Did small Virginia limited-partnership interests create apportionment or income-tax consequences for a corporation and pension trust?

Plain-English summary

Virginia allowed the corporation to use its limited-partner standard without attributing the partnerships' Virginia property, payroll, and sales factors, but it did not extend that treatment to the pension trust. Both entities were based outside Virginia, held less than 10% interests, and had no other Virginia operations.

For the corporation, the interests satisfied the four conditions in P.D. 95-19: limited-partner status, unrelated general partners, combined related-party ownership of 10% or less, and no structure primarily designed to avoid Virginia tax. The ruling therefore found the corporation met the standard for avoiding partnership-factor attribution.

The qualified pension trust received a different answer. Virginia said P.D. 95-19 did not apply to pension trusts. Partnership income kept its source character when passed through, so the trust would likely owe Virginia fiduciary income tax if its distributive share included income from business conducted in Virginia.

What this means for you

• Entity type matters; a corporate limited-partner rule may not apply to a trust.
• For the corporate standard, test ownership, related parties, general-partner relationships, and tax-avoidance purpose together.
• Passing the 10% ownership threshold alone is not enough; all four conditions must be met.
• A nonresident trust should trace each partnership item's Virginia source.
• Partnership income generally keeps the same character in the partner's hands.

Common questions

Q: Did the corporation's partnership interests create Virginia apportionment factors?
A: Not under the stated facts, because all four P.D. 95-19 conditions were met.

Q: Did the same safe standard protect the pension trust?
A: No. Virginia expressly said it did not apply to qualified pension trusts.

Q: Could the trust owe Virginia tax without its own employees or offices here?
A: Yes. Virginia-source income passed through from partnerships could create fiduciary income-tax liability.

Citations and references

• IRC §§ 501(c)(3), 401(a), and 702(b).
• Va. Code §§ 58.1-400, 58.1-408 through 58.1-421, 58.1-360, 58.1-362, 58.1-363, and 58.1-391 B.
• Virginia Public Documents 95-19 and 06-18; P.D. 88-235, 92-60, and 94-240 are also discussed.

Subject

Income tax of the limited partnership interests held by a Corporation and a Trust

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-169

Original ruling text

September 6, 2013

Re: Request for Ruling: Corporate and Fiduciary Income Tax

Dear *:

This will reply to your letter in which you request a ruling with respect to limited partnership interests held by * (the "Corporation") and *** (the "Trust").

FACTS

The Corporation, commercially domiciled outside Virginia, is exempt from income tax under Internal Revenue Code (IRC) § 501(c)(3). The Trust is a qualified pension trust under IRC § 401(a) for the benefit of employees of the Corporation. Neither entity has physical presence or any other operations in Virginia.

Each entity receives alternative investment income from limited partnerships that conduct business in Virginia. The entities own less than 10% limited partnership interests in each of the pass-through entities. To the extent that the entities own interests in the same partnership, the aggregate limited partnership interest is less than 10%. Neither entity is related to the general partners of the limited partnerships. A ruling is requested as to Virginia income tax implications of the limited partnership interests held by the Corporation and the Trust.

RULING

Corporate Income Tax

Virginia Code § 58.1-400 imposes income tax "on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources." 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. The existence of positive Virginia apportionment factors clearly establishes income from Virginia sources. Corporations that have income from business both within and without Virginia are required to compute their Virginia source income in accordance with the statutory formula set forth in Va. Code §§ 58.1-408 through 58.1-421.

In Public Document (P.D.) 95-19 (2/13/1995), the Department ruled that a corporate limited partner is generally required to include its proportionate share of the partnership's property, payroll and sales with its own property, payroll and sales for purposes of determining its Virginia apportionment factor. In addition, the Department also set forth a standard, pending the promulgation of regulations, under which no partnership attribution of apportionment factors would be required if (1) a corporation holds a limited partnership; (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 interest of the limited partnership; and (4) the structure is not a device primarily designed to avoid Virginia taxation of the limited partnership's income.

Although the Department recognized in P.D. 88-235 (8/10/1988) that limited partnership interests were, in many cases, more akin to passive investments than to operational activities, it had to modify its position on a number of occasions due to the expanding array of investment and business opportunities available through limited partnerships. See P.D. 92-60 (5/1/1992) and P.D. 94-240 (8/5/1994). For this reason, the policy in P.D. 95-19 was established to provide a bright line test as to when a limited partnership interest is exempted from passing its property, payroll and sales attributes through to a taxable entity. The established policy requires a limited partnership interest to meet all four tests in order to avoid apportionment factor attribution.

In the instant case, the Corporation's limited partnership interest in the pass-through entities does not exceed 10%, and the Corporation is not related to any of the general partners. Additionally, the Corporation has attested that none of the arrangements are primarily designed to avoid Virginia taxation of the limited partnership's income. Based on the information provided, the Corporation's limited partnership interests would meet the standard provided in P.D. 95-19.

Fiduciary Income Tax

Virginia Code § 58.1-360 provides that trusts are liable for Virginia income tax on Virginia taxable income. Virginia taxes a nonresident trust on its gross income from sources within Virginia less expenses attributable to the income from Virginia sources reduced by the amount of income from Virginia sources distributed to beneficiaries. See Va. Code §§ 58.1-362 and 58.1-363.

You contend that, pursuant to P.D. 95-19, the Trust would be exempt from having to include the apportionment factors from the limited partnerships. The Department has ruled that P.D. 95-19 does not apply to qualified pension trusts holding limited interests in partnerships or limited liability companies. See P.D. 06-18 (2/07/2006).

Virginia generally conforms to the federal treatment of partnerships. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners. IRC § 702(b) states, "The character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share . . . shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership." Each item of partnership income, gain, loss or deduction has the same character for a partner for Virginia income tax purposes as for federal income tax purposes. See Va. Code § 58.1-391 B.

Virginia Code § 58.1-362 provides that the Virginia taxable income of a nonresident trust is its share of income, gain, loss and deduction attributable to Virginia sources with certain adjustments. According to the information provided, the Trust may own property in Virginia through limited partnership interests. The Trust receives income from these partnerships that is generated in part from business conducted in Virginia. As such, if a portion of the income from a pass-through entity is Virginia source income, the Trust would likely be liable for Virginia income tax.

This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's website. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-538624768.o