Could a Virginia locality deny the BPOL out-of-state deduction merely because the contractor used payroll apportionment to situs receipts?

Subject

Taxpayer is permitted a deduction for gross receipts attributable to business conducted in other states

Plain-English summary

Virginia ruled that payroll apportionment did not eliminate the contractor's BPOL deduction for qualifying out-of-state business. The government contractor had offices in Virginia, other states, and foreign countries and used payroll to approximate how much gross receipts belonged to its county location.

The out-of-state deduction covered receipts attributable to business in another state or country where the taxpayer was liable for an income or income-like tax. The Virginia Supreme Court and Department precedent allowed that deduction even when payroll apportionment was needed to situs receipts.

The determination clarified a three-step method after gross receipts were already sitused by payroll:

1. identify whether employees at the Virginia definite place participated in earning receipts from customers in other jurisdictions where the taxpayer filed an income-tax return;
2. determine the gross receipts eligible for deduction; and
3. multiply those eligible receipts by the same Virginia payroll factor used to situs gross receipts.

The case returned to the county to apply that method and revise the 2012 BPOL liability.

What this means for you

• Payroll situs is an approximation; it does not itself disqualify the separate out-of-state deduction.
• The other jurisdiction must be one where the taxpayer is liable for an income or income-like tax.
• Keep customer-level receipts, employee-participation evidence, payroll factors, and other-state returns aligned.

Common questions

Q: Did all out-of-state customer receipts qualify?
A: No. The ruling's example excluded receipts from a state where the taxpayer did not file an income-tax return.

Q: Was the full eligible out-of-state amount deducted?
A: No. The eligible receipts were multiplied by the Virginia payroll factor because only that portion had been approximated into Virginia situs.

Q: Did Virginia set the contractor's final deduction?
A: No. The county had to calculate it on remand.

Citations and references

• Va. Code §§ 58.1-3703.1 and 58.1-3732(B)(2).
• Ford Motor Credit Co. v. Chesterfield County, 281 Va. 321, 707 S.E.2d 311 (2011).
• Public Documents 10-228, 10-229, 12-88, 12-89, and 12-146.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-31

Original ruling text

March 5, 2014

Re: Appeal of Final Local Determination

Locality Assessing Tax: *

Taxpayer: *

Business, Professional and Occupational License Tax

Dear *:

This final state determination is issued upon the application for correction filed by * (the "Taxpayer") with the Department of Taxation. The Taxpayer appeals the assessment of Business, Professional and Occupational License (BPOL) tax issued to the Taxpayer by the *** (the "County") for the 2012 tax year.

The BPOL tax is imposed and administered by local officials. Virginia Code § 58.1-3703.1 authorizes the Department to issue determinations on taxpayer appeals of BPOL tax assessments. On appeal, a BPOL tax assessment is deemed prima facie correct, i.e. , the local assessment will stand unless the taxpayer proves that it is incorrect.

The following determination is based on the facts presented to the Department summarized below. The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site.

FACTS

The Taxpayer, a government contractor, had a definite place of business in the County, as well as offices located in other states and countries. For BPOL tax purposes, the Taxpayer sitused gross receipts using payroll apportionment for the taxable year at issue. It claimed an out-of-state deduction on its 2012 BPOL return.

The County audited the Taxpayer, disallowed the out-of-state deduction, and issued an assessment. The Taxpayer appealed the assessment to the County. In its final determination, the County determined the Department of Taxation over-reached its statutory authority and its determinations in Public Document (P.D.) 10-228 (9/29/2010) and P.D. 12-89 (5/31/2012) are inconsistent with applicable statutory requirements. The Taxpayer appeals the County's final determination, contending it qualified for the out-of-state deduction and it properly followed the Department's rulings in calculating the deduction.

ANALYSIS

Out-of-State Deduction

Virginia Code § 58.1-3732 B 2 provides a deduction from gross receipts otherwise taxable for any receipts "attributable to business conducted in another state or foreign country in which the taxpayer . . . is liable for an income or other tax based upon income." Because revenues are sitused by directly assigning receipts to a taxpayer's definite place of business, it would be entitled to claim the deduction for those gross receipts that are attributable to business conducted in another state or foreign country in which it was liable for an income or income like tax based on income.

In P.D. 10-228, the Department ruled that when gross receipts are apportioned by using the general payroll apportionment formula, the amount of the out-of-state deduction would be determined by multiplying the total out-of,-state gross receipts by the same payroll factor used to determine the situs of gross receipts. The Department further clarified how the out-of--state deduction should be computed when payroll apportionment is used to situs gross receipts in P.D.12-89 and P.D. 12-146 (8/31/2012).

