Could an out-of-state company obtain advance permission to replace Virginia's statutory apportionment formula with separate accounting?

Subject

Request is not in accordance with procedure for requesting a change in method

Plain-English summary

An out-of-state limited liability company earned income or loss from an investment in a business operating in Virginia. It asked to replace Virginia's statutory allocation and apportionment formula with separate accounting, arguing that this would better reflect Virginia income and that other states allowed it.

Virginia denied the request. A different result under separate accounting did not establish that the statutory formula was unconstitutional or inequitable, and another state's method did not control Virginia's rules. The taxpayer supplied no clear and cogent evidence of income out of all reasonable proportion to Virginia activity, gross distortion, or double taxation attributable to Virginia.

The request also did not follow the required procedure. A taxpayer had to file the original return using the statutory method and pay the tax, then file a timely amended return that proposed the alternative, explained the inequity, and supplied supporting records. The Department said an advance ruling could not provide the necessary examination of completed-period financial records.

What this means for you

• Alternative apportionment was described as extraordinary relief, not an elective accounting method.
• A lower result under separate accounting, standing alone, does not prove unconstitutional distortion.
• The procedural sequence matters: statutory return and payment first, then a timely documented amended refund claim.

Common questions

Was separate accounting automatically available because other states allowed it?

No. Virginia said it did not follow other states' apportionment procedures.

What evidence was required?

The taxpayer had to demonstrate an unconstitutional result or Virginia-caused double taxation under the standards in 23 VAC 10-120-280.

Why would Virginia not approve the method prospectively?

The Department said the necessary profit sources and completed financial records could not be examined through an advance ruling request.

Citations and references

• Va. Code § 58.1-421 and 23 VAC 10-120-280, alternative apportionment standards and procedure.
• Moorman Mfg. Co. v. Bair, rational relationship of an apportionment method to in-state business.
• Hans Rees' Sons, Inc. v. North Carolina and Norfolk & Western R. Co. v. Missouri State Tax Commission, disproportion and gross-distortion standards.
• Department of Taxation v. Lucky Stores, Inc., Virginia's disfavor of separate accounting.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-117

Original ruling text

July 19, 2007

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will reply to your letter in which you request an alternative method of allocation and apportionment on behalf of your client, * (the "Taxpayer").

FACTS

The Taxpayer is a limited liability company commercially domiciled in * (State A). The Taxpayer derives income or loss from an investment in *** (Company B), which conducts business in Virginia.

The Taxpayer asserts that the use of separate accounting would more accurately reflect the income subject to Virginia tax. It contends that other states allow the Taxpayer to use separate accounting. The Taxpayer requests permission to use an alternative method of allocation and apportionment because it avers that Virginia's statutory Method of allocation and apportionment is inequitable.

RULING

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). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.

An apportionment formula used as an approximation of a corporation's income reasonably related to the activities conducted within a taxing state will only be disturbed when the taxpayer has proved by "clear and cogent evidence" that the income attributed to the state is in fact "out of all reasonable proportion to the business transacted . . . in that state," Hans Rees' Sons, Inc. v. North Carolina , 283 U.S. 123, 135 (1931), or has "led to a grossly distorted result," Norfolk & Western R. Co. v. Missouri State Tax Commission , 390 U.S. 317, 326 (1968).

Title 23 of the Virginia Administrative Code (VAC) 10-120-280 provides that the statutory method of allocation and apportionment is inequitable if: 1) it results in double taxation of the income, or a class of income, of the taxpayer; and 2) the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.

The Department's long-standing policy holds the use of separate accounting in disfavor. See Department of Taxation v. Lucky Stores, Inc ., 217 Va. 121, 225 S.E.2d 870 (1976). The Taxpayer has not provided any evidence that demonstrates that the statutory apportionment method is inequitable. The fact that separate accounting produces a different result from the three-factor formula is not sufficient to show the statutory apportionment method is inequitable. Moreover, Virginia does not follow other state's apportionment procedures.

In addition, the Taxpayer has not followed the established procedure for requesting an alternative apportionment method. The policies that apply to requests for an alternative method of allocation and apportionment under Va. Code § 58.1-421 are well established. In order for a taxpayer to request an alternative method of allocation and apportionment, the taxpayer must file the return using the statutory method and pay any tax due. Next, the taxpayer is required to file an amended return proposing an alternative method within the time prescribed for filing amended returns claiming refunds. The amended return must include a statement of why the statutory method is inapplicable or inequitable and an explanation of the proposed method of allocation and apportionment. 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 VAC 10-120-280.

In the context of a ruling request, when a taxpayer does not provide the Department with the opportunity to examine the records underlying the claim, the taxpayer cannot demonstrate that Virginia's factor formula produces an unreasonable or distorted result. Further, even if other states allow separate accounting, a corporation's argument that Virginia's statutory method (rather than another state's method) causes an unconstitutional result will not be accepted without documentation revealing the sources of the corporation's profits. This cannot be done until after a corporation has fully accounted for and prepared its financial statements after the close of a taxable period. Consequently, it is impractical for the Department to issue an advanced ruling with regard to allocation and apportionment. The procedures set forth under Title 23 VAC 10-120-280 were designed for this purpose.

CONCLUSION

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, you have not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer. Furthermore, the Taxpayer's request is not in accordance with the procedure for requesting an alternative method of allocation and apportionment outlined in Title 23 VAC 10-120-280. Based on the foregoing, I must deny the Taxpayer's request to use an alternative method of allocating and apportioning income.

The Code of Virginia and regulation sections cited are available on-line at www.tax.virgiiiia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this ruling, please contact * in the Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

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