Could a Virginia corporation exclude wages of employees working solely overseas from its payroll-factor numerator by substituting wages subject to Virginia income-tax withholding?

Subject

Overseas employees and the Virginia payroll-factor numerator

Plain-English summary

Virginia would not replace the corporate payroll-factor numerator with wages subject to Virginia income-tax withholding. Withholding and payroll-factor rules can produce different amounts: wages can be included in one calculation and excluded from the other.

Wages reported to the Virginia Employment Commission were strongly presumed to be compensation paid or accrued in Virginia because the unemployment-reporting and payroll-factor tests are similar. But that presumption was rebuttable. If an employee performed no services in Virginia, the compensation did not have to be attributed to Virginia for the payroll factor.

The company had asserted that many employees worked only in foreign countries, but it had not provided objective evidence showing their work locations.

Result: the proposed withholding-based numerator was rejected, but the company received 60 days to provide clear evidence identifying employees who worked solely outside Virginia. Audit staff would reconsider and adjust the assessment if warranted.

What this means for you

• Do not use Virginia withholding wages automatically as the corporate payroll-factor numerator.
• Treat VEC-reported wages as presumptively Virginia payroll unless records rebut that treatment.
• Keep employee-by-employee evidence showing where services were actually performed.
• Analyze base of operations, direction or control, and residence when an employee performs some services in Virginia.

Common questions

Q: Did Virginia finally rule that every VEC-reported wage belonged in the numerator?

A: No. It treated those wages as strongly presumed Virginia compensation but allowed the company to rebut the presumption.

Q: Were withholding records enough to rebut it?

A: No. The Department required evidence of the employees' actual work locations.

Citations and references

• Va. Code §§ 58.1-412 and 58.1-413.
• Va. Code § 60.2-217(A)(2).
• 23 VAC 10-120-190 and 23 VAC 10-120-200.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-166

Original ruling text

August 18, 2015

Re: § 58.1-1821 Application: Corporate Income Tax

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, 2010, and 2011.

FACTS

The Taxpayer, a corporation headquartered in Virginia, provided security services to certain agencies of the United States government. The Department audited the Taxpayer for the 2010 and 2011 taxable years and made a number of adjustments. One of the adjustments was to increase the numerator of the Taxpayer's Virginia payroll factor based on the amount of employee wages the Taxpayer reported to the Virginia Employment Commission (VEC). The Taxpayer appeals the adjustment, contending that the compensation for the services of its employees who worked exclusively overseas should have been excluded from the payroll factor numerator. The Taxpayer asserts that the numerator should equal the amount of employee wages subject to Virginia income tax withholding.

DETERMINATION

Virginia's payroll factor is a fraction, the numerator of which is the total amount paid or accrued in Virginia during the tax period by the corporation for compensation, and the denominator is the total compensation paid everywhere during the taxable year. See Va. Code § 58.1-412. Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-120-190, total wages reported to the Virginia Employment Commission (VEC) are presumed to be compensation paid to employees in Virginia.

Under Va. Code § 60.2-217 A 2, compensation must be reported to the VEC if the employment is not localized in any state but is performed to some extent in Virginia and either:

1. the base of operations is located in Virginia,

2. the place from which such employment is directed or controlled is in Virginia,

3. the base of operations or place from which such employment is directed or controlled is not in any state in which a portion of the employment is performed, but the employee resides in Virginia.

The Department adjusted the numerator of the Taxpayer's payroll factor for each of the taxable years at issue to reflect the amount of wages the Taxpayer reported to the VEC. The Taxpayer, however, contends that the presumption that wages reported to the VEC are compensation paid to employees in Virginia is rebuttable. The Taxpayer asserts that the majority of its employees worked exclusively in foreign countries and that wages were reported to the VEC only as an administrative convenience because it was not practical to determine each employee's state of residence for purposes of state unemployment insurance reporting.

There is a strong presumption that total wages reported to Virginia for unemployment compensation purposes represent compensation paid or accrued in Virginia. See Public Document (P.D.) 02-127 (10/6/2002). The presumption exists because the tests for determining whether compensation must be reported to the VEC under Va. Code § 60.2-217 A are nearly identical to the tests for determining when compensation is deemed paid or accrued in Virginia for purposes of the Virginia payroll factor under Va. Code § 58.1-413. See also Title 23 VAC 10-120-200. The presumption, however, is rebuttable. See P.D. 87-80 (2/27/1987). Even if the compensation is not subject to the provisions of the Virginia Unemployment Compensation Act (Title 60.2 of the Code of Virginia ), it must nevertheless be included in the numerator of the Virginia payroll factor if it is deemed paid or accrued in Virginia under Va. Code § 58.1-413. See Title 23 VAC 10-120-190 C.

If none of an employee's service is performed in Virginia, the compensation does not need to be reported to the VEC or attributed to Virginia for purposes of the payroll factor. See P.D. 14-158 (8/28/2014). If the employee performs some part of the service in Virginia, however, additional analysis is required. Under such circumstances, compensation will be deemed paid or accrued in Virginia under Va. Code § 58.1-413 3 if:

a. The base of operations or, if there is no base of operations, the place from which the service is directed or controlled is in the Commonwealth; or

b. The base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the employee's residence is in the Commonwealth.

The Taxpayer asserts that many of its employees only performed services in foreign countries during the taxable years at issue, and, as a result, compensation paid to these employees should be excluded from the payroll factor numerator. The Taxpayer has provided no objective evidence, however, indicating where its employees were performing services.

The Taxpayer asks that the Department accept as the numerator of the payroll factor the aggregate amount of employee wages from which it was required to withhold Virginia income tax. The Department, however, has found that compensation on which the withholding is based may not be the same as the amount of compensation paid or accrued in Virginia for purposes of the Virginia payroll factor. For example, the Department has held that an employer may be required to withhold Virginia income tax from employee wages even if it does not have a positive payroll factor. See P.D. 12-­151 (9/21/2012). In addition, compensation may be included in the numerator of the payroll factor even if it is not subject to income tax withholding. See P.D. 91-180 (8/26/1991). Thus, there are circumstances in which wages and salaries subject to Virginia income tax withholding may not reflect the entire amount to be included in the payroll factor.

Accordingly, the Department will not accept the Taxpayer's proposed numerator for the payroll factor. Recognizing, however, that the VEC reports may have overstated Virginia payroll, the Taxpayer will be afforded the opportunity to submit clear, cogent evidence to show which of its employees included on the VEC reports performed services solely outside Virginia. The Taxpayer must submit additional evidence concerning the location the employees in question during the taxable years at issue within 60 days of the date of this letter to: *, Interstate Auditor, P.O. Box 2509, Dallas, Georgia 30132-9998. If the information is not received within the allotted time, the Department's assessment will be considered to be correct and collection actions may resume.

Once the documentation is received, the audit staff is instructed to reconsider the amount of the payroll factor numerator consistent with the policies set forth in this determination and adjust the assessment if warranted. If the Taxpayer is not satisfied with the result of that review, it may appeal to the Tax Commissioner pursuant to Va. Code § 58.1-1821.

The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5970894583.M