My nonprofit is domiciled in Virginia and owns limited-partnership interests that allocate income to other states -- can I exclude that out-of-state income from my Virginia UBTI?

Plain-English summary

A nonprofit educational institution domiciled in Virginia -- tax-exempt under IRC § 501(c)(3) except for its unrelated business taxable income (UBTI) -- owned less-than-10% limited-partnership interests in various investment partnerships. Those partnerships allocated their income among several states on their tax reporting documents. The Taxpayer originally reported all of its federally computed UBTI on its Virginia returns, then filed amended returns seeking refunds for the portion of partnership income the partnerships had allocated to states other than Virginia, arguing that income was "non-unitary investment function income" that Virginia had no constitutional right to tax.

Virginia's statutes don't allow separate accounting for this income. Virginia Code § 58.1-401 5 makes a nonprofit's Virginia corporate income tax apply to its UBTI as reported on its federal return. From that starting point, only certain dividends may be allocated under § 58.1-407 -- everything else, after the adjustments in §§ 58.1-402 and 58.1-403, is subject to apportionment. Nothing in the statute lets a nonprofit carve out its share of partnership income that happens to be allocated to other states on the partnerships' own reporting documents.

The request became a request for alternative apportionment -- and failed both prongs. Because there was no statutory basis to exclude the out-of-state-allocated income directly, the Department treated the Taxpayer's request as a request for an alternative method under Va. Code § 58.1-421. Under 23 VAC 10-120-280, that requires showing either (1) an unconstitutional result, or (2) inequity from double taxation that is attributable to Virginia specifically, not to another state's different apportionment scheme. The Taxpayer couldn't satisfy either prong: the Allied-Signal nondomiciliary-sourcing doctrine it invoked applies to what a state can tax of an out-of-state corporation, not to an entity domiciled in that state, and even treated as nonbusiness investment income, the partnership income would still be sourced to Virginia as the Taxpayer's state of commercial domicile.

Double taxation, but not Virginia's fault. The Department acknowledged double taxation could occur here, but explained that under Virginia's own policy, if the Taxpayer had instead been domiciled outside Virginia, none of the partnerships' property, payroll, or sales factors would ever have been attributed to it -- so any double taxation traces back to other states' claims on the income, not to Virginia's scheme. Because Virginia's apportionment method is internally consistent (it would tax no more than 100% of income if every state applied it), and non-discriminatory overlap between two internally consistent state schemes isn't unconstitutional, the Department denied the alternative-method request and upheld its denial of the refunds.

What this means for you

For Virginia-domiciled nonprofits and other entities with multistate passive investment interests

Owning limited-partnership interests that allocate income to other states on their own reporting documents doesn't let you shrink your Virginia tax base by that same amount. If you're domiciled in Virginia, your entire federally computed UBTI (or federal taxable income, for a for-profit corporation) is the starting point for Virginia apportionment, and only dividends get separate allocation treatment -- the partnerships' own income-allocation choices don't control your Virginia return.

For anyone invoking Allied-Signal to source investment income away from Virginia

Allied-Signal governs what minimal connections a state needs before it can constitutionally tax a NONdomiciliary corporation's income. If you're domiciled in Virginia, that doctrine doesn't help you -- and even if your income were treated as nonbusiness investment income outside the unitary business, it would still be sourced to Virginia as your commercial domicile, not excluded.

For anyone requesting an alternative apportionment method under Va. Code § 58.1-421

Double taxation alone doesn't win an alternative-method request. You must show the inequity is attributable to VIRGINIA's own scheme -- not simply that another state also taxes some of the same income under its own, different apportionment rules. If the income wouldn't have been attributed to you in Virginia at all under a different domicile scenario, the double taxation traces to the other state, not to Virginia, and the request will be denied.

Common questions

Q: My nonprofit is domiciled in Virginia, and the partnerships I invest in allocate some income to other states on their K-1s or similar documents. Can I exclude that allocated-elsewhere income from my Virginia UBTI?
A: No. Virginia law has no separate-accounting provision for this; your Virginia UBTI starts with your entire federally reported UBTI, and only certain dividends -- not partnership income generally -- can be allocated instead of apportioned.