The County argues that there is no statutory basis for allowing the out-of-state deduction when using payroll apportionment to situs gross receipts. Virginia Code § 58.1-3732 B 2 allows the deduction for gross receipts attributable to business conducted out-of-state. The Department has consistently held that using payroll apportionment to situs gross receipts does not prohibit a taxpayer from taking the out-of-state deduction. See P.D. 99-87 (4/23/1999), P.D. 04-80 (8/25/2004), P.D. 05-118 (7/19/2005), P.D. 09-146 (10/8/2009), P.D. 10-228 and P.D. 12-89. In addition, the Virginia Supreme Court, in Ford Motor Credit Co. v. Chesterfield County , 281 Va. 321, 707 S.E.2d 311 (2011), held that the out-of-state deduction is permitted even when payroll apportionment is used to situs gross receipts.

Payroll apportionment is a concept based on income tax principles. The legislature granted the use of this method for situsing gross receipts when the normal statutory methods were untenable. 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, 98 S.Ct. 2340 (1978). As such, the apportionment of gross receipts by using a taxpayer's payroll is a process designed to reasonably approximate gross receipts from business transactions within a locality.

In P.D. 10-228 and 10-229 (9/29/2010), the Department reasoned that because the situs of gross receipts using payroll apportionment is an approximation, any deduction for out-of-state gross receipts would be, at best, an estimate. In P.D. 12-88 (5/31/2012), P.D. 12-89 and P.D. 12-146, the Department set forth a methodology to compute the out-of-state deduction when a taxpayer must situs gross receipts using payroll apportionment. In promulgating its method, the Department considered whether the method met the statutory-requirements of Va. Code § 58.1-3732 B 2 in granting a deduction, whether it could reasonably be administered, and whether it could be applied uniformly.

Out-of-State Deduction Computation

After further reviewing the example in P.D. 12-89, the Department finds it necessary to clarify the three-step process for computing the deductions. The clarified process assumes gross receipts have already been sitused by payroll apportionment. The three steps to computing the out-of-state deduction when payroll apportionment is used to situs gross receipts are as follows:

1. Determine if employees from the definite place of business earn, or participate in earning receipts attributable to customers in other states where a taxpayer filed an income tax return;

2. Determine the receipts that are eligible for deduction; and

3. Multiply the receipts eligible for the deduction by the same payroll factor used to determine the situs of gross receipts.

An example of the out-of-state deduction computation when there is payroll apportionment follows:

T has definite places of business in a Maryland, North Carolina, Pennsylvania and a Virginia locality. Its employees from the Virginia locality participate in earning receipts attributable to each state where it has a definite place of business. T is required to file income tax returns in Virginia, Maryland, and North Carolina. The Taxpayer has total gross receipts of $1,000,000. Payroll is attributable as follows:

40% to Virginia

30% to Maryland

10% to North Carolina

20% to Pennsylvania

Using the three-step process as described above, the out-of-state deduction would be determined as follows:

1. Employees from T's definite place of business participate in earning gross receipts from customers located in Maryland, North Carolina and Pennsylvania.

2. The gross receipts eligible for the deduction would be computed by multiplying gross receipts ($1,000,000) by the combined payroll percentages of Maryland and North Carolina (40%). Gross receipts derived from customers in Pennsylvania are not eligible for the deduction because no income tax return is filed in Pennsylvania. Based on this computation, gross receipts eligible for the deduction would be $400,000 ($1,000,000 x 40%).

3. The out-of-state deduction would be the gross receipts eligible for the deduction ($400,000) multiplied by the Virginia payroll factor (40%). In this example, the out-of-state deduction would be $160,000 ($400,000 x 40%).

This deduction would be subtracted from gross receipts sitused to Virginia in determining gross receipts subject to the BPOL tax. In this example, gross receipts sitused to Virginia would be equal to total gross receipts ($1,000,000) multiplied by the Virginia payroll factor (40%) or $400,000. Subtracting the$160,000 out-of-state deduction from the $400,000 gross receipts sitused to the definite place of business results in $240,000 gross receipts on which BPOL tax could be assessed.

DETERMINATION

In accordance with this determination, the Taxpayer is permitted a deduction for gross receipts attributable to business conducted in other states. As such, I am remanding this case to the County in order to ascertain the appropriate amount of the out-of-state deduction using the methodology set forth in the example above and adjust the Taxpayer's BPOL tax liability for the 2012 tax year accordingly.

If you have any questions regarding this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5336970860.B