Virginia “Subject to Tax” Exception Applies on Post-Apportionment Basis

The “subject to tax” exception to the Virginia’s intangible addback provision applies only to the extent that royalty payments are actually taxed by another state. However, a related member did not have to pay this tax for the exception to apply.

The Supreme Court of Virginia recently considered how the “subject to tax” exception applies to royalties. The taxpayer argued that all of the royalties at issue fell under the “subject to tax” exception because they were included in the taxable income of the related member. However, the court determined that the exception applies on a post-apportionment basis. The court stated that it was not clear from the plain language of the statute whether the “subject to tax” exception applied on a pre-or post-apportionment basis. Thus, the court looked to the legislative intent behind the statute. It concluded that accepting the taxpayer’s argument would:

  • negate the addback statute’s intended operation, and
  • decrease the revenue estimated to be raised by enacting the addback statute.

Further, the court noted that the statute was enacted to close a loophole. That loophole had allowed corporations to pay royalties to a related member in a state in which its apportionment factor was insignificant. Applying the exception on a pre-apportionment basis would reopen the loophole.

The taxpayer also argued  that, to the extent the royalties were apportioned to and taxed by certain states, they fell within the “subject to tax” exception. The court agreed, holding that to the extent that the royalties were actually taxed by “Separate Return States, Combined Return States, or Addback States,” the royalties fell within the “subject to tax” exception, regardless of which entity paid the tax.

Kohl’s Department Stores, Inc. v. Virginia Department of Taxation, Virginia Supreme Court, No. 160681, August 31, 2017, ¶206-382

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All stories by: CCHTaxGroup