Did a distributor create Virginia corporate-income-tax nexus by holding title to inventory at a related Virginia manufacturer's plant for three to seven days?

Plain-English summary

Corporation B had Virginia corporate-income-tax nexus because it owned inventory stored in Virginia. Corporation A manufactured goods at its sole Virginia facility and transferred title to Corporation B when production ended. The goods remained there for three to seven days before shipment to Corporation B's out-of-state customers.

Inventory counted as property for Virginia's apportionment factor. Corporation B therefore had a positive Virginia property factor and Virginia-source income. The storage also went beyond solicitation protected by P.L. 86-272, even though Corporation B had no Virginia employees or facilities and paid no storage fee.

Corporation A's treatment depended on its filing status. With all property and payroll in Virginia and no contrary evidence, Virginia presumed that Corporation A did business entirely in Virginia and could not apportion on a separate return. A combined return would likewise attribute all of Corporation A's income to Virginia.

If Corporation A belonged to an affiliated group filing a consolidated Virginia return and another member was taxable in another state, the group as a whole could allocate and apportion. In that setting, Corporation A's goods placed with a common carrier for known out-of-state customers would be excluded from the Virginia sales-factor numerator.

Common questions

Q: Did a three-to-seven-day inventory stay count as Virginia property?
A: Yes. Corporation B held title while the inventory remained at the Virginia plant.

Q: Did P.L. 86-272 protect Corporation B?
A: No. Storing inventory in Virginia exceeded protected solicitation.

Q: Were Corporation A's outbound sales automatically excluded from its Virginia sales factor?
A: No. The stated exclusion depended on a consolidated filing context and known ultimate destinations outside Virginia.

Citations and references

• Va. Code §§ 58.1-405 and 58.1-400.
• 15 U.S.C. §§ 381-384 (P.L. 86-272).
• 23 VAC 10-120-120, 10-120-160(A)(2)(a), and 10-120-220(A)(2).
• 23 VAC 10-120-321(A), 10-120-322(A), and 10-120-323(A).
• IRC § 1502.
• Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992).

Subject

Nexus; Positive property factor subject to corporate income tax.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-168

Original ruling text

October 23, 2012

Re: Ruling Request: Corporate Income Tax

Dear *:

This is in response to your letter in which you request a ruling regarding nexus and the Virginia sales factor. I apologize for the delay in responding to your letter.

FACTS

Corporation A is a manufacturer jointly owned, 80% by a related entity (Corporation B) and 20% by a common parent corporation. Both Corporation B and the common parent are headquartered outside Virginia.

Corporation A's sole facility is located in Virginia. Corporation A sells its finished products exclusively to Corporation B for distribution throughout the United States. Corporation B takes title to the goods at the end of the manufacturing process. The finished goods remain at Corporation A's manufacturing facility for three to seven days until they are shipped by common carrier to Corporation B's customers located outside of Virginia.

Corporation B does not have any facilities or employees in Virginia. All orders for finished goods are received at Corporation B's headquarters. Corporation B does not pay rent or a storage fee for the temporary storage of its inventory pending transport. At the time the title is transferred, both Corporation A and Corporation B know the customer's name and the destination of the shipments. The cost of labor for preparing the products for shipping is borne by Corporation A. Corporation B bears the cost of shipping.

You request a ruling as to whether the sale of the goods must be reported in the numerator of Corporation A's sales factor and whether Corporation B has nexus for Virginia corporate income tax purposes.

RULING

Corporation A

Under Va. Code § 58.1-405, a corporation is presumed to be doing business entirely within Virginia if its business activities within another state are such that the other state does not have jurisdiction to impose a net income tax, a franchise tax measured by net income, or a privilege tax measured by net income. The actual imposition of a net income, franchise, or privilege tax is not required, but the state must have jurisdiction, if it so chooses, to impose a tax measured by net income. See Title 23 of the Virginia Administrative Code (VAC) 10-120-120. Thus, before the Department can address the issue of Corporation A's sales factor, a determination must be made as to whether Corporation A is doing business entirely within Virginia.

