Could a corporation reduce Virginia's related-party factoring-expense add-back by bad debts and cash discounts because a prior audit accepted that method?

Subject

Related-Party Factoring Expense Add-Back

Plain-English summary

A corporation's disregarded LLC sold accounts receivable at a discount to an affiliated holding company. For 2008 and 2009, the corporation added back the factoring expense but reduced it by the affiliate's bad debts and cash discounts.

Virginia required the full factoring expense to be added back. The statutory definition of intangible expenses included losses connected with factoring transactions, and the corporation did not establish that any listed exception applied.

The corporation argued that a prior audit had accepted its net calculation. Virginia found no evidence that the earlier auditor had been specifically aware of or approved that methodology. Prior processing therefore did not override the Department's rule that the entire related-party factoring expense was subject to add-back, and the assessments were upheld.

What this means for you

• Related-party factoring losses fall within Virginia's intangible-expense add-back.
• Bad debts and cash discounts do not automatically reduce the factoring expense.
• A taxpayer must establish a statutory exception to avoid the full add-back.
• Prior audit treatment is weak support without evidence that the auditor knowingly decided the same issue.

Citations and references

• Va. Code §§ 58.1-402 B 8 a and 58.1-302.
• P.D. 13-211, P.D. 09-67, P.D. 09-68, P.D. 10-286, and P.D. 13-156.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-223

Original ruling text

July 26, 2017

Re: § 58.1-1821 Application: Corporate Income Tax

Dear *:

This will reply to your letter in which you seek reconsideration of the Department's determination letter, issued as Public Document (P.D.) 13-211 (11/12/2013), to * (the “Taxpayer”) for the taxable years ended December 31, 2008 and 2009. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer was the sole owner of a single member limited liability company, * (OLLC), which was treated as a disregarded entity for federal income tax purposes. OLLC sold accounts receivables at a discount to *** (IHC). The Taxpayer filed Schedule 500AB with its 2008 and 2009 Virginia corporate income tax returns and added back the factoring expense net of bad debts and cash discounts incurred by IHC.

Under audit, the Department adjusted the add-back to include the full amount of the factoring expense on the basis that there is no exception for the reduction reported by the Taxpayer. The Taxpayer filed an appeal, contending that the bad debts and cash discounts were not intangible expenses and costs required to be added-back.

In P.D. 13-211, the Department denied the Taxpayer's request for an abatement of the assessments because it determined that “intangible expense and costs” subject to the add-back include all expenses related to or incurred in connection with factoring transactions without any reduction. The Taxpayer seeks a reconsideration, asserting that the add-back should be net of bad debts and cash discounts incurred by IHC because the Department allowed this methodology on a prior audit.

DETERMINATION

Virginia Code § 58.1-402 B 8 a provides that there shall be added back to the extent excluded from federal taxable income:

[T]he amount of any intangible expenses and costs directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with one or more members to the extent that such expenses and costs were deductible or deducted in computing federal taxable income for Virginia purposes.

Virginia Code § 58.1-302 specifically defines “intangible expenses and costs” to include losses related to or incurred in connection with factoring transactions. Several exceptions to the add back requirement are detailed in Va. Code § 58.1-402 B 8 a. In P.D. 13-211, the Department determined that the Taxpayer was required to add-back all intangible expenses related to its factoring transactions because no exceptions to the add-back requirement applied.

In its request for reconsideration, the Taxpayer relies on the fact that in an audit for the 2005 and 2006 taxable years, the Department adjusted the add-back for the factoring expense in accordance with calculations provided by the Taxpayer. Those calculations included intangible expenses net of bad debts and cash discounts. The Taxpayer asserts that because this methodology was accepted in a prior audit, it should also be allowed for the taxable years at issue.

While the Taxpayer's computation of the intangible addition was allowed, no evidence has been presented that the prior auditor was specifically aware of the Taxpayer's methodology. Furthermore, the Department has held that the entire factoring expense is subject to the add-back unless an exception enumerated in Va. Code § 58.1-402 B 8 a applies. See P.D. 09-67 (5/13/2009), P.D. 09-68 (5/13/2009), P.D. 10-286 (12/22/2010) and P.D. 13-156 (8/13/2013).

After reviewing the additional information provided in your letter and the audit reports, I find that the auditor properly computed the add-back of the factoring expense for the taxable years ended December 31, 2008 and 2009. Accordingly, the Department's assessments are upheld. An updated bill, with accrued interest to date, will be mailed to the Taxpayer. No further interest will accrue provided the outstanding balance is paid within 30 days from the date indicated on the revised bill.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/540.B