Source: https://www.grantthornton.com/library/alerts/tax/2018/SALT/U-Z/VA-endorses-direct-labor-method-out-of-state-BPOL-tax-assessment-11-27.aspx
Timestamp: 2019-04-18 11:16:11+00:00

Document:
On Sept. 26, 2018, the Virginia Department of Taxation rejected a city’s assessment of Business, Professional, and Occupational License (BPOL) tax which relied upon the taxpayer’s payroll apportionment to source its gross receipts in computing the out-of-state deduction.1 The case was remanded for the city to recalculate the out-of-state deduction. The taxpayer had originally sourced its gross receipts using the direct labor method, which was accepted by the city during audit and explicitly endorsed by the Department.
Upon its second review of the refund claim, the city issued a final local determination which used payroll apportionment, rather than the originally employed direct labor method, to calculate the out-of-state deduction. The taxpayer appealed to the Department again, arguing that the city erroneously computed the deduction.
BPOL ruling With another opportunity to consider the matter, the Department first considered the receipts sourcing issue. The city’s final local determination stated that the taxpayer sitused gross receipts using payroll apportionment, under which the entire payroll of the taxpayer’s business was used to determine how to source gross receipts. This was contrary to the taxpayer’s contention that it had used the actual direct labor sourcing method. Under direct labor sourcing, gross receipts are sourced to out-of-state locations by including labor charges made by each employee located in the city as the numerator of a ratio, and the total labor cost charged to these same contracts by all of the taxpayer’s employees across the country as the denominator. The resulting ratio (the direct labor percentage), was multiplied by total receipts from all of the contracts worked on by the employees working at the city’s definite place of business to determine gross receipts attributable to the city, which was the amount eligible for the out-of-state deduction.
In its first ruling covering this matter, the Department had upheld use of the direct labor method in the computation and further indicated that “payroll apportionment provides only a reasonable estimate and has been used only as a method of last resort.” Therefore, the Department confirmed that the use of the direct labor method provided a substantially more accurate measurement than payroll apportionment.
To be eligible for the deduction, the taxpayer had to complete the second step of identifying the taxable gross receipts actually attributable to business conducted in another state in which it filed an income tax return and paid income tax.
The Department questioned why the city ultimately determined the out-of-state deduction for the taxpayer by multiplying gross receipts sitused outside the city by the direct labor percentage. Finding the calculation at odds with the city’s position that the taxpayer used payroll apportionment to compute the deduction, the Department declined to rule on the accuracy of the new calculation. Instead, it noted the lack of clarity in the computation and remanded the case to the city in order to recalculate the taxpayer’s out-of-state deduction for the tax periods at issue in accordance with the Department’s first decision in this matter. The Department left open the possibility that the city could issue another determination that the taxpayer may disagree with, which could result in the Department’s third evaluation of this matter.
With Virginia BPOL filings due on March 1, 2019, taxpayers that are subject to the BPOL tax should consider their current BPOL tax apportionment methodology.
In its decision, the Department explicitly noted that the use of modern technology, coupled with cost accounting methodologies, could allow many businesses to accurately situs gross receipts without adding a significant administrative burden. It will be interesting to see if the Tax Commissioner applies similar reasoning to other areas of Virginia taxation that rely upon considerable amounts of information to compute necessary measures. For example, one conceivably could apply this rationale to the computation of the sales factor for corporate income tax purposes to argue that taxpayers may accurately source gross receipts based on a reasonable method.
1 Ruling of Commissioner, P.D. 18-168, Virginia Department of Taxation, Sept. 26, 2018.
2 VA. CODE ANN. § 58.1-3703.A.
3 VA. CODE ANN. § 58.1-3706.A.
4 VA. CODE ANN. § 58.1-3703.1.A.3(a).
5 VA. CODE ANN. § 58.1-3732.B.2.
6 Ruling of Commissioner, P.D. 17-93, Virginia Department of Taxation, June 9, 2017.
7 23 VA. ADMIN. CODE § 10-500-80a, Example B1. In this example, a merchant is permitted to deduct all gross receipts from the sale of goods to a North Carolina resident because the merchant filed a North Carolina income tax return.
8 Ruling of Commissioner, P.D. 17-159, Virginia Department of Taxation, Sept. 8, 2017.
9 Nielsen Co. (US), LLC v. County Board of Arlington County, 767 S.E.2d 1 (Va. 2015).

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