Q: Doesn't Allied-Signal say a state can't tax non-unitary investment income unrelated to its in-state business?
A: Allied-Signal addresses what a state can tax of a NONdomiciliary corporation. If your entity is domiciled in Virginia, that doctrine doesn't apply, and your investment income is still sourced to Virginia as your state of commercial domicile even if treated as nonbusiness income.

Q: The partnerships' income is already being taxed by other states -- isn't taxing it again in Virginia unconstitutional double taxation?
A: Not necessarily. Double taxation from two different but each internally consistent state apportionment schemes isn't unconstitutional. To get relief from Virginia specifically, you must show the inequity is attributable to VIRGINIA's own method -- here, the Department found that if the Taxpayer had been domiciled outside Virginia, none of the partnerships' factors would have been attributed to it, so the double taxation traced to other states' claims, not Virginia's scheme.

Q: Is there any way to get Virginia to grant an alternative apportionment method in a situation like this?
A: Only in extraordinary circumstances proven by clear and cogent evidence -- either that the statutory method produces an unconstitutional result, or that it causes double taxation attributable specifically to Virginia. General assertions that partnership income was allocated elsewhere by the partnerships themselves aren't sufficient.

Citations and references

• Va. Code § 58.1-401 5 (a nonprofit's Virginia corporate income tax applies only to its unrelated business taxable income, as reported federally)
• Va. Code § 58.1-402 and § 58.1-403 (computation of entire federal taxable income, as adjusted and modified, as the starting point for apportionment)
• Va. Code § 58.1-407 (only certain dividends are allocated rather than apportioned)
• Va. Code § 58.1-421 (alternative method of allocation/apportionment; required standards)
• 23 VAC 10-120-280 (a statutory method is inequitable only if it causes double taxation attributable to Virginia, not to another state's different method)
• Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S. 768, 787 (1992) (governs the minimal connections needed for a state to constitutionally tax a NONdomiciliary corporation; inapplicable to a Virginia-domiciled entity)
• Moorman Mfg. Co. v. Bair, 437 U.S. 279 (1978) (apportionment is an inherently approximate process; a state's method is constitutionally valid if rationally related to business transacted within the state, even with some overlap)
• Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 169 (1983) (a state's apportionment method is internally consistent if, applied by every jurisdiction, it would tax no more than all of a taxpayer's income)
• Comptroller of the Treasury v. Wynne, 575 U.S. 542, 562 (2015) (double taxation resulting from two different but nondiscriminatory, internally consistent state schemes is not constitutionally prohibited)
• Public Document 97-285 (6/25/1997) and P.D. 02-67 (4/29/2002) (the Allied-Signal nondomiciliary doctrine does not apply to a taxpayer domiciled in Virginia)
• Public Document 07-197 (11/30/2007) (nonbusiness investment income is sourced to the taxpayer's state of commercial domicile)
• Public Document 95-19 (2/13/1995) and P.D. 88-235 (8/10/1988) (conditions under which a limited partner's share of a partnership's property, payroll, and sales factors are excluded from its own apportionment factors)

Subject

Allocation and Apportionment : Alternative Method - Passive Investment Income of Domiciled Entity

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-32

Original ruling text

February 15, 2022

Re: § 58.1-1821 Application: Corporate Income Tax

Dear *:

This will reply to your letter in which you appeal the Department’s denial of amended returns seeking a refund of corporate income tax paid by your client, * (the “Taxpayer”) for the taxable years ended June 30, 2015, 2016 and 2017. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer, a nonprofit educational institution domiciled in Virginia and generally exempt from federal income tax under Internal Revenue Code (IRC) § 501(c)(3), was subject to tax only on its unrelated business taxable income (UBTI). The Taxpayer owned less than 10% limited partnership interests in various investment partnerships (the “Partnerships”). The Partnerships issued tax reporting documents that allocated their income among various states. The Taxpayer’s original Virginia returns for the taxable years at issue included all UBTI reported on their federal returns in its Virginia taxable income. The Taxpayer later submitted amended returns requesting refunds of tax paid on income attributable to the Partnerships and not allocated to Virginia. Under review, the Department denied the refunds. The Taxpayer appealed, contending the income from the Partnerships should not be subject to Virginia income tax because it was non-unitary investment function income.

