Could an out-of-state partnership use separate accounting instead of Virginia's statutory apportionment formula for 2012?

Subject

Partnership did not justify or properly request separate accounting

Plain-English summary

Virginia denied an out-of-state partnership's request to use separate accounting instead of the statutory apportionment formula. The partnership had Virginia-source income in 2012 and sold real estate in its home state. It argued that Virginia's formula substantially increased the income taxed by Virginia and that other states allowed separate accounting.

Pass-through entities doing business in Virginia and another state had to allocate and apportion income under the corporate rules. A different result from separate accounting did not by itself make the statutory formula inequitable. The taxpayer needed clear and cogent evidence that the formula attributed income out of all appropriate proportion, produced a gross distortion, or caused double taxation attributable to Virginia.

No such evidence was supplied. Virginia also disfavored separate accounting because constitutional apportionment is an approximation of in-state business activity, not a calculation of actual transaction-by-transaction income.

The partnership also used the wrong procedure. It first needed to file under the statutory method and pay the tax, then submit an amended return within the refund period explaining the claimed inequity and proposed alternative. A ruling request without access to the underlying records could not establish the required distortion.

What this means for you

• A lower tax result under separate accounting is not enough for alternative apportionment.
• The evidence must show unconstitutional distortion or Virginia-caused double taxation under the cited standards.
• Follow the filing, payment, amended-return, explanation, and documentation procedure before requesting relief.
• Another state's allocation method does not make Virginia's formula inequitable.

Common questions

Why did the out-of-state property sale not justify separate accounting?

The taxpayer showed a different result but did not prove unconstitutional or inequitable attribution.

What procedural step was missing?

It had not filed and paid under the statutory method and then claimed an alternative through an amended refund return.

How exceptional was alternative relief?

Virginia described it as available only in extraordinary circumstances supported by clear and cogent evidence.

Citations and references

• Va. Code §§ 58.1-408 through 58.1-421, including § 58.1-421.
• 23 VAC 10-120-280.
• Moorman Manufacturing Company v. G. D. Bair, etc., 437 U.S. 267 (1978).
• Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123 (1931).
• Norfolk & Western Railroad Company v. Missouri State Tax Commission, 390 U.S. 317 (1968).
• Department of Taxation v. Lucky Stores, Inc., 217 Va. 121, 225 S.E.2d 870 (1976).
• Virginia Public Documents 07-150, 85-61, 86-88, 92-85, 06-13, 07-75, and 11-138.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-86

Original ruling text

June 10, 2013

Re: Ruling Request: Allocation and Apportionment of Income

Dear Sir:

This will respond to your request that * (the "Taxpayer") be permitted to use an alternative method of apportionment for Virginia income tax purposes.

FACTS

The Taxpayer, a limited partnership headquartered in * (State A), had Virginia source income for the taxable year ended December 31, 2012. During the year, the Taxpayer sold real estate located in State A. The Taxpayer claims that using Virginia's statutory method of apportionment substantially increases the amount of income subject to tax by Virginia. According to the Taxpayer, because it is permitted to use separate accounting to attribute income in other states, it should be able to use separate accounting in Virginia. The Taxpayer, therefore, requests permission to allocate income to Virginia based on separate accounting for the 2012 taxable year.

RULING

If the entire business of the pass-through entity is not deemed to have been transacted or conducted within the Commonwealth, then such pass-through entity's income from Virginia sources is the portion of income allocated and apportioned to Virginia in the same manner as corporations. See Public Document (P.D.) 07-150 (9/21/2007). Accordingly, partnerships that have income that is subject to tax in Virginia and at least one other state are required to apportion income as provided in Va. Code §§ 58.1-408 through 58.1-421.

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 Manufacturing Company v. G. D. Bair, etc. , 437 U.S. 267, 98 S.Ct. 2340 (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 appropriate 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 Railroad Company 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), P.D. 85-61 (3/18/1985), P.D. 86-88 (4/30/1986), P.D. 92-85 (6/1/1992), P.D. 06-13 (2/7/2006), P.D. 07-75 (5/18/2007), and P.D. 11-138 (7/28/2011). The Taxpayer has not provided any evidence that demonstrates the statutory apportionment method is inequitable. The fact that separate accounting produces a different result from the statutory method is not sufficient to show the statutory apportionment method is inequitable.

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: (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, because constitutional apportionment is designed to approximate income from business transactions within a state and not result in actual income from business transactions within a state, a taxpayer's argument that Virginia's statutory method does not reflect actual income in Virginia cannot be accepted.

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, the Taxpayer has 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 sections, regulations, 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 ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5351824026.o