I amended my corporate return to fix an apportionment mistake and I'm owed a refund -- do I still need to document the numbers, or does the Department just have to accept my corrected calculation?

Plain-English summary

A corporation had already gone through one round with the Department (P.D. 18-117) over refunds claimed on amended 2012 and 2013 Virginia corporate income tax returns; that earlier ruling told the taxpayer to submit more information to substantiate the refunds. After more back-and-forth (including a referral to the Department's audit unit and further document requests), the audit staff concluded the taxpayer still hadn't substantiated the refunds, and the taxpayer appealed again.

The underlying legal issue was apportionment, and here the taxpayer's correction was legally sound: one of its business sectors had originally apportioned ALL its sales to Virginia using payroll apportionment, when the sector's contracts actually mixed sales of tangible personal property with sales of services (and some contracts combined both). Virginia sources these two categories differently -- tangible personal property sales go to the DESTINATION where the property is delivered, while service sales (and other non-tangible-property sales) go based on COST OF PERFORMANCE, meaning wherever the greater proportion of the income-producing activity actually happened. The taxpayer submitted amended returns applying the correct destination-basis and cost-of-performance methods instead of blanket payroll apportionment.

Even though the taxpayer's original returns were wrong on the law, that alone doesn't guarantee a refund. Virginia Code § 58.1-1823 only allows a refund once the Department is actually SATISFIED that the originally-paid tax exceeded the correct amount -- which gives the Department authority to scrutinize the evidence behind an amended return's numbers, not just accept the taxpayer's corrected total. Here, several documentation problems doomed the refund claim: the supporting schedules didn't reconcile to the sales figures actually reported on either the original or amended returns; some of the workpapers covering "most of the change" related to a SEPARATE ENTITY that didn't even appear to be part of the taxpayer's combined-return affiliated group; and there was no underlying documentary trail (invoices, customer ledgers, or cost-of-performance accounting records) connecting the corrected numbers to actual transactions. Because a proper factual foundation was never established, the refunds were denied -- not because the correction method was wrong, but because the Department couldn't verify the resulting dollar amounts.

What this means for you

Corporations discovering an apportionment error and filing amended returns for a refund

Being right about the correct SOURCING METHOD (destination basis for tangible property, cost of performance for services) isn't enough by itself. You need documentation that actually reconciles to your reported figures -- invoices or customer ledgers showing delivery destinations for tangible property sales, and accounting records showing where the greatest proportion of costs/activity occurred for service contracts. Generalized explanations of what changed and why, without a traceable numeric foundation, won't satisfy the Department's review.

Corporate groups filing combined returns

If your supporting workpapers for a refund claim rely heavily on data from an entity that isn't part of your affiliated group's combined return, expect the Department to flag that as a documentation gap -- make sure your workpapers are scoped to the actual reporting entities on the return being amended.

Businesses with contracts that mix tangible property and services

Don't apply a single apportionment method (like payroll apportionment) across an entire business sector if the underlying contracts actually split between tangible personal property sales (destination-based) and service sales (cost-of-performance based). Misapplying one method to both can produce a large, and largely unsupportable, swing when later corrected.

Common questions

Q: If I prove my original apportionment method was legally wrong, is the Department required to grant my refund?
A: Not automatically. Virginia Code § 58.1-1823 requires the Department to be affirmatively satisfied, based on the evidence, that the originally-paid tax exceeded the correct amount -- being right about the correct method is necessary but not sufficient without documentation that reconciles to your reported numbers.

Q: How does Virginia source sales of tangible personal property versus sales of services for corporate apportionment?
A: Tangible personal property sales are sourced to the DESTINATION where the property is delivered. Sales other than tangible personal property (including services) are sourced based on COST OF PERFORMANCE -- attributed to Virginia only if the greater proportion of the income-producing activity, measured by cost, occurred in Virginia versus any other single state.

Q: What kind of documentation does the Department expect for an apportionment-correction refund claim?
A: Records that reconcile to the amounts on the return -- for tangible property, documentation like journals, customer ledgers, or invoices showing delivery destinations; for services, accounting records showing where the greatest proportion of costs were incurred. Generalized explanations without a traceable numeric foundation aren't sufficient.

