How should a Virginia combined-return filer treat at-cost intercompany reimbursements, partnership factors, and a foreign subsidiary with a Virginia employee?

Subject

Sales-factor, partnership-factor, and foreign-subsidiary treatment on a combined return

Plain-English summary

Virginia gave the combined-return filer three separate answers. First, reimbursements billed at cost to related entities were not included in the sales factor when the transactions produced no gain or loss. The Department treated those reimbursements as lacking the arm's-length character required for apportionment-factor receipts.

Second, the corporation had to include its proportionate share of property, payroll, and sales from both partnerships in which it was a general partner. It also had to attribute factors from a third partnership because its limited partnership interest was 15%, above the Department's 10% safe-harbor condition for certain passive limited partners.

Third, a foreign subsidiary organized and commercially domiciled in the Marshall Islands was not subject to Virginia corporate income tax and could not be included in the combined return. The subsidiary had a Virginia employee, but all of its trade or business income came from outside the United States and it had no federal taxable income from which Virginia taxable income could begin.

What this means for you

• Related-party cash receipts do not automatically enter the sales factor; the economic substance and whether the transaction creates gain or loss matter.
• A corporate partner may need to blend its proportionate share of partnership property, payroll, and sales into its own Virginia factors.
• A limited partnership label alone did not avoid factor attribution where the ownership interest exceeded 10%.
• Virginia payroll can create an apportionment factor, but this ruling found no Virginia taxable income where the foreign corporation had no federal taxable income and all business income was foreign.

Common questions

Were at-cost reimbursements included in the sales factor?

No. The ruling said transactions with no gain or loss were not arm's-length business transactions for apportionment-factor purposes.

Did the 15% limited partnership interest require factor attribution?

Yes. The taxpayer exceeded the 10% condition in the Department's stated limited-partner standard.

Did one Virginia employee make the foreign subsidiary taxable?

Not under the facts presented. The subsidiary had no federal taxable income because all trade or business income was earned outside the United States, so it had no Virginia taxable income and could not be included in the combined return.

Citations and references

• Va. Code §§ 58.1-301, 58.1-302, and 58.1-443.
• 23 VAC 10-120-20, 10-120-190(C), and 10-120-330.
• Virginia Public Documents 88-226, 88-235, 92-116, and 95-19.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-148

Original ruling text

October 8, 2009

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will reply to the ruling request concerning the apportionment factors of * (the "Taxpayer"), and the taxability of a foreign subsidiary. I apologize for the delay in the Department's response.

FACTS

The Taxpayer files a combined Virginia corporation income tax return and requests guidance on three issues regarding corporate income tax. Each issue will be addressed separately below.

RULING

Sales Factor: Intercompany Transactions

The Taxpayer incurs expenses that are billed and reimbursed at cost by subsidiaries and other related entities. The Taxpayer asks whether the proceeds from these transactions should be reported in its sales factor.

Intercompany transactions can be included in gross receipts used to compute the sales factor if the affiliates deal with each other at arm's length as if they were ordinary customers. See Public Document (P.D.) 92-116 (6/29/1992). If no gain or loss is realized, the transaction is not an arm's length business transaction for apportionment factor purposes and the proceeds from the transaction would not be included in the sales factor.

Partnership Factor Attribution

The Taxpayer is the general partner in two limited partnerships, Partnership A and Partnership B, respectively. It also holds a 15% limited partnership interest in Partnership C. The Taxpayer asks whether it must include the partnerships' factors in its own apportionment factors.

The Department has previously ruled that a corporation that holds an interest in a partnership must include its proportionate share of partnership property, payroll and sales in its own factors for purposes of apportioning Virginia taxable income. See P.D. 88-226 (7/29/1988). It appears that the Taxpayer would be required to include its proportionate share of partnership property, payroll and sales of both Partnership A and Partnership B in its apportionment formula for Virginia because it is a general partner in both partnerships.

In P.D. 88-235 (8/10/1988), however, the Department ruled that a corporation that was a limited partner was not required to include its share of partnership property, payroll and sales for purposes of determining its Virginia apportionment factor. The Department modified the limited partnership policy in P.D. 95-19 (2/13/1995). In that ruling the Department set forth the standard, pending the promulgation of regulations, under which no partnership attribution of apportionment factors would be required. For corporate limited partners, proportionate attribution of a partnership's apportionment factors is not required if:

(1) a corporation holds a limited partnership interest; (2) all general partners are unrelated third parties; (3) the combined partnership interests held by the corporation and all related parties constitute 10% or less of the profit and capital interests of the limited partnership; and (4) the structure is not a device primarily designed to avoid Virginia taxation of the limited partnership's income.

In the instant case, the Taxpayer holds more than a 10% limited partnership interest in Partnership C and would be required to include its proportionate share of Partnership C's property, payroll and sales in its own factors for purposes of apportioning Virginia taxable income.

Controlled Foreign Corporations

One of the Taxpayer's related entities (FS) is a corporation organized and commercially domiciled in the * (Country A) that is a wholly owned subsidiary of the Taxpayer through several foreign and domestic subsidiaries. FS files Form 1120-F with the Internal Revenue Services (IRS), but reports no federal income tax liability. FS also has an employee that lives in Virginia for which it is required to report Virginia payroll for purposes of unemployment compensation. The Taxpayer asserts that FS is a controlled foreign corporation (CFC) and requests a ruling as to whether FS is subject to Virginia income tax and must file as part of the Taxpayer's combined Virginia return.

Virginia Code § 58.1-443 provides that a consolidated or combined Virginia corporate income tax returns cannot include a controlled foreign corporation (CFC) if the source of its income is derived without the United States. Title 23 of the Virginia Administrative Code (VAC) 10-120-330 provides that: a CFC is a corporation that is 1) organized under the laws of a foreign country; 2) commercially domiciled in a foreign country, and 3) an affiliate of one or more corporations having income from Virginia sources. The income of a CFC is derived from sources without the United States if such CFC is not subject to income tax under the federal statutes, and dividends paid by such CFC would qualify as "foreign source income" under Va. Code § 58.1-302.

In this case, FS is organized under the laws of the Marshall Islands and its commercial domicile is in that country. The question becomes whether all of FS's income is derived from sources outside the United States.

Generally, a corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. See the definition of "income and deductions from Virginia sources" under Title 23 VAC 10-120-20. There is a presumption that total wages reported to Virginia for unemployment compensation purposes represent compensation paid or accrued in Virginia. See Title 23 VAC 10-120-190 C.

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. For corporate income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with federal taxable income (FTI). Because FS derives all of its income from a trade or business conducted outside the United States, it does not have any FTI and would therefore have no income subject to Virginia tax. As such, even though FS has employees in Virginia, it would not be subject to Virginia income tax and could not be included in the Taxpayer's Virginia combined return.

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

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1331567246.B