Public Law (P.L.) 86-272, as codified at 15 U.S.C. §§ 381-384, 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). The Department has a longstanding policy of narrowly interpreting the provisions of P.L. 86-272.

In this case, all of Corporation A's property and payroll are located within Virginia. Under such circumstances, the Department finds it doubtful that Corporation A would be subject to a net income, franchise, or privilege tax in any other state. Without any evidence to the contrary, the Department must presume that Corporation A is doing business entirely within Virginia and would not be eligible to apportion its income.

The facts presented do not specify if Corporation A is a member of an affiliated group for Virginia income tax purposes. If a separate return is filed, only the income, expenses, gains, losses, allocable income and apportionment factors will be included in the return. See Title 23 VAC 10-120-321 A. As indicated above, Corporation A would be subject to tax on all of its income if it uses a separate filing status.

Under the combined filing status, a corporation allocates and apportions income using its commercial domicile and apportionment factors. See Title 23 VAC 10-120-323 A. Again, Corporation A would attribute all of its income to Virginia and the resulting tax would be combined with the income tax liabilities of the other members of the combined group to determine the group's income tax.

Under Title 23 VAC 10-120-322 A, the return of an affiliated group that has elected to file consolidated returns will show the consolidated net income prepared in accordance with Internal Revenue Code (IRC) § 1502 and applicable regulations and consolidated apportionment factors. In Public Document (P.D.) 91-293 (11/19/1991), the Department ruled that a consolidated group, as a whole, determines if it is eligible to allocate and apportion income. As such, if any member is subject to tax in another state, then the entire group's taxable income is allocated and apportioned. With respect to a consolidated sales factor, all sales by any member into other states would be excluded from the numerator regardless of whether the member is actually subject to tax in another state or where its property and payroll are located.

In this case, Corporation A manufactures products specifically to fill orders placed by Corporation B. The orders submitted by Corporation B indicate the amount of products ordered, Corporation B's customer, and shipping information. Once Corporation A has finished goods sufficient to fill an order, they are packed and shipped to Corporation B's customers via common carrier.

The Department has previously ruled that direct delivery in Virginia to an independent carrier designated by the purchaser for transportation purposes does not constitute a sale attributable to Virginia, when the seller knows the ultimate recipient of the merchandise is located outside of Virginia. See P.D. 91-248 (10/8/1991), P.D. 91-­277 (10/29/1991), P.D. 95-42 (2/13/1995), and Title 23 VAC 10-120-220 A 2.

Based on the facts presented, Corporation A would know the ultimate destination of the goods that are going to be transported outside Virginia. Accordingly, if Corporation A is a member of an affiliated group that files consolidated Virginia returns, sales placed in transport for shipment to Corporation B's customers outside Virginia would not be included in the numerator of the Virginia sales factor.

Corporation B

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.

The Taxpayer contends that Corporation B does not have property in Virginia because Corporation A's sales are attributed outside of Virginia for apportionment purposes. Corporation B has no sales or payroll in Virginia. It does however, take title to inventory that it maintains in Virginia for three to seven days prior to its shipment outside of Virginia. Title 23 VAC 10-120-160 A 2 a includes "inventory" as property for purposes of the Virginia property factor. Therefore, Corporation B would have a positive property factor for apportionment purposes.

Virginia has held that the storage of inventory in a state goes beyond the mere solicitation of sales that is protected by P.L. 86-272. See P.D. 92-125 (7/17/1992). Further, the Department's longstanding policy is that the presence of inventory in Virginia subjects a corporation to income tax. See P.D. 02-132 (10/8/2002) and P.D. 97-447 (11/10/1997). Based on the information provided, I must conclude that Corporation B would have income from Virginia sources because the inventory would create a positive property factor and would be subject to Virginia corporate income tax.

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, regulations, 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

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