Citations and references

• P.D. 18-117 (6/8/2018) (the Department's prior ruling in this same taxpayer's earlier appeal, directing submission of additional substantiating information)

Subject

Administration : Amended Return - Department's Authority to Review, Allocation and Apportionment : Sales Factor - Tangible Personal property, Other than Tangible Personal Property

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-128

Original ruling text

September 21, 2021

Re: § 58.1-1821 Application: Corporate 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. I apologize for the delay in responding to your appeal.

FACTS

In Public Document (P.D.) 18-117 (6/8/2018), the Department instructed the Taxpayer to submit additional information in order to substantiate the refunds claimed on its amended Virginia 2012 and 2013 corporate income tax returns. The additional information was referred to an audit unit for review, and subsequently more information was requested. Based on a review of all of the information submitted, the audit staff determined that the Taxpayer had still failed to substantiate the refunds claimed. The Taxpayer appealed, contending that the information it has provided is sufficient to support the issuance of the refunds.

DETERMINATION

Generally, Virginia Code § 58.1-1823 allows a taxpayer to file an amended return within three years from the last day prescribed by law for the timely filing of the return. The amended return shall supply all the information required in an original return and, in addition, the taxpayer must attach a statement explaining the changes made and the reasons for the changes. See Title 23 of the Virginia Administrative Code (VAC) 10-20-180 A 2.

If the Department is satisfied, by evidence submitted to it or otherwise, that the tax assessed and paid upon the original return exceeds the proper amount, the Department may reassess the taxpayer and order that any amount excessively paid be refunded to him. Any order of the Department denying such reassessment and refund, or the failure of the Department to act thereon within three months shall, as to matters first raised by the amended return, be deemed an assessment for the purpose of enabling the taxpayer to pursue the remedies allowed under Chapter 18 of Title 58.1 of the Code of Virginia .

Virginia Apportionment

The Taxpayer admits that one of its business sectors incorrectly apportioned sales to Virginia on the basis of payroll. The sector actually included contracts for both sales of tangible personal property, services, and a combination of both. When it discovered the mistake, the Taxpayer submitted amended returns using the correct apportionment methodologies for both sales of tangible personal property and all other sales.

Virginia statutes and regulations clearly set forth the apportionment methodology used to apportion sales to Virginia. In the case of sales of tangible personal property, Virginia attributes sales on a destination basis. See Virginia Code § 58.1-415 and Title 23 VAC 10-120-220. Under Virginia Code § 58.1-416, 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 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.

Based on Virginia statutes and regulations, the Taxpayer failed to properly calculate its sales factor for this business sector on its original returns. The Taxpayer was required to report the sales of tangible personal property resulting from this sector based on the destination to which the property was delivered, whether that be within or without Virginia. Revenue resulting from services or other than tangible personal property should have been reported based on the Taxpayer’s cost of performance.

Amended Returns

Because Virginia Code § 58.1-1823 allows for a refund only in cases in which the Department is satisfied by the evidence submitted to it or otherwise that the tax originally paid exceeds the proper amount, the Department has authority to scrutinize amended returns that claim refunds. A review of all of the information submitted to the Department in this case, including additional information submitted while this appeal was pending, indicates that the Taxpayer has provided some generalized explanations concerning the changes as well as schedules in support of the amended sales factor computations. While the explanations have helped the Department understand the reasons why the amended returns were filed, the schedules themselves still lack a proper factual foundation to enable the Department to verify the amount of refund claimed. A proper factual foundation could be established, for example, by documentation, such as journals, customer ledgers and invoices, showing the delivery destination of tangible personal property or accounting records that demonstrate where the greatest proportion of costs should be attributed for a service contract.

Further, workpapers provided while this appeal was pending do not reconcile with the Virginia sales reported on the original or amended returns for the business sector at issue. Documentation showing the computations should always reconcile to the amounts ultimately reported on the return. Without clear amounts showing the trail to source documents, it is impossible for the Department to determine the accuracy of the refund amount claimed.

Moreover, the Taxpayer also provided several worksheets for a specific entity, in an effort to show that this entity accounted for most of the change to the sales factor computation. This entity, however, does not appear to be included in the Taxpayer’s affiliated group and was not reported on the combined return schedules.

To date, the Taxpayer has not established a sufficient factual foundation to satisfy the Department that the refund amounts claimed are correct. See Virginia Code § 58.1-1823. Therefore, the refunds claimed on the amended 2012 and 2013 returns are denied.

The Code of Virginia sections, regulations and public document 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/3473.M

Related Documents

18-117