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On April 9, 2018, Virginia Gov. Ralph Northam signed legislation modifying several apportionment factor provisions. Specifically, eligible companies operating in qualified localities may elect to modify their Virginia apportionment method by reducing their property, payroll, and/or sales factor numerators based on certain investments for tax years beginning on or after Jan. 1, 2018.1
Also, for tax years beginning on or after Jan. 1, 2019, debt buyers must utilize a single sales factor to apportion Virginia taxable income.2
For sourcing purposes, debt buyers generally must source to Virginia amounts recovered on debt collected from Virginia residents or entities with a Virginia commercial domicile, instead of using a cost of performance sourcing approach.
Incentives for eligible companies
New legislation allows eligible companies operating in qualified localities to apportion Virginia taxable income using modified apportionment factors and to qualify for certain grants and loans.
An eligible company is defined as a corporation or pass-through entity with no existing property or payroll in Virginia as of Jan. 1, 2018, which meets three conditions between Jan. 1, 2018 and the end of 2024:
- Either (i) spends at least $5 million on new capital investment and creates at least 10 new jobs in one or more qualified localities or (ii) creates at least 50 new jobs in one or more qualified localities
- Directly or indirectly derives more than 50% of its revenue from out-of-state sources (i.e., is a traded-sector company)
- Is certified by the Virginia Economic Development Partnership Authority as generating a positive fiscal impact3
The annual determination of whether a company will generate a positive financial impact is based on several factors, including job creation, private capital investment, and anticipated additional state and local tax revenue.4
The Virginia Economic Development Partnership Authority is tasked with developing guidelines for this certification process.5
New capital investment includes acquisitions of or improvements to real property located in one or more qualified localities from 2018 to 2024. To qualify as a new job, a position must be permanent, full-time and of indefinite duration, pay at least 150% of the minimum wage, and require a minimum of 35 hours of an employee’s time per week for the entire normal year of the eligible company’s operations or 1,680 hours per year.6
Qualified localities include real property in a locality adjacent to a qualified locality and, before Jan. 1, 2018, either: (i) was owned or partly owned by a qualified locality or an industrial development authority of which a qualified locality is a member; or (ii) was owned or partly owned by a locality or industrial development authority, was leased to a private party, and was subject to a revenue-sharing agreement providing that a portion of the revenues from the lease would be distributed to a qualified locality.7
Virginia generally requires the use of a three-factor formula with double-weighted sales for multistate corporations to apportion income to Virginia.8
However, special apportionment provisions have been adopted and apply to various entities, including motor carriers, financial corporations, construction corporations, railway companies, manufacturing companies, retail companies, and taxpayers with enterprise data center operations.9
Many of these entities are required to utilize a single sales factor apportionment method with market-based sourcing.
The new legislation generally allows a taxpayer the option to subtract from the numerator of the corresponding factor the value of its: (i) property acquired in any qualified locality or localities between 2018 and 2024; (ii) payroll attributable to jobs created between 2018 and 2024; and (iii) sales in Virginia during the taxable year.10
This election is available in the taxable year in which the taxpayer first becomes eligible and for six consecutive years, except for any year in which its total, cumulative new capital investment or number of new jobs fall below the applicable initial threshold.11
As with Virginia’s existing statutory apportionment provisions, special rules are included for motor carriers,12
and taxpayers with enterprise data center operations.18
The Virginia Department of Taxation is responsible for developing guidelines regarding these modifications and information about the modification of the apportionment method must be included in eligible taxpayers’ income tax returns.19
Grants and loans
The legislation authorizes the governor to give grants or loans to eligible companies from the Commonwealth Development Opportunity Fund.20
In order to qualify for up to $2,000 per new job per year, the company must distribute at least half of the grant or loan to its employees in jobs located in a qualified locality. Similarly, specified Virginia localities are also able to provide grants or loans to eligible companies.21
The legislation provides new provisions related to apportionment for debt buyers. Specifically, debt buyers are required to utilize a single sales factor to compute Virginia taxable income for years beginning on or after Jan. 1, 2019.22
For these taxpayers, only money recovered on debt collected from a Virginia resident or an entity with a Virginia commercial domicile should be sourced to Virginia for apportionment purposes.23
If the taxpayer does not have access to enough information to determine whether a sale other than a sale of tangible personal property is in Virginia pursuant to these provisions, the taxpayer may estimate the dollar value of the portion of the sale in Virginia, provided the estimate is undertaken in good faith, is a reasonable approximation of the dollar value of the portion of such sale in Virginia, and in using the estimate, the taxpayer did not have as its principal purpose the avoidance of tax due. The Department must implement procedures for obtaining approval to use an estimate and adopt remedies and procedures for cases in which it determines that the sourcing rules have been abused, which may include reliance on the location of income-producing activity and direct costs of performance.24
Notably, the legislation clarifies that income taxes on sales related to debt collected are to be imposed to the maximum extent permitted under federal and Virginia law. Also, it highlights that the legislative intent is for nexus to be asserted up to constitutional limits.25
The adopted changes continue Virginia’s recent trend of departing from the standard apportionment provisions for taxpayers, and providing incentives for certain industries to relocate to or expand in Virginia, while targeting at least one service industry that tends to negatively impact Virginia residents. The litany of apportionment options is relatively unique to Virginia and could certainly produce some distinctive results, especially for those companies that are engaged in manufacturing, for which an election to use a single sales factor may already be in place. Multi-entity taxpayers engaged in several of the specific industries that may qualify for a preferential apportionment regime could face difficulties in gathering the required details to complete their apportionment calculations.
Notably, the new legislation provides apportionment factor relief for companies investing in specified areas, as long as the election to apportion in such manner is made. One would expect the state to provide guidance relatively quickly, and perhaps create a form on which such an election may be made. Over the next several years, the state is likely to track whether this type of incentive translates to a significant amount of increased investment in desired areas, or whether it ultimately is utilized by just a handful of taxpayers.
The adoption of specific apportionment rules for debt buyers reflects the notion that a pure cost of performance, multi-factor apportionment method, in the view of the state, does not fairly reflect income for all taxpayers. Historically, for sales of items other than tangible personal property (such as services), the treatment of such sales for purposes of Virginia sales factor apportionment requires an analysis of where the service provider’s costs are located. Under this cost of performance rule, out-of-state debt buyers generally do not have to source any receipts from their activities to Virginia, and may not have a current corporation income tax filing requirement in Virginia, if their activities are performed completely outside Virginia, even when some of the activities economically affect in-state debtors in an adverse manner.
The combination of the new sourcing rule, along with the shift from three-factor sourcing to a single sales factor could result in nexus challenges by the state, and a potentially dramatic increase in Virginia corporation income tax liability for some out-of-state debt buyers. However, the allowance of a reasonable method to debt buyers that do not have the information available to use the statutorily required method of sourcing may somewhat mitigate the impact of this new rule to debt buyers when it takes effect next year.
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