DETERMINATION

The Code of Virginia does not provide for the allocation of income other than certain dividends. A taxpayer’s entire federal taxable income, adjusted and modified as provided in Virginia Code § 58.1-402 and § 58.1-403, less dividends allocated pursuant to Virginia Code § 58.1-407, is subject to apportionment. In the case of a nonprofit, the Virginia corporate income tax applies to the extent of its UBTI. See Virginia Code § 58.1-401 5. Under the plain language of the statute, therefore, the Taxpayer must begin the calculation of Virginia taxable income with its UBTI as reported on its federal return. There is no provision in the law for separate accounting that would exclude from this starting point the Taxpayer’s proportionate share of income allocated to other states by the Partnerships. Accordingly, the Taxpayer’s exclusion of income that was allocated to other states by the Partnerships has been treated as a request for an alternative method of allocation and apportionment in accordance with Virginia Code § 58.1-421.

The Department will not grant an alternative method of allocation and apportionment unless it determines that: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer’s situation; or (2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state’s method of apportionment. See Title 23 of the Virginia Administrative Code (VAC) 10-120-280.

The Taxpayer asserts that the income in question is from a non-unitary investment unrelated to its operational activities within Virginia and, therefore, must be sourced under the principles established in Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 787 (1992). The decision of the United States Supreme Court in Allied-Signal , however, clarified that in order for a state to constitutionally tax a nondomiciliary corporation, certain minimal connections had to exist between the interstate activities and the taxing state. Because the Taxpayer is domiciled in Virginia, the judicial doctrines controlling Allied-Signal and prior cases do not apply to this situation. See Public Document (P.D.) 97-285 (6/25/97) and P.D. 02-67 (4/29/2002). Even if the Department concluded that the Partnerships’ income should be sourced as nonbusiness income under Allied-Signal , the income would still be sourced to Virginia as the Taxpayer’s state of commercial domicile. See P.D. 07-197 (11/30/2007).

The Taxpayer further contends that sourcing the Partnerships’ income to Virginia results in double taxation. The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state’s method of allocation and apportionment is rationally related to the business transacted within a state, then each state’s tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair , 437 U.S. 279 (1978).

The Department recognizes that double taxation may result in this case, but as stated above, in order to grant an alternative method of allocation and apportionment, that inequity must be attributable to Virginia, rather than another state’s method of apportionment. Based on the information known about the Taxpayer’s interests in the Partnerships, it appears that such interests would satisfy the conditions set forth in P.D. 95-19 (2/13/1995) and the Taxpayer’s share of the Partnerships’ property, payroll and sales would be excluded from its apportionment factors. See also P.D. 88-235 (8/10/1988).

Under Virginia’s policy, if the Taxpayer had been domiciled elsewhere and was only receiving passive investment income attributable to the Virginia activities of a partnership in which the Taxpayer had a limited partnership interest satisfying the conditions of P.D. 95-19, there would have been no attribution of the partnership’s property, payroll and sales factors to the Taxpayer. With no positive Virginia apportionment factors, the Taxpayer would not have been subject to Virginia income tax in that scenario. As such, the inequity was not attributable to Virginia’s system of taxation, rather to the other states to which the Taxpayer claimed it was liable to pay income tax. Because the application of Virginia law to these facts, if applied by every jurisdiction, would result in no more than all of the Taxpayer’s income being taxed, the policy meets the test of internal consistency. See Container Corp. of America v. Franchise Tax Board , 463 U.S. 159, 169 (1983). Further, tax schemes that may result in double taxation only as a result of two different but nondiscriminatory and internally consistent schemes are not constitutionally prohibited. See Comptroller of the Treasury v. Wynne , 575 U.S. 542, 562 (2015).

The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Based on the facts presented, it has not been demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer. Accordingly, I must deny the Taxpayer’s request to use an alternative method of allocating and apportioning income. Therefore, the denial of the requested refunds is upheld.

The Code of Virginia sections, regulation 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/3501.X

Related Documents

88-235

95-19

97-285

02-67

07-197