Virginia Rules that Intercompany Accounting Entry Creates Sales Tax Liability

Even though no cash was exchanged, a parent company was assessed sales tax on cost allocations to its subsidiaries.

By Denisse Beldin, SALT associate

It is not uncommon for a company to account for a transaction with its affiliate through an accounting entry whereby no actual monetary payment exchanges hands, whether it’s for interest on a loan or for the purchase of goods/services. However, just because no cash was exchanged doesn’t mean that there isn’t a sales tax obligation, as explained in a ruling of the Virginia Tax Commissioner issued on May 17, 2016. [1]

In that ruling, the taxpayer (“the parent”) was a holding company for various subsidiary companies that perform electrical and telecommunications contract work. The parent purchased equipment that is used interchangeably by the subsidiaries to perform the contract work. The parent paid sales/use tax at the time of purchase. The parent made cost allocations to each subsidiary for such subsidiary’s use of the equipment (this method was not intended to generate a profit for the parent).

The Virginia Department of Revenue (“DOR”) audited the parent and assessed sales tax on the amounts representing the cost allocations recorded as journal entries in the parent’s books. The DOR then provided a credit to the parent for sales/use tax paid at the time of its purchase.

The Commissioner ruled that the transactions were subject to sales tax because (i) they met the statutory definition of a taxable “lease or rental” and (ii) the parent was in the business of leasing and renting tangible personal property based on its activities. A “lease or rental” is defined as “the leasing or renting of tangible personal property and the possession or use thereof by the lessee or renter for a consideration, without transfer or title to such property.” [2] Specifically, with respect to the consideration requirement, the Commissioner noted that prior rulings had concluded that the use of intercompany transactions to account for the costs associated with the purchase or lease of tangible personal property constituted consideration. [3] The fact that there was no direct payment of cash, issuance of a note or other actual exchange of value is irrelevant.

The ruling then goes on to note that the parent’s equipment purchases are exempt under the resale exemption since that exemption applies to the purchase of tangible personal property for subsequent sale and/or lease/rental. Therefore, the proper way to account for these transactions is for the parent to (i) issue a resale certificate to its vendor at the time of the purchase, (ii) charge and collect sales tax from its subsidiaries for use of the equipment based on the intercompany accounting entries recorded each month to allocate costs for the use of the equipment in Virginia by the subsidiaries and (iii) remit those sales tax dollars the DOR.

When accounting for your company’s business, it is crucial to consider the potential sales tax liability that can arise from intercompany transactions. This is particularly true when analyzing more complicated transactions, such as internal restructurings, where assets and stock may be transferred among affiliates and those transactions are simply recorded by accounting entry. Aprio’s SALT team has extensive experience addressing the sales and use tax consequences of these transactions. Our experts can help forecast any potential sales and use tax exposure and recommend potential alternative structures to minimize that exposure.

Contact Denisse Beldin, SALT associate, at denisse.beldin@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the July 2016 SALT Newsletter. To view the newsletter, click here.

[1] Ruling of the Tax Commissioner, P. D. 16-84 (5/17/16).

[2] Va. Code Ann. § 58.1-602

[3] Ruling of the Tax Commissioner, P. D. 04-134 (9/16/04).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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