidiary?
A: No. The subsidiary had to qualify independently and did not meet the stated exemption.

Citations and references

• Va. Code §§ 58.1-301, 58.1-400, 58.1-400.1, and 58.1-401(6); Va. Code §§ 56-485 et seq.
• IRC §§ 501(c)(12) and 512; Treas. Reg. § 1.1502-6.
• 15 U.S.C. §§ 381-384 (P.L. 86-272).
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Roanoke City Circuit Court, Law No. 82-0846 (Oct. 27, 1983).
• Virginia Public Documents 85-45, 91-273, 93-35, and 96-395.

Subject

Telecommunications cooperative in Virginia

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-14

Original ruling text

March 2, 2012

Re: Request for Ruling: Corporate Income Tax

Dear *:

This is in response to your letter in which you request a ruling concerning the tax exempt status of your client, * (the "Taxpayer"), and its wholly owned subsidiary (Sub) for Virginia income tax purposes. I apologize for the delay in responding to your request.

FACTS

You represent that the Taxpayer is a telecommunications cooperative in Virginia pursuant to Telephone Cooperatives Act, Va. Code § 56-485 et seq. The Taxpayer does not accumulate profits and does not pay dividends. It does retain patronage capital, which is distributed to members of the association. Under Internal Revenue Code (IRC) § 501(c)(12), the Taxpayer is generally exempt from federal income tax so long as at least 85% of its income results from amounts collected from members and for the sole purposes of meeting losses and expenses. When the Taxpayer fails to meet the 85% test, it is required to file a federal corporate income tax return and has elected to include Sub in a consolidated filing.

Sub, a communications corporation commercially domiciled in Virginia, is subject to federal income tax and files a separate income tax return except when it is eligible to be included in a consolidated return with the Taxpayer.

The Taxpayer requests a ruling that it is exempt from Virginia income tax to the extent that it does not have unrelated business taxable income (UBTI) and that the consolidated income of the Taxpayer and Sub is exempt from Virginia income tax.

RULING

Telephone Cooperatives

Under Va. Code § 58.1-401 6, no corporate income tax levied pursuant to Va. Code § 58.1-400 or minimum tax on telecommunications companies levied pursuant to Va. Code § 58.1-400.1 is imposed on a telephone company, chartered in Virginia, operating exclusively as a local mutual association and is not designated to accumulate profits for the benefit of, or to pay dividends to, its shareholders or members. The Taxpayer asserts that the Internal Revenue Service (IRS) has defined a "mutual association" in its Exempt Organizations Determinations Manual to include telephone companies. Accordingly, the Taxpayer believes it would be exempt from Virginia income tax.

Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the IRC, unless a different meaning is clearly required. As such, Virginia's conformity to federal law is limited to the actual use of a specific term in a Virginia statute. Further, conformity does not extend to terms, concepts, or principles specifically provided for in Title 58.1 of the Code of Virginia .

The Department has not been able to identify any section of the IRC that defines or refers to the term "local mutual association." Accordingly, the Department is not bound by a definition from a manual published by the IRS.

In general, a mutual association is a non-stock association organized and operated for the benefit of its members. Further, the requirement that the telephone company be a local mutual association infers that the members benefiting from the cooperative are located within a reasonable proximity of one another.

The facts provided indicate that the Taxpayer does not accumulate profits and pay dividends from such profits to its members. As such, if it is operating exclusively as a local mutual association, it would be exempt from corporate income and telecommunications minimum tax even though it may be subject to federal income tax because less than 85% of its income meets the test prescribed in IRC § 501(c)(12).

For corporate income tax purposes, Virginia generally "conforms" to federal law in that it starts the computation of Virginia taxable income with federal taxable income (FTI). As such, a taxpayer exempt from tax under IRC § 501 will also be exempt from Virginia income tax unless such taxpayer has incurred unrelated business taxable income (UBTI) as defined in IRC § 512. Under such circumstances, the taxpayer must file a Virginia return and pay Virginia income tax on such income. See Public Document (P.D.) 85-45 (3/08/1985).

The Taxpayer believes that it would be exempt from income tax under Va. Code § 58.1-401 6, and would, therefore, not be subject to Virginia income tax on its UBTI. By reason of their character as legislative grants, statutes relating to exemptions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Department of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

By letter dated April 8, 2011, the Department requested the Taxpayer to provide additional documentation in order to allow a thorough evaluation of this case. To date, the Taxpayer has not provided the requested information.

Further, Virginia Code § 58.1-400.1 C specifies that "The State Corporation Commission shall certify to the Department the . . . gross receipts for each telecommunications company." It has been the Department's longstanding policy that the State Corporation Commission (SCC), not the Department, determines the components of gross receipts. See Public Document (P.D.) 91-273 (10/23/1991). In addition, the Department has determined on several occasions that certified gross receipts cannot be changed without approval from the SCC. See P.D.s 93-35 (2/24/1993) and 96-395 (12/31/1996). Absent any other documentation, the fact that the Taxpayer has gross receipts certified by the SCC appears to indicate that it is not exempt under Va. Code § 58.1-401.

Subsidiaries of Tax Exempt Corporations

The Taxpayer submits that, if it is exempt from Virginia income tax, its subsidiary should also be covered under the exemption. For taxable years in which the Taxpayer is required to file federal income tax returns, Sub is included in a federal consolidated return. For taxable years that the Taxpayer is exempt, Sub files a separate income tax return except when it is eligible to be included in a consolidated return with the Taxpayer. When the Taxpayer fails to meet the 85% test, it is required to file a federal corporate income tax return and has elected to include Sub in a consolidated filing. The Taxpayer believes the income of Sub is actually income of the Taxpayer when it is included in the federal consolidated return and is not subject to Virginia income tax.

As indicated previously, exemptions must be strictly construed against the taxpayer and in favor of the taxing authority. The exemption under Va. Code § 58.1-401 6 is specifically limited to a telephone company, chartered in the Virginia, operating exclusively as a local mutual association. The facts provided do not indicate that Sub is a local mutual association.

Further, under Treas. Reg. § 1.1502-6, members of a group included in a federal consolidated return are severally liable for the tax for the taxable year in which they were included. It is clear from the facts provided that Sub is not exempt from federal income tax.

Virginia Code § 58.1-400 imposes an 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" unless a corporation meets one of the exemptions under Va. Code § 58.1-401 or is pursuant to Public Law 86-272, codified at 15 U.S.C. §§ 381-384. Based on the facts presented, Sub does not meet any of these exemptions. As such, Sub would be subject to Virginia income tax and must file Virginia income tax returns.

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

The Code of Virginia sections and public documents 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/1-4702888198.o