Could a corporation use alternative records to support cost-of-performance changes to its Virginia sales factor?

Plain-English summary

Virginia did not immediately grant or finally deny the corporation's refund claims. Instead, it allowed the taxpayer to submit alternative documentation supporting where its income-producing activities occurred for purposes of the 2012 and 2013 sales-factor numerators.

For sales other than tangible personal property, the ruling applied an all-or-nothing cost-of-performance test: a transaction was a Virginia sale if a greater portion of the relevant costs occurred in Virginia than in any other state. The Department said no single type of documentation works for every business, but taxpayers must retain suitable records substantiating their returns.

The taxpayer received 60 days to provide detailed descriptions of its business sectors, methodologies, and supporting records. Refunds would be issued only to the extent the evidence supported the amended sales factors; an adverse audit response could then be appealed within 90 days.

The official page's metadata labels this as individual income tax, but the operative ruling text repeatedly identifies corporate income tax returns and corporate refund claims. This page follows the ruling body.

Common questions

Did Virginia approve the refunds? Not yet. Approval depended on the Department's review of the additional documentation.

Was one prescribed cost schedule mandatory? No. The ruling accepted that different evidence may substantiate different businesses, provided it adequately supports the sourcing result.

Citations and references

• Va. Code §§ 58.1-416, 58.1-102, and 58.1-1821
• 23 VAC 10-120-230
• General Motors Corp. v. Commonwealth, 268 Va. 289, 602 S.E.2d 123 (2004)
• Virginia Tax Bulletin 05-3

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-117

Original ruling text

June 8, 2018

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek a refund of corporate income tax paid by * (the “Taxpayer”) for the taxable years ended December 31, 2012, and 2013.

FACTS

The Taxpayer filed amended Virginia corporate income tax returns for the 2012 and 2013 taxable years, in each case adjusting its sales factor numerator and claiming refunds. The Department denied the refunds on the basis that the Taxpayer did not provide adequate documentation to substantiate which sales should not have been attributed to Virginia based on cost of performance. The Taxpayer appealed, contending that although it could not provide the specific documentation the Department requested, it has alternative documentation for the Department to review.

DETERMINATION

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 Virginia 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). This 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 Virginia Code § 58.1-416 in a manner similar to Virginia Code § 58.1-418, taxpayers, including pass-through entities, 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.

The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct costs associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would not be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.

The Department denied the refunds on the basis that the Taxpayer failed to substantiate the changes to its sales factor numerator. The Department asked for a schedule showing a breakdown of costs associated with generating the income by category and state. After the Taxpayer stated that it would not be able to provide the cost breakdown by states, the refunds were denied.

Ultimately, whether a sale transaction should be attributed to Virginia based on cost of performance is a question of fact, to be determined based upon a review of all of the relevant facts and circumstances. There is not one particular kind of documentation that substantiates cost of performance for all businesses in all circumstances. Taxpayers, however, are required to retain suitable records and documents substantiating all information contained on any return. See Virginia Code § 58.1-102. The Taxpayer explains that it had four business sectors that used one of three different cost of performance methodologies to determine the location of income-producing activities. The Taxpayer states that it has alternative documentation to support where transactions were attributed under these methodologies.

Accordingly, the Taxpayer is instructed to forward its documentation for review and include a detailed description of its business sectors and a detailed explanation of its cost of performance methodologies. The information should be sent within 60 days of the date of this letter to *, Tax Auditor, Office of Compliance, Desk Audit, Audit/Office Audit, P.O. Box 26829, Richmond, Virginia 23261-6829. The information will be reviewed and refunds will be issued to the extent the information adequately substantiates the changes to the Taxpayer's sales factor numerator. Upon completion of the review, the audit staff is directed to issue a response to the Taxpayer communicating the result of the review. If the Taxpayer is not satisfied with the outcome of the review, the Taxpayer may file an appeal within 90 days of the Department's response under Virginia Code § 58.1-1821.

The Code of Virginia sections and regulations 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/